Over 10 years ago I became interested in REITs because their high yields (10-12%) were above yields on junk bonds funds (9% or less). In addition, very often a portion of REIT dividends receive favorable tax treatment. That comparison has changed. Yields on junk bond funds have returned to similar levels around 9% even though the economy is not as healthy. However yields on high yield REITs are roughly 5-6% (and less), far lower than yields on junk bond funds.
The Dow Jones REIT Index has gone through a lot in this decade. It rose, along with the markets, on higher dividends by its REITs and a more favorable evaluation of the yields. The index reached a high of 360 in early 2007. For much of 2008 and the index did not suffer badly while market averages were selling off. In September, the index fell off a cliff, losing 2/3 of its value in just 10 weeks. Then the index had a substantial recovery off the March lows in the mid 80s. It peaked at 181 in September (at half its record high) which was followed by a lethargic performance as market averages moved ahead in late 2009. REITs are back in favor this year, taking the index to an interim high of 198 (up 8% in Q1). Only one REIT filed Chapter 11, General Growth Properties (NYSE:GGP), during the financial meltdown. But even its stock is doing well, selling at an 18-month high on prospects of a strong company emerging from bankruptcy.
The sharp rebound for REITs is difficult to understand. Dividends and derived yields are important metrics for REITs. Many REITs have cut dividends to conserve money during the financial difficulties in the economy. The best had excellent track records with consecutive annual dividend increases. Now most can only brag about paying "a" dividend quarterly for many years (without annual increases).
Lower yields offered by REITs at a time of high vacancy rates and potentially higher interest rates (on mortgages) are disturbing. Low interest rates (on mortgages) have been a major factor enabling REITs to get through these tough times. Recent days have seen renewed concerns about rising interest rates on Treasuries, especially the 10-year Treasury bond (a competitive investment for mortgages). The 10-year bond rate has climbed to 3.83%. Breaking above the 4% high yield of last year could bring higher interest rates on REIT mortgages and cause REIT stocks to be sold. The danger that interest rates could rise further is real because the credit worthiness of US debt is increasingly being called into question based on a predicated stream of massive government borrowings in the future. In recent months, I have been warning about problems REITs face. Warnings flags are still flying. With the index rising to new interim highs, its speculative quality has been raised and that worries me.
Disclosure: No position