When Do REITs Underperform?

Real Estate Investment Trusts (REITs) are typically known for their steady income generation and diversification benefits. However, there are specific conditions when REITs can decline, leaving investors vulnerable to lower returns. Let’s get into the details to understand when do REITs underperform.

Will REITs Crash?

Like other investment products, there are certain risks associated with REITs as well. 

There are certain conditions when REITs can underperform, like particular market and economic conditions, but understanding these triggers can help investors avoid major losses.

1. When Interest Rates Are High

REITs tend to underperform when REIT interest rates in India are high. 

This happens because:

• Borrowing costs increase for REITs, which in turn affects their profitability and growth potential.
• Investors tend to shift toward safer, income-generating investments, such as bonds, when interest rates rise, resulting in reduced demand for REITs.

In 2022, when the RBI increased interest rates, REITs in India experienced slower growth in their unit prices as investors sought higher returns from government bonds or fixed deposits, both of which became more attractive with rising rates.

2. During Economic Slowdowns or Recessions

During a recession, REITs can struggle for several reasons:

• During a downturn, businesses may reduce their office space requirements or delay expansions, leading to lower occupancy rates and potential rent reductions.
• A slowdown increases the risk of tenants defaulting on rent payments, affecting REIT dividends.

During the 2008 global financial crisis, REITs worldwide, including those in India, experienced a steep decline in their market value due to economic contraction and higher vacancy rates in commercial properties.

3. When Property Values Decline

REITs are highly sensitive to changes in property values. 

When the value of the underlying real estate assets falls, REITs may:

• Suffer from reduced asset values.
• Provide lower capital appreciation for investors.

In 2020, as the pandemic led to widespread uncertainty in property markets, REITs like Nexus Select Trust, which focuses on retail properties, saw significant depreciation in asset value due to the declining demand for commercial retail spaces.

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Are REITs Profitable?

REITs can appreciate, but the growth is generally tied to the performance of the underlying real estate assets:

• Capital Appreciation: If the real estate market is strong and property values rise, REITs generally experience higher NAV and unit price growth.
• Rental Income: Consistent rental income from high-quality tenants helps support long-term appreciation.

One practical example can be of Embassy Office Parks REIT. 

Despite facing market fluctuations, it has shown consistent NAV appreciation over the years due to substantial rental income from major tenants like Microsoft and Google, which ensures stability and growth.

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If you are interested in investing in REITs in India, then begin your journey now. To start, begin the process of opening a Demat account with a reliable stockbroker.

Still confused about choosing the right stockbroker? Fill in your details in the form below:

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Conclusion

REITs can be a great way to generate income and diversify your portfolio, but like any investment, they come with certain risks. Understanding when REITs underperform can help investors make informed decisions.

REITs perform best during periods of economic stability, low-interest rates, and strong real estate market conditions. Keep an eye on macroeconomic factors and property market trends before making your move.

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FAQs

Q1. Do REITs do well when interest rates fall in India?

Yes, REITs tend to perform better when interest rates fall due to reduced borrowing costs and their increased attractiveness compared to traditional debt investments.

Q2. Are REITs recession-proof investments?

No, REITs are not recession-proof. They can suffer from lower demand for commercial space and tenant defaults during economic slowdowns or recessions.

Q3.When should I consider buying REITs for long-term growth?

The best time to buy REITs is when interest rates are low and the real estate market is experiencing growth. During market corrections, REITs with strong tenant portfolios can also be an attractive buy.