One of the common quote by Peter Lynch is:

“Behind every stock (symbol) is a company. Find out what it's doing.”

Similarly, a REIT  is no different, it is usually is a company that owns income generating real estate (hence the term “Real Estate Investment Trust'), as it generates income through renting out (and occassional buying and selling of properties) and distributes the rental income directly to the REIT holder on a regular basis.

Appended below shows, how REITs work:

Structure of REITs

The purpose of this article is to compare the pros and the cons of investing in REITs vs common stocks and factors that affect the performamce of REITs.

And to do that, what's better than a table..?

 

REITs

Common Stocks

Mode of Transaction

Stock Exchange

Stock Exchange

Issuance of Rights

Yes

Yes

Volatility

Less

More

Scope

Restricted to Real Estate

Wide Ranging

Dividend

Consistent

Depends

Risk Level*

Lesser

More

Note:  

  • - Lower risk is not to be perceived as No Risk.

Factors Affecting REITs

*  Quality and Characteristics of the Assets (Sector, Asset Size & Age, Geographical).

*  Interest Rate, Gearing, Currency Exchange and Re-Financing Needs.

*  Tenant Mix and Quality, Types and Length of Leases.

*  Dividend Policies, Management Fees.

*  Other Factors: Natural Calamity (eg. Earthquake).

All else being equal, on a broad picture basis, for investors who are in the market long enough, he would have noticed the influence of interest rate on the price movement of REITs, and this, shall be the focus of discussion in the next few paragraphs.

According to Wikipedia: “Economic climates characterized by rising interest rates have a detrimental effect on REIT shares. The dividends paid by REITs look less attractive when compared to bonds that have increasing coupon rates. Also, when investors shy away from REITs, it makes it difficult for management to raise additional funds to acquire more property.”.

For the seasoned (REIT) investor, he would know that REIT's share price is affected by interest rate changes. Why is this so? REIT, being a high yield instrucment and has a reasonably high gearing ratio (between 25% to 45%, a good portion of which are 30% and above for S-REITs [Singapore Listed REITs]), it is reasonable to expect that REIT prices fluctuate according to interest rate changes.

I quote:

“On May 22, 2013, then Federal Reserve Chairman Ben Bernanke merely suggested to Congress that the Fed might begin in the near future to taper its program of quantitative easing. At the time, economies around the world were gaining their footing; raising rates after such a long period of holding them at artificially low levels seemed only natural.

The reaction in the U.S. REIT market was swift.

The total returns of the FTSE NAREIT All REITs Index fell sharply, ending the month down 6.6 percent. In the next three months, the index lost another 8.5 percent.”.

~ Source: REIT .com

In such a situation, depending on your entry price and trade plan (if you are just trading, that's when risk management can come into play). However, in the same article that mentioned the above, it also described:

“The knee-jerk reaction to sell REITs on the prospects of rising interest rates flies in the face of some long-term data that suggest that REITs can—and have—performed quite well in rising interest rate environments,” notes T. Ritson Ferguson, CEO and co-CIO of CBRE Clarion Securities.

Which makes perfect sense to me. i.e. Market being quite sentimentally driven at times, could and would react, on a short term basis, to an increase in interest rate and hence drive down the price of REITs. However, when FED reduce interest rate, one of the basis that FED based on is the underlying strength of the economy (and would often than not, delay doing so, if and when the overall US / Global economies are still showing weakness).

Under scenarios whereby FED's assessment of the economic strength of US / Global is good, and went ahead to increase the interest rate, and that the assessment is correct – meaning the economy in the months ahead indeed performed well, i.e. There's business activities and job growth, such activities will translate into demand for commercial real estates, which in turn translate into upward rental revisions for various REITs sectors, meaning improved earnings, hence increase the DPU (distribution per unit, i.e. Dividend payable to unit holders of REITs).

In conclusion, like common stocks, while the capital invested in REITs is not protected, it is underpinned by physical real assets, with generally more predictable income streams and is a tax efficient vehicle.

Also, while REITs in general are affected by interest rate fluctuation in the near term, in the mid to longer term, the underlying performance of the economy play a significant role in how the DPU and the capital growth of REITs.

Useful resources:

REITSWEEK.COM — News & Data on REITs and Real Estates