How Interest Rates Impact REIT Performance

Real Estate Investment Trusts (REITs) are a popular choice for income-focused investors, offering exposure to property markets without the need to own physical buildings. But while they’re known for steady dividends and long-term growth, REITs are highly sensitive to one key economic factor: interest rates.

Understanding the relationship between REIT and interest rates is essential for anyone navigating property-focused portfolios—especially in a climate of fluctuating borrowing costs. In this article, we’ll break down how rate movements affect REITs, what it means for property investment returns, and how to manage the associated yield impact.

REITs in Brief: What They Are and Why They Matter

Before diving into interest rates, let’s clarify what REITs are.

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. Types of REITs include:

• Equity REITs: Own and manage properties (e.g. residential, retail, office)
• Mortgage REITs (mREITs): Invest in real estate debt (e.g. mortgages, MBS)
• Hybrid REITs: Combine both equity and debt strategies

REITs are required to pay out at least 90% of taxable income as dividends, making them attractive to income-seeking investors—especially in retirement or yield-focused portfolios.

The REIT and Interest Rates Connection

At a glance, higher interest rates might seem like bad news for REITs—and often they are. But the relationship is nuanced. Here’s how interest rates impact REIT performance:

1. Cost of Capital Increases

REITs often rely on borrowing to acquire and develop properties. When rates rise, so do their financing costs.

Result:

• Higher expenses reduce profitability
• Projects become less attractive
• Dividend growth may slow

2. Investor Yield Comparisons Shift

REITs compete with bonds for yield-hungry investors. When bond yields rise, REIT dividends may look less appealing.

Result:

• Investors rotated out of REITs into “safer” fixed-income options
• REIT share prices can fall as a result

3. Discounted Cash Flow Models Adjust

Rising rates increase the discount rate in valuation models, which reduces the present value of future income.

Result:

• Valuations compress
• REITs may underperform during rate-tightening cycles

But It’s Not Always Negative

Despite the challenges, REITs can still perform well during rising-rate environments—especially when those rate hikes are driven by strong economic growth.

Why?

• Higher demand for property boosts rental income
• Inflation (often tied to rate hikes) lifts real asset values
• Short-lease sectors (like hotels and self-storage) can quickly raise rents

Historically:

• REITs have delivered positive returns during moderate rate increases
• Performance depends more on why rates are rising, not just that they are

Property Investment Returns Across REIT Sectors

Not all REITs are equally sensitive to rate changes. Different property sectors react differently based on lease structures, tenant profiles, and capital intensity.

1. Office and Industrial REITs

• Typically have longer leases
• Less frequent rent resets
• More vulnerable to rising rates due to slower revenue adjustment

2. Residential and Self-Storage REITs

• Shorter lease terms (monthly to yearly)
• Can adjust rents more rapidly
• More resilient in rising rate environments

3. Retail REITs

• Varies widely based on tenant mix (e.g. shopping centres vs. grocery-anchored)
• Moderate sensitivity depending on consumer trends and lease flexibility

4. Healthcare REITs

• Often tied to government or long-term contracts
• Less correlated with economic growth, more exposed to policy risks

5. Mortgage REITs

• Highly sensitive to interest rates and yield spreads
• Can suffer from volatility in both funding and asset income
• Tend to underperform during sharp rate shifts

Understanding your REIT exposure by sector can help you anticipate the yield impact of rate movements more accurately.

The Yield Factor: Why It Matters Most

Many investors focus on total return—but for REITs, yield is the headline attraction.

Key yield considerations:

• As rates rise, REIT prices often fall to maintain competitive yields
• Lower prices = higher dividend yields if payouts remain stable
• However, if rising rates hurt cash flows, payouts can also decline

What to watch:

• Payout ratio: Is the REIT paying out more than it earns?
• FFO growth: Funds From Operations (REIT profitability metric)
• Dividend history: Stable or growing dividends indicate resilience

Managing the yield impact is about balance: seek REITs that offer income without compromising stability.

How to Invest in REITs During Rate Volatility

If you believe rates are on the move—up or down—there are a few smart tactics to keep your REIT exposure effective.

1. Focus on Quality Over Yield

High-yield REITs can be tempting but may also be riskier. Instead, look for:

• Strong balance sheets
• Low debt-to-equity ratios
• Diverse tenant bases
• Proven management teams

2. Diversify Across Property Types

Blending residential, industrial, and retail REITs can help buffer sector-specific risks.

3. Choose Active or Smart Beta REIT ETFs

If you prefer not to pick individual REITs, consider funds that:

• Tilt toward quality or low leverage
• Actively manage sector rotation
• Adjust for interest rate sensitivity

4. Reinvest Dividends Strategically

During market dips, reinvesting dividends can boost long-term returns and help average down your cost basis.

REITs vs. Bonds During Rate Hikes

REITs and bonds both serve income investors—but behave differently when interest rates rise.

REITs may be more volatile, but they offer long-term property investment returns with built-in inflation protection and upside potential.

Final Thoughts: REITs Are Sensitive—but Still Strategic

The link between REIT and interest rates is undeniable—but not absolute. While rising rates often put downward pressure on REITs in the short term, they don’t eliminate the long-term value of real estate investing.

The key is to understand the yield impact, monitor sector-specific dynamics, and build your REIT exposure into a broader asset allocation strategy. With the right approach, REITs can continue to offer a blend of income, diversification, and growth—even when rates are on the rise.