Real estate has long been viewed as a core component of diversified portfolios, offering potential benefits such as income potential, inflation protection, and exposure to tangible assets. But just like equities or fixed income, real estate — and Real Estate Investment Trusts in particular — respond differently to various phases of the market cycle.
So, how do REITs behave as economic and interest rate conditions change, and what role can they play in navigating volatility?
Real Estate Exposure Through REITs
REITs are publicly traded vehicles that own, operate, or finance income-producing properties such as office buildings, apartment complexes, industrial warehouses, or retail centres. Some specialized REITs focus on healthcare, data infrastructure, or hospitality.
Because REITs are required to distribute most of their taxable income — at least 90% — to unitholders, they are typically considered an income-generating asset class. These distributions, along with potential for long-term capital appreciation, make REITs a hybrid between equities and fixed income in many portfolios.
Sensitivity to Interest Rates and Growth
REIT valuations are closely tied to interest rate and economic cycles. When interest rates rise, REITs often face short-term pressure as higher yields on bonds and Guaranteed Investment Certificates (GICs) tend to compete for investor attention. Borrowing costs for property acquisitions or refinancing may also increase, which can reduce profit margins.
Conversely, when the Bank of Canada lowers rates to stimulate economic growth, REITs typically benefit from lower financing and refinancing costs, higher investor demand for income-generating assets and improved property valuations as cap rates compress.
Historically, REITs have shown stronger performance during late-recession or early-recovery phases, when rates begin to stabilize and economic activity starts to reaccelerate.
Real Estate’s Relationship with Inflation
Periods of moderate inflation can be constructive for real estate. As construction and replacement costs rise, property values often adjust higher. In many cases, REITs can pass increased costs onto tenants through rent escalations, helping to preserve real returns.
However, persistent or unexpected inflation may prompt more aggressive rate hikes from the Bank of Canada, which can weigh on valuations. In such periods, REITs with longer lease terms or higher leverage may be more vulnerable to repricing pressures.
Performance Across Market Phases
Different real estate sectors tend to perform differently depending on where the economy is in its cycle:
- Expansion: As economic activity accelerates and demand strengthens across commercial and residential markets, industrial and residential REITs often capture the strongest growth momentum, tending to benefit from rising occupancy rates and rental income.
- Peak: As the market approaches its peak, prudent investors tend to prioritize REITs backed by strong balance sheets and dependable cash flows, positioning defensively ahead of potential volatility.
- Contraction: During periods of economic contraction, investors often rotate into defensive sectors like residential and healthcare REITs, which tend to benefit from consistent occupancy and essential-service demand.
- Recovery: During recovery phases, falling interest rates and improving economic conditions can create attractive opportunities across diversified REITs.
This cyclical variation underscores the importance of sector diversification within REIT holdings, or through broad-based REIT ETFs.
Important Considerations and Limitations
REITs, like all publicly traded securities, are subject to market volatility. Factors such as interest rate fluctuations, tenant or sector concentration risk, regulatory changes and broader macroeconomic shifts can all influence REIT performance.
Additionally, publicly traded REITs may experience more pronounced price swings than private real estate holdings because their share prices respond to market sentiment and trading activity, even though the underlying property values typically change only gradually.
How Well Do REITs Hold Up Through Cycles?
Over multiple market cycles, REITs have shown their value as both an income and diversification tool. Their ability to generate steady cash flow, offer inflation-sensitive characteristics, and provide access to real assets makes them a credible component in a long-term strategy.
That said, performance can vary significantly by sector, leverage structure, and timing within the market cycle. Investors should evaluate REIT exposure in the context of broader portfolio objectives, income needs, and risk tolerance.
If you’re looking to explore diversified REIT investments or assess how REITs fit within your broader asset mix, Qtrade’s Portfolio Analytics and ETF Screener can help identify suitable REITs and ETFs.