A higher chance of a Fed rate hike has put these five dividend stocks at high-risk of a sell-off that could send their share prices down double-digits. Replace any of these popular stocks about to fall with the four Tim Plaehn recommends today that will be fine if the Fed hikes rates this year.
The Friday, September 9 stock market sell-off was especially hard on the Real Estate Investment Trust (REIT) sector. While the S&P 500 experienced an uncomfortable 2.5% one day drop, REITs, as represented by the Vanguard REIT Index Fund (NYSE: VNQ), fell by 4.0%. The declines were triggered by the expectation that the Fed will soon increase interest rates. While almost all REITs fell on Friday, the reality is that some REIT subsectors are more rate sensitive than others. You can adjust your income stock portfolio based on your expectations of what the Fed actually ends up doing with rates.
It’s important to first take a moment and discuss the current expectations of “higher interest rates”. The Federal Reserve Open Market Committee controls short-term interest rates in the U.S. by conducting open market operations to control the current Federal Funds rate, which is the interest rate banks pay to borrow short-term from each other or the Fed. The Federal Reserve dropped the Fed Funds Rate to zero to 0.25% target range in December 2008, and it stayed there until late 2015 when the Fed announced a 0.25% increase in the target range, so it now stands at 0.25% to 0.50%. The possible rate hike that scared the market so much last Friday is another 0.25% increase. That’s right, just the prospects of one-quarter of one percent increase in rates led to a 4% drop in REIT values.
It is likely that the Fed will bump rates by a quarter percent between now and the end of 2016. The last small increase was in December 2015. There is an expectation that this increase will be the start of a steady climb up to something like 3% short-term rates. I do not think this will happen as long as GDP growth remains stuck at 2% or less. If the Fed Funds Rate does go above say 1%, by the end of 2017, it is because the economy is getting much stronger than its current state. Which brings us back around to which REITs you want to own. If you think that the Fed will continue to push interest rates higher, you want to stay away from the most interest rate sensitive sectors of the REIT space. However, higher rates mean stronger economic growth so those REITs that more closely follow stock values should do well.
Net Lease and Healthcare are the two REIT sectors with returns most closely tied to interest rates. These sectors have long-term leases on their properties, and like long-term bonds when interest rates rise market values will fall. History shows that share prices in these sectors are likely to decline as interest rates rise and long-term bond prices drop. Net lease REITs typically own stand-alone properties leased by retail companies such as drug stores, convenience stores, and auto parts stores. Realty Income Corp (NYSE: O) and National Retail Properties, Inc. (NYSE: NNN) are two popular stocks in this group. Both should be able to continue their long histories of dividend growth, but share values will suffer in a rising rate environment. HCP, Inc. (NYSE: HCP), Welltower Inc. (NYSE: HCN) and Ventas, Inc. (NYSE: VTR) are the three dominant, large-cap healthcare REITs. As with the net lease REITs, these companies should be able to continue to grow their businesses, but if interest rates rise, you will see cheaper share values.
Hotel/lodging and office REITs are the two subsectors that most closely track the ups and downs of the overall stock market. The Hotel industry is very cyclical and the hotel REITs historically have had more volatile share values than the stock market averages. If the economy picks up steam, hotel REIT shares will put some nice pop into your portfolio.
However, if economic growth slows so will hotel results and investment returns. In the sector, Chatham Lodging Trust (NYSE: CLDT) offers the benefit of monthly dividends and Host Hotels & Resorts (NYSE: HST) is the only true large cap company in the sector. Office REITs have tenants that do better in a stronger economy. If a company is growing, they will need to lease more office space. Boston Properties, Inc. (NYSE: BXP) is a large cap office REIT with a long history of growth. Columbia Property Trust Inc. (NYSE: CXP) is a turn-around play as the company recycles its portfolio to focus on high-barrier-to-entry primary markets, such as San Francisco, New York, Washington D.C., and Boston.
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