Over the course of just one year, COVID-19 changed the lives of billions of people around the world. To curb the spread of the pandemic and prevent the collapse of healthcare systems, governments imposed strict stay-at-home orders, borders were closed, business were shuttered, and 225 million people lost their jobs.

One overlooked area, though, that experienced the brunt of this health crisis was the real estate market.

According to some reports, as many as 60% of business closures due to the pandemic became permanent. In Canada, financial insecurity was exacerbated with housing prices rising in excess of 30%. With interest rates on the rise, affordability has become even less tenable.

The negative impact of COVID-19 on the commercial and residential real estate market cannot be overstated. Fast forward to 2022 and rising interest rates and surging inflation has led many investors to wonder if investing in real estate investment trusts (REITs) would be a good idea.

What Is a REIT?

Real estate investment trusts (“REITs”) allow individuals to invest in large-scale, income-producing real estate. A REIT is a company that owns and typically operates income-producing real estate or related assets.

How Does Inflation and Rising Rates Impact a REIT?

On the surface, it does make some sense why investors are concerned. After all, a REIT needs to take on more debt to build its property portfolio. Concerns of growing debt levels helps explain, in part, why the S&P/TSX REIT index is flirting with bear market territory, down 18.3% year-to-date.

But investors may have overestimated the impact rising interest rates and soaring inflation has on REITs. For staters, REITs typically include annual rent escalations into their long-term agreements with tenants. Many of which are tied to inflation. If anything, a diversified REIT can mitigate the risk of rising rates and inflation with reliable rent hikes, which translates into a consistently growing revenue stream.

REITs also tend to do well during periods of inflationary growth. That’s because inflation generally occurs during periods of economic growth, which fuels the demand for property. Higher property prices mean the value of a REIT’s underlying portfolio grows.

Why Invest in the Real Estate Sector?

During the pandemic some REITs did exceptionally well, including apartments and industrial/warehouse.

Other REITs that performed well were stand-alone retail properties that were leased to investment-grade tenants like banks, grocery stores, pharmacies, convenience stores, etc.

In addition to diversified tenants, it’s also important to consider REITs that are geographically diversified and focused on real estate opportunities in often overlooked, regionally dominant markets.

California is a global hub for technology companies and New York is a leader in the global financial sector but companies in both sectors, including Hewlett Packard and Tesla have relocated to Texas.

Goldman Sachs, meanwhile, announced it is moving part of its business to West Palm Beach, Florida from New York City. And Miami’s mayor Francis Suarez was said to be looking to entice bitcoin miners by promoting the city’s low energy prices and unlimited supply of cheap nuclear energy.

More and more businesses are moving to smaller markets with strong demographic and economic drivers to cut costs. This can come in the form of cheaper real estate, low utility prices, no state income tax, and a more favourable business environment.

When it comes to investing in real estate, it’s important to diversify your investment across various property types, geography, and tenant sub-industries, including industrial, warehouse, and residential. This defensive strategy can help insulate a portfolio from local market turbulence and from where we are in the broader economic cycle.

About Evolve ETFs

With over $2 billion in assets under management, Evolve is one of Canada’s fastest growing ETF providers since launching its first ETF in September 2017. Evolve is a leader in thematic ETFs and specializes in bringing disruptive innovation ETFs to Canadian investors. Evolve’s suite of ETFs provide investors with access to: (i) long term investment themes; (ii) index-based income strategies; and (iii) some of the world’s leading investment managers. Established by a team of industry veterans with a proven track record of success, Evolve creates investment products that make a difference.  For more information, please visit www.evolveetfs.com.

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