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The Myth of REIT Interest-Rate Risk

SAN FRANCISCO (TheStreet) -- With 18 new REIT IPOs this year, including Extended Stay America (STAY) on Wednesday, it's clear to see that REITs are now a mainstream asset class. With more than $624 billion in U.S. REIT liquidity (based on market cap as of Oct. 31, 2013) investors -- small and large -- are becoming increasingly attracted to the notion of owning real estate as a means to diversify with lower risk.

So why then does the financial media and market participants assert REIT sensitivity to interest rates? After all, REITs have been punished since May 22 on Fed fears relative to the threat of rising interest rates. In other words, why would I want exposure in an asset class that is acting like a bond (today)? While attending the annual REIT World conference (in San Francisco), I caught up with Dr. Brad Case, vice president of Research with NAREIT.

Case explained: "Publicly traded equity REITs outperformed stocks and bonds for most periods in the past 20 years and have low correlations with both. But since May 2013, REITs have underperformed the stock market. The same fears about Federal Reserve tapering and interest rate increases that sparked the bear market in bonds have hit sentiment on REITs."

Case goes on to explain that REIT income is not "fixed income" and he points out that GDP growth underpins commercial real estate demand and fundamentals:

"Data show that economic growth, demand for commercial real estate and fundamentals like occupancy rates, FFO (Funds from Operations) and rental income are strongly linked to REIT performance."

It's clear that REITs are not bonds, yet Mr. Market has been valuing REIT shares without bifurcating the asset classes. Case went on to explain that REITs are "in the third inning of a long real estate cycle" - one in which Case stated has been on average an 18 year cycle. Case explained that the current cycle began in 2009 and new construction is way below average, constraining the supply of new properties.

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To further validate that argument, consider the fact that REITs own around 15% of total U.S.-based commercial real estate. With supply so low today, there is extraordinary capacity for U.S. REITs to grow and scale the nation, resulting in an ever-increasing pipeline of growth opportunities.

At a luncheon Wednesday, Robert "Bob" Cohen, co-chairman and co-CEO with Cohen & Steers, explained that "the sources of growth in capital flows are radically different. It's now a global market and the potential capital flows are massive. ... REITs are not just institutionalized but globalized."

Steers was explaining the tremendous growth in REIT products consisting of ETFs, 401K's, and mutual funds -- all driven by the insatiable demand for income and growth.

Remembering that REITs are forced by law to payout at least 90% of taxable income as dividends, and unlike other securities, REITs have a unique value proposition that results in steady and consistent dividends. Clearly REITs are not fixed income and for every $100 of dividends paid out in 1992, REITs increased to paying out $432 in dividends in 2012 -- REITs paid out a record of $29 billion in dividends in 2012.

Having a disciplined approach to investing is critically important for all investors, no matter what type of investment strategy they use. Dividend investors are no different and that's why it's important to educate yourself, develop a strategy, and stick to it.

However, at the end of the day, REITs provide one of the best and lasting forms of dividend differentiation -- a powerful model of repeatability that can enhance your investment portfolio by providing sustainable growth utilizing the power of compounding. That's how John B. Rockefeller explained his wealth and success; and he summed up:

"Do you know the only thing that gives me pleasure? To see my dividends coming in."

In my monthly newsletter I have introduced the 3D REIT Portfolio (Disciplined and Durable Dividend Portfolio). Here are a few of my stalwart REIT picks:

At the time of publication, the author was long the following REITs: O, ARCP, CSG, GPT, ROIC, STAG, UMH, CBL, VTR, HTA and DLR.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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