Buyer Beware: Why REITs Aren’t as Safe as Bonds

Investors who replaced their bonds with REITs in 2022 were surprised. Here are some similarities and differences between the two.

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Real estate investment trusts (REITs) are often treated as bond proxies for their fixed-income like distributions. Investors like bonds for the periodic interest payments and the “guarantee” to get back the par value at maturity. They could earn price appreciation on top of interest income.

Many Canadian REITs offer decent monthly cash distributions. In fact, some even have a track record of increasing their cash distributions over time. So, when bond yields dropped to low levels, some investors turned to REITs for greater investment income.

Bonds

Like REITs, bonds aren’t created equal. Government bonds are lower risk than corporate bonds. Typically, short-term bonds are lower risk than long-term bonds, but they also usually have lower projected yields and returns.

Bonds also have different credit ratings. Generally, ones with A-grade credit ratings have a low probability of defaults. Default risk means the government or company halts interest payments or can’t pay back the par value at maturity.

On Monday, Lorne Steinberg, president at Lorne Steinberg Wealth Management stated on BNN that if investors seek high-yield bonds with yields in the 8% range, it’s important to diversify with an exchange-traded fund (ETF) that has bonds from at least 50 companies because of occasional defaults.

Bonds and REITs are both sensitive to interest rate changes

Like bonds, REITs are also sensitive to interest rate changes. By taking an educated guess on where interest rates may be headed, investors can bank on exceptional price appreciation from timing their bond or REIT purchases. At least, you could aim to avoid paying a high price for low income.

When interest rates are low, the cost of capital reduces for REITs, which potentially increase their investment returns. When interest rates fall, bond prices increase (as do REIT stock valuations). And when interest rates rise, bond prices fall (as do REIT stock valuations).

The Bank of Canada increased the policy interest rate through 2022 from 0.25% to 4.25%, dragging down the Canadian REIT industry, using iShares S&P/TSX Capped REIT Index ETF (TSX:XRE) as a proxy, by 21%.

XRE Chart

XRE data by >YCharts

Investors should be ready to bear systematic risk or market risk when investing in REITs.

Be ready for systematic risk

When investors buy REITs, they should be ready to ride through market volatility. Even if a REIT is doing well versus its peers, the stock could still be falling if interest rates rise quickly or the economy isn’t doing well. Therefore, it would be super helpful for investors to be aware of where we’re at in the economic cycle, and on top of changes to the monetary and fiscal policies.

Here’s an example. During the recent period of low interest rates, before rates started rising in 2022, stock valuations, including for REITs were pumped up to high levels. Some were even in bubble territory!

Other than low interest rates, the stock rally that occurred post-pandemic through March 2022 was also attributable to an increase in money supply from over $200 billions of dollars pumped into the economy as the COVID-19 pandemic aid, such as the Canada Emergency Response Benefit, wage subsidies, and rent subsidies. At the time, the Canadian government determined it was essential to provide financial assistance to certain industries and workers that were directly impacted by the pandemic.

The Foolish investor takeaway

REITs are similar with bonds in some ways, such as providing investment income, price appreciation prospects, and being sensitive to interest rate changes. However, REITs shouldn’t be treated as bond proxies.

REITs act more like stocks than bonds. So, investors must beware of potential bubbles or downturns in the market and aim not to overpay for REITs, which can be a complicated endeavour. Additionally, REIT’s investment income could be more favourably taxed than interest income, which are taxed at your marginal tax rate.

Quality REITs may be characterized by growing cash distributions over time, which suggests the REIT may be able to increase their rental income.

For the higher risk that investors take in REIT investments, they could potentially get higher returns over an economic cycle given that they aim to buy REITs that have quality management and assets when the stocks are undervalued.

Should you invest $1,000 in Propel right now?

Before you buy stock in Propel, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Propel wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $20,697.16!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 29 percentage points since 2013*.

See the Top Stocks * Returns as of 3/20/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Investing

Start line on the highway
Tech Stocks

Where I’d Invest $5,000 in Growth Stocks With Long-Term Potential Through 2030

DO you have $5,000 to invest to grow your wealth over the long term? These growth stocks could deliver strong…

Read more »

Asset Management
Investing

2 Canadian Value Stocks I’d Buy Now and Hold for a Lifetime

Here are two cheap Canadian stocks investors can buy and hold for outsized gains in 2025 and beyond.

Read more »

tsx today
Stock Market

TSX Today: Why Canadian Stocks Could Fall on Thursday, April 3

TSX stocks may come under pressure today as sharp commodity declines and Trump’s sweeping new tariffs spark fresh concerns over…

Read more »

A shopper makes purchases from an online store.
Tech Stocks

Buy the Dip on the Return of Recession Stocks?

If a recession comes back, there are some stocks that could fair well afterwards. And this is one of the…

Read more »

RRSP Canadian Registered Retirement Savings Plan concept
Retirement

Here’s the Average Canadian TFSA and RRSP at Age 60

Many Canadian retirees have tens of thousands invested in ETFs like the iShares S&P/TSX 60 Index Fund (TSX:XIU).

Read more »

TFSA (Tax-Free Savings Account) on wooden blocks and Canadian one hundred dollar bills.
Dividend Stocks

Here’s Exactly How a $20,000 TFSA Could Potentially Grow to $200,000

Index funds like the iShares S&P/TSX Capped Composite Index (TSX:XIC) are tax free in a TFSA.

Read more »

dividend growth for passive income
Investing

5 Canadian Growth Stocks to Buy and Hold for the Next 15 Years

These Canadian stocks have tremendous long-term growth potential, making them five of the best investments you can buy and hold…

Read more »

Man holds Canadian dollars in differing amounts
Stocks for Beginners

Cash Is King? Think Again During Today’s Market Dip

Sure, cash is great, but during a market dip investors may want to consider using some of the cash to…

Read more »