By Jacob Sonenshine

Stocks of real-estate investment trusts have rallied. That is great news for investors, and a signal that it might not be smart to buy much more now.

The Real Estate Select Sector SPDR Fund is up 26% to about $44 from a multi-month low of $35 in late April, largely because the yield on 10-year Treasury debt has plunged. It has dropped by almost a full percentage point to 3.8% as investors correctly anticipated that the Federal Reserve would start cutting short-term interest rates in response to lower inflation.

Lower rates on safe government debt are a plus for REITs because they make their yields -- the annual dividend payment as a percentage of the price -- look more attractive.

The dividends the Real Estate Select Sector SPDR fund is expected to generate over the coming 12 months are only 3% of the price, but the payouts tend to grow as rental incomes for the companies in the fund increase over time. The companies in the fund, such as Simon Property Group, Prologis, American Tower and Crown Castle, are largely diversified away from office buildings, which are suffering from high vacancy levels.

Investors who bought the stocks back in April should hold on to them. At the time, the forward 12-month yield was 4%, but if dividends rise at the annual rate analysts expect for the next couple of years, the average annual yield for the coming decade would be about 5.1%, according to Barron's calculations based on FactSet data.

Investors who bought in April locked in that potential yield at the time. It has proven to be a good move, given that it is far better than what the Treasury market now offers. The stock-price gains were a bonus.

Those who haven't gotten in yet should hold off. Buying at the current higher price would equate to an average annual yield of about 4%, assuming the same expected dividend payments. That isn't much better than Treasuries, and not worth the risk.

Trading action for the Real Estate Select Sector SPDR fund indicates there aren't many potential buyers left -- a factor that foreshadows potential losses. The fund has been unable to crack above a multiyear high of just over $45: It touched that level in August 2022, but promptly dropped. It reached $45 a few days ago, but has dipped again.

More losses in the short term are highly plausible. In the past few days, the 10-year Treasury yield has stabilized after its long slide. If markets see the Fed's rate cut last week, and those that are expected to follow, as enough to allow continued inflation, the yield may head a bit higher. That would pressure real-estate stocks.

"A near term breather for REITS appears likely with yields stabilizing and prospectively turning higher," writes Evercore strategist Julian Emanuel.

These stocks are fine to hold onto. Buying more right now could be a mistake.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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September 24, 2024 13:17 ET (17:17 GMT)

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