While real estate investment trusts (REITs) have had a rough start to the year along with the general market, these lucrative investment vehicles continue to be a great way to balance portfolios while gaining exposure to the real estate sector. Adding these incoming-producing investments can result in significant advantages over traditional real estate investing including increased liquidity, greater diversification, tax benefits and potentially higher returns with lower risk.

Real estate investment trusts either own or manage income-producing real estate, normally through directly investing in properties or the mortgages on those properties. The IRS mandates that REITs must pay out 90% of their taxable income to shareholders. This typically translates into much higher dividends than your average S&P 500 stock. One of the best ways to increase returns when investing in REITs is to compound the dividends received. Investors may also choose to utilize a Dividend Reinvestment Plan (DRIP), which automatically reinvests the dividends received into additional shares. 

Investors have the option to buy REITs directly, or may choose to further diversify by investing in REIT ETFs or mutual funds. The Vanguard Real Estate ETF (VNQ Quick QuoteVNQ - Free Report) is one example that heavily invests in REITs and boasts a Zacks ETF #1 ranking (Strong Buy). VNQ invests in a variety of REITs and has outperformed the broader market over the past year with a nearly 20% return. The Vanguard Real Estate ETF offers high potential for investment income as well as growth.

Image Source: Zacks Investment Research

REITs not only offer above-average yields, but also the potential for future price appreciation. With interest rates historically low for many years, investors have turned to vehicles like REITs when searching for ways to increase yield. But given the recent chatter surrounding more-than-anticipated future interest rate increases, a potential issue for REIT investors is their sensitivity to interest rates.

We examined six different historical periods over a 30-year timeframe in which interest rates rose as measured by the 10-year treasury yield. During these times of increasing rates, REITs generated positive returns in four of them, while outpacing the general stock market in three of the cases. Our study shows that a rising interest rate environment does not translate to lower REIT prices. This is mainly due to the fact that during economic expansions, the value of the underlying real estate increases.

Image Source: Zacks Investment Research. Other sources: S&P Dow Jones Indices LLC, Bloomberg, The Federal Reserve

While REIT prices may react in the short-term to changes in the outlook for interest rates, over longer periods there is typically a positive correlation between rising rates and REIT returns. A stronger economic backdrop normally leads to higher occupancy rates, increased NOI (net operating income), and expanding property values. All of these components lead to higher dividend payments for REIT investors.

Now that we’ve established REITs can outperform even in rising rate environments, let’s take a look at two REITs with a healthy outlook that are outperforming the broader market. These REITs are both components of the VNQ ETF we mentioned above. Both companies are part of the Zacks REIT and Equity Trust – Other industry group, which currently ranks in the top 42% out of approximately 250 industries.

Investing in stocks within leading industry groups can provide a constant ‘tailwind’ to our investing success. Also note the favorable valuation for this industry group below:

Image Source: Zacks Investment Research

EastGroup Properties, Inc. (EGP Quick QuoteEGP - Free Report)

EastGroup Properties is a domestic, self-administered REIT that acquires and operates industrial properties along the major Sunbelt markets with a primary focus on states such as Florida, Texas, Arizona, and California. EGP’s portfolio includes development projects and lease-up and under-construction acquisitions and is currently comprised of approximately 45.8 million square feet. EastGroup Properties is headquartered in Mississippi and was founded in 1969.

EGP has a remarkable track record in terms of earnings surprises, beating estimates in each quarter for the past five years running. A Zacks #2 (Buy) stock, EGP most recently reported Q4 EPS of $1.62, a +2.53% surprise over the $1.58 consensus estimate. The industrial REIT has delivered a trailing four-quarter average earnings surprise of +3.24%, helping shares advance nearly 44% in the past year.