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REIT investors be warned, says broker

The Real estate investment trust (REIT) sector has been one of the best-performing sectors over the past few years thanks to lowering interest rates and a strong Australian economy.

Broker Morgan Stanley said to clients in a note that the Australia REIT sector doesn’t look that attractive considering the yield for 10-year bonds has increased so that the difference is now only 1.78%, meaning the yield margin is quite narrow.

Rising interest rates are likely to mean the value of property may fall in the short-to-medium-term, meaning it may not be worth to invest across the whole Australian REIT sector.

However, individual businesses such as Goodman Group (ASX: GMG), DEXUS Property Group (ASX: DXS), Stockland Corporation Ltd (ASX: SGP), Lendlease Group (ASX: LLC) and Charter Hall Group (ASX: CHC) remain attractive to Morgan Stanley.

However, whilst some property businesses may do better than others I am generally avoiding the whole sector. I do not think that most of the above options offer strong income or growth opportunities.

I do have my own favourites in the REIT sector including Rural Funds Group (ASX: RFF), Arena REIT No 1 (ASX: ARF) and National Storage REIT (ASX: NSR). I believe these three REITs are much more likely to be able to continue paying distributions if the economy were to hit a bump.

Foolish takeaway

I do fear that rising interest rates will be more damaging to some property businesses than many investors are currently thinking over the next two to three years. It depends how far the US Fed goes, if it raises its rate to near 3% or higher over the next year or two, property yields will seem less appealing.

That’s why I’d rather go for growth shares like this top ASX stock for my portfolio at this point in the cycle.

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Motley Fool contributor Tristan Harrison owns shares of ARENA REIT STAPLED and RURALFUNDS STAPLED. The Motley Fool Australia owns shares of and has recommended RURALFUNDS STAPLED. The Motley Fool Australia has recommended National Storage REIT. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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