REITs in a Rising Interest Rate EnvironmentSheaff Briefs Editor
Concerned that, as soon as interest rates start moving in an upward direction, any real estate-related investments you have will be slated to take a “hit”? ’Tain’t necessarily so, according to Alfred Galli in Seeking Alpha. He concludes that “on an historical basis, there is no strong correlation between rates and prices (of real estate).”
Michael Orzano of S&P Dow Jones Indices admits there’s growing concern today about how REITs will perform “when interest rates ultimately rise from their current subdued levels.” Orzano, like Galli, agrees this is a misconception. “Although interest rates certainly affect real estate values, rising interest rates do not necessarily lead to poor returns on Real Estate Investment Trusts.”
Since the early 1970s, Orzano found, there have been six periods during which ten-year U.S. Treasury Bond yields rose significantly. How did that affect U.S. Real Estate Investment Trusts (REITs)?
- In four of those periods, U.S. REITs earned positive total returns.
- In half of those periods, U.S. REITs outperformed the S&P 500.
- In one of the periods, U.S. REITs and the S&P500 performances were identical.
- In two periods, the REITs underperformed the S&P 500.
“How can this be?” Investors are tempted to ask. After all, according to some assertions, higher interest rates:
- Decrease the value of properties
- Increase REIT borrowing costs
- Make dividend yields of REITs less attractive compared to lower-risk fixed income securities
Some “Yes, buts” are in order, Orzano explains. There are other factors associated with rising rates that positively affect REIT fundamentals.
Rising rates are frequently associated with economic growth, which is positive for real estate in terms of higher occupancy rates. Real estate owners can increase rents, which helps increase REIT dividends. In fact, the income component of REIT returns has exceeded inflation in 14 out of the past 15 years.
The conclusion? Whether interest rates are rising or falling does not seem to be the key driver of REIT performance over the medium- and long-term periods of time.