Assessing the Impact of Rising Rates on REITs

July 03, 2018

Keywords: Market News, Yield, Equity, Asset Allocation, Interest Rate Risk, Asset Management, REITs

Conventional wisdom suggests that higher interest-rate environments are typically a negative for real estate investment trusts (REITs) — but a close look at historical data paints a more complicated picture.

Yes, historically REITs have performed poorly during the initial stages of a rising-rate period, but they often have rebounded as the rate increases are known and accounted for by the market. In fact, REITs have had positive performance in 87 percent of rising-rate periods, and outperformed the S&P 500 in 53 percent of rising-rate periods.

While we haven’t had to recover from 0 percent rates before, REITs have already rebounded from early-year selloffs, rising 10 percent in the second quarter to post slight gains so far year to date. And this positive performance may continue given historical trends.

Historical Patterns

REITs must pay out at least 90 percent of their taxable income as dividends, and as a higher-yielding investment they can be expected to exhibit sensitivity to interest-rate changes. It’s true that real estate is a high-debt sector and rising rates will typically increase costs of borrowing money. However, many REITs have locked in cheaper debt costs and have the fundamental soundness to perform well even as rates are rising.

There are other important factors to consider when assessing the historical performance of these types of investments. REITs have been both positively and negatively correlated with the S&P since 2005, but these correlations vary considerably by sector and industry. For example, industrial REITs, buoyed by the boom in e-commerce and the corresponding need for warehouse space, have proven to be the least interest-rate sensitive over the past 10 years.

Typically REITs perform worse when rates rise quickly and sharply instead of at a more gradual pace. In 2017, the total returns of the FTSE Nareit All Equity REITs index rose 8.7 percent, while total returns for the S&P 500 increased 21.8 percent — but 2018 is already playing out more favorably for real estate investments. The FTSE Nareit All Equity Index outperformed the S&P 500 for the third straight month in May, rising 3.5 percent, compared with the S&P 500’s 2.4 percent increase.

Other Factors

Investors may ignore strong real estate fundamentals in a rising-rate environment and focus too closely on interest rates. Rising rates typically mean the economy is performing well, which typically leads to increased demand for real estate, rising real estate prices and increased rent revenues. Overall current consumption and confidence levels are strong, so real estate is expected to continue to do well fundamentally in this favorable macroeconomic environment.

Further, REIT’s tend to provide an inflation hedge due to their typically high long-term debt. In fact, REIT dividend growth has outpaced inflation in 18 of the past 20 years.

Rising rates warrant close monitoring for REIT investors, but barring significant economic deterioration or a bear market, investors may not see further negative impact on REITs from higher rates.

Disclosures

This material is for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer, or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expresses may change as subsequent conditions vary. The information herein is based on sources which Miles Capital believes to be reliable, but is not guaranteed to be accurate or complete.

Past performance is not a guarantee of future results. There is no guarantee that any forecasts made will come to pass. There is potential for profit or loss with any investment. Index performance is shown for illustrative purposes only — you cannot invest directly in an index. No part of this material may be reproduced in any form, or referred to in any publication without the express written permission of Miles Capital, Inc.