Should Rising Interest Rates Affect REITs?

Susan Persin

By Susan Persin 
For Trepp

NEW YORK, NY -- Federal Reserve Board Chairman Ben Bernanke commented in both May and June that the Federal Reserve may begin to wind down its bond purchases in the fall.

 His remarks sent stock markets down and pushed interest rates up. The REIT market was particularly affected.

The FTSE NAREIT All REIT return was 5.8% in April, but fell to -6.56% in May and -2.28% in June. So far in July, the return has measured a slight 0.16%, bringing the year-to-date return to 5.97%.

Ben Bernanke

 The REIT market may have retreated at least partially in response to over exuberance in the first four months of 2013, but higher interest rates have also played a significant role in the pullback. Interest rates are rising, yet they remain low by historical standards, so why is there such a significant impact on REITs?

Evidence suggests that REITs can perform well in higher interest rates environments.

Looking back to the year 2000, the 10-year Treasury rate had risen steadily to an average of 6.03% from 5.65% in 1999 and 5.26% in 1998, yet total REIT returns for industrial/office (33.38%), retail (17.97%), residential (34.30%), and lodging (45.77%), and other property types were still very strong.

In its 2000 annual report, Boston Properties (BXP), which was the second largest office REIT at the time, noted that, “the Year 2000 was one of the most successful in Boston Properties’ history.” In comparison, the June 2013 10-Year Treasury rate was 2.3%, up from a 2012 average of 1.8%.

Additionally, at NAREIT’s REIT Week conference in June, representatives from a number of REITs indicated that their interest rate risk is limited because much of their financing is locked in. Many REITS have also used hedging strategies to limit interest rate risk.

The direct impact of higher interest rates on REITs’ borrowing costs seems to be less of an issue than the indirect impact of higher rates:

1)    Higher interest rates will undoubtedly affect the economy, which will impact demand for commercial real estate. Higher rates will make housing less affordable and could affect or altogether derail the housing recovery. Higher rates could also lead consumers to cut back on purchases ranging from autos to travel to consumer goods. Declining demand for these goods and services would affect corporate expansions and their demand for all types of commercial real estate, which would hurt market fundamentals and consequently affect REITs.

2)    Higher interest rates will affect the value of the real estate held by REITs. Higher borrowing costs mean that buyers aiming for a certain return will be willing to pay less for a property.

3)    Investors looking for the greatest returns can be fickle. In recent years they have poured money into REITs whose attractive dividends helped them achieve the greatest yields. As higher interest rates make yields elsewhere more attractive, investors will pull back on their REIT allocations to invest elsewhere.

The REIT market’s negative reaction to higher interest rates seems disproportionate, given the nation’s consistent economic expansion and improving real estate market fundamentals. The greater danger appears not to be higher borrowing costs, but rather any number of factors that could derail the nation’s economic recovery and make already skittish investors more nervous.

For a complete copy of the company’s news release, please contact:

Eric@greatink.com