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| 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%.
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| 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.
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