With the rise of interest rates due to the decelerating federal stimulus program, real estate investment trusts (REITs) have taken a pretty big hit, according to recent reports. REITs were a boon in the world of rock bottom interest rates, but their popularity has since declined considerably. With REITs, 90 percent of profits are paid as dividends to investors. When interest rates are low, REITs are an easy bet. But as soon as rates start climbing, REITs drop out of favor, owing to their sensitivity to interest rate changes.
Fluctuating Interest Rates Drive down REITs IndexAt a recent industry conference in Chicago, real estate investors and analysts discussed the impact of fluctuating interest rates on REITs. Reporter Diana Olick from CNBC’s Realty Check column found that REITs were down by 8 percent as investors rushed out of the market into stocks. “REITs are highly sensitive to the interest rate environment, they’re effectively bond substitutes on the equity side. They are enormous users of capital,” said David Toti, an REIT analyst. “A change in rates impacts their cost of capital, and it impacts their ability to acquire aggressively.”
As high-yield investments, REITs become less attractive when rates rise, says Toti. But it’s important to note that investors and analysts are on a continual high alert for any sign that interest rates and yields will return to historically average numbers. So when there is a drop in the REIT index, industry analysts are quick to point towards rising interest rates. Of course, interest rates have risen slightly since May, hovering just over 4 percent.
There appears to be some new evidence that when interest rates are driven up, REITs take a hit. During the second quarter, REITs stocks suffered, with the iShares FTSE NAREIT Mortgage REITs Index down more than 11 percent from the index reading three months ago. One expert, however, cautioned against jumping the gun. Marty Cicco, managing director of Evercore Partners told REIT.com that investors may be jumping the gun. On the question of whether or not the Federal Reserve’s fiscal policy and rising rates have influenced REIT performance, Cicco said, “I would suggest that the last two weeks have been a knee-jerk reaction, not just within the REIT sector, but the markets broadly.”
Positive Outlook for Multi-family, Student Housing, Healthcare REITsIn other words, there can still be a positive outlook for REITs, particularly in the healthcare sector. Top-tier companies who made a lot of gains during the recession still have much to gain from REITs. Other sectors that could benefit from rising rates include multifamily and student housing development. Over the past years, multifamily REITs have been eclipsed by more successful office or industrial REITs.
For today’s rising interest rates, REITs with the most cushion would include properties that typically have short-term leasing situations - such as multi-family, student housing, or healthcare.