U.S. REITs enjoyed a strong start to 2013, but having reached the year’s midpoint, they now face challenges related to rising interest rates, according to industry analysts.
REITs were down 2.9 percent in June, according to data from the FTSE NAREIT U.S. REIT Index. REITs ended the first half with total returns of 5.8 percent, trailing the S&P 500, which had total returns of 13.8 percent for the year so far.
The performance represented a reversal from the beginning of the year, when the REIT market had total returns of 14.5 percent from January through the end of April.
“REITs were soaring for most of the first half of the year as a modest economic recovery combined with limited new construction set a solid foundation for operating fundamentals,” said Jim Sullivan, managing director and analyst at Green Street Advisors. “In addition, the capital markets have been wide open for REITs.”
As the economy starts to slowly improve, Federal Reserve Chairman Ben Bernanke indicated earlier this year that the federal government intends to pull back on its quantitative easing policies in the near future.
“Rising interest rates are a strong headwind for any capital-intensive industry such as real estate, and REITs got hit hard as interest rates moved upward,” Sullivan said.
David Toti, senior managing director with Cantor Fitzgerald, said he expects REITs will continue to have their up and downs in the next six months.
“They have found a little bit of footing since then, but are not out of the rough waters yet,” he said. “The reality is that there’s going to be the macro fixed-income commentary that will continue to whip the group and take the stage much more in the near term.”
Some Promise in Second Half
However, the outlook for REIT performance in the second half of 2013 appears to show some potential, according to market observers.
Brad Case, NAREIT’s senior vice president of research and industry information, noted that REITs still have an annualized return of more than 13 percent, “which is nothing to sneeze at, especially as returns are now averaging 17 percent per year during what has been essentially three years of uncertain macroeconomic progress.”
Sullivan said the outlook for operating fundamentals “remains decent,” with the supply-and-demand equation looking favorable for owners in most major property types. Sullivan added that the Fed’s tapering plan isn’t set in stone.
“As far as real estate values go, it’s hard to see commercial real estate prices going up while interest rates are rising,” he said. “Yet, it’s not a given that rates will continue going up, especially if the economy falters. Overall, it looks like REITs are now fairly priced and should play a role in any well-diversified investment portfolio.”
Toti said he expects that investors may begin to question what happens to REITs’ external growth strategies. He said REITs have been aggressively accruing capital, but as the cost of capital goes up, some wonder if that will slow the development pipeline.