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Derivatives Specialist Says REITs Adapting to Fed's Tapering

05/15/2014 | By Allen Kenney

Luke Zubrod, director of risk and regulatory advisory services with Chatham Financial, joined REIT.com for a video interview during REITWise 2014: NAREIT’s Law, Accounting and Finance Conference held in Boca Raton, Fla.

Zubrod was asked about the biggest risks and opportunities available in the current derivatives marketplace. Zubrod said the “tremendously low” interest-rate environment and availability of cheap capital present the most significant opportunity at the moment. He noted that in the most recent quarter, one REIT issued five- and 10-year notes at less than 2.5 percent and 4 percent.

“That probably would have been unimaginable even a couple years ago,” Zubrod said. “That presents a real opportunity in terms of establishing a balance sheet that is filled with low-cost long-term capital.”

In terms of risks, Zubrod cited the Federal Reserve’s intention to taper off its quantitative easing policies. Zubrod referred to the new Fed philosophy as “quantitative dis-easing.”

“I think this gets at the third of three chapters of the Fed’s unwinding of its stimulus,” he said. “The first chapter will be stopping its bond purchase program, which will be ending around the end of this year. The second will be the raising of the benchmark interest rate, which is expected, based on [Fed Chairman Janet] Yellen’s comments, in the middle of next year. The third—and probably most perilous aspect of this wind down of the stimulus—is the selling back of what will then be an almost $4.5 trillion bond portfolio that the Fed has.”

Selling off that big of a portfolio will push interest rates up, he noted. That raises questions about the “competing forces and complementary forces placing pressure on interest rates,” according to Zubrod. Zubrod said some of critical issues at that juncture will include the stability of the U.S. economy, the status of the Eurozone and the health of the Chinese economy.

“These are really the sorts of questions that will put a lot of volatility into the interest-rate markets,” he said. “Bringing all of this together—the opportunities and the risks—what it counsels is using this opportunity to remove as much uncertainty from capital and interest-rate decisions or exposures in the future. Looking at the data from REITs, REITs have been workings towards this end now for a couple of years. They’ve been taking advantage of the times that we’re in.”