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REITs Facing Higher Cost of Capital in 2014, Analyst Says

11/22/2013 | By Sarah Borchersen-Keto

REITs will likely face a higher cost of capital in 2014, along with the likelihood of higher interest rates, according to Paul Adornato, managing director with BMO Capital Markets.

In a video interview during REITWorld 2013: NAREIT’s Annual Convention for All Things REIT at the San Francisco Marriott Marquis, Adornato remarked that “REITs are going to have to come to grips with having a little bit less capital markets access, and by that I mean that the cost of capital is likely to rise for just about all of the REITs.”

Adornato pointed out that REITs have benefitted from a period of very low interest rates and good equity market access during the past year. In 2014, however, “we think that those REITs that are less dependent on the capital markets, that have more growth from internal sources, that is from re-leasing and redevelopment of existing properties… might have better results,” Adornato said.

The biggest surprise in the REIT sector during 2013, according to Adornato, was the volatility generated by the market’s reaction to anticipated interest rate developments.  “Of course REITs are somewhat interest rate sensitive, but not to the extent that we saw the stocks react this year,” he said.

Adornato added that “we felt perhaps there was a bit of an overreaction with respect to interest rates primarily because the REITs have done a very good job in structuring their balance sheets and taking advantage of the very low interest rate environment in order to put into place long-term fixed-rate debt.”  Adornato said that while he understands that there would be a reaction due to the fact that REITs are income vehicles, “we felt that the reaction to the tapering fears was a bit overdone.”

Meanwhile, Adornato said that in a year from now he would hope to be able to report that “REITs have done a very good job in terms of the underlying fundamentals ,” such as their  operating businesses and supply and demand,  “and that operations continued in line with expectations.”