08/05/2013 | by
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U.S. equity REIT stocks were up 6.7 percent for the year through the end of July, but it marked the third consecutive month in which REITs trailed the broader market. Analysts say a rise in interest rates is the likely culprit.

Data from the FTSE NAREIT U.S. REIT Index showed that U.S. equity REITs posted total returns of of 0.83 percent in July. The S&P 500 was up 5.09 percent for the month, and the NASDAQ Composite returned 6.56 percent for the month.

“What I think is most important about the stock performance over the last couple of months is that the market is obviously very focused on the move in interest rates, and it’s having an impact on the sector,” said Anthony Paolone, an analyst with J.P. Morgan. “You’ll have a lot of generalist investors who are not going to have a good feeling about commercial real estate and deploying capital into REIT stocks – for right or wrong – if they feel that interest rates are going higher over the near term.”

Ross Smotrich, a REIT analyst with Barclays, said the underperformance of REITs reflects a trend he’s noticed throughout the year, which is that REIT stocks are moving in correlation with fluctuations in the 10-year bond market.

Brad Case, NAREIT’s senior vice president of research and industry information, also said recent increases in interest rates have had an impact on the REIT market because of how some investors view commercial real estate.

“We’ve seen some discussion that kind of treats commercial property just like bonds,” he said. “If interest rates go up, the value of a bond will fall. But that’s because a bond is a fixed-income instrument. Commercial property is not.”

However, Case said the stock market may be reacting “inappropriately” to the Federal Reserve’s hints about raising interest rates and “not fully appreciating the history of REIT returns during the period when the economy is strengthening.”

Case said it’s important for investors to realize that rising interest rates don’t necessarily mean that the economy is overheating.

“Generally speaking, when interest rates are going up, it’s because the economy’s strengthening, and that’s certainly what we’re seeing now,” he said. “In the mid-1990s and the early part of the last decade, what we’ve seen is that REIT returns have been very strong during those periods where interest rates were rising because the economy is strengthening.”

Lodging a Top Performer

The lodging sector posted total returns of 5.56 percent for the month, and the self-storage sector posted gains of 3.40 percent, according to the FTSE NAREIT U.S. REIT Index. Smotrich said sectors with shorter lease durations tend to perform better when interest rates are rising. These sectors can better protect themselves against inflation, he said.

“Meanwhile the longer-duration assets, health care and net-lease, have been underperforming,” he said.