REITs Lose Ground In First Half on Interest Rate Concerns

7/8/2015 | By Sarah Borchersen-Keto

REITs Lose Ground In First Half on Interest Rate Concerns

REIT returns lost ground in the first half of 2015, in part over expectations of the potential market impact of rising interest rates.

For the year to July 6, total returns from the FTSE/NAREIT All REIT Index declined 3.2 percent. The S&P 500 was up 1.5 percent during the same period. The yield on the 10-year Treasury note gained 0.1 percent during that time.

“REITs remain very attractive from an earnings profile and balance sheet perspective but with market angst over the timing of Federal Reserve action, it is hard to see the group getting traction until that occurs,” said Alexander Goldfarb, managing director at Sandler O’Neil & Partners.

Todd Lukasik, senior analyst at Morningstar, said REIT prices are likely to move inversely with changes in long-term government bond yields. While the potential negative impact of rising interest rates remains a key concern for some REIT investors, Lukasik pointed to other factors investors should consider.

According to Lukasik, the majority of U.S. REITs have improved their balance sheets since the last downturn and appear as a group to be more conservatively leveraged than they were at the time of the last boom in the mid-2000’s.

Moreover, “upcoming maturities for many U.S. REITs over the next few years still carry interest rates that far exceed current borrowing costs, so even a 100-basis point rise from here would have a negligible impact on cash flow, at least over the medium term,” Lukasik stated.

Goldfarb emphasized that real estate remains attractive to direct investors, noting that despite the increase in the 10-Year Treasury yield, cap rates have stayed flat or even trended down in some cases.

Meanwhile, Lukasik said that higher interest rates are likely to have a negligible impact on Morningstar’s value estimates for U.S. REITs.

Andrew McCulloch, managing director and head of real estate analytics at Green Street Advisors, noted that “huge” pent-up demand from large institutional investors and an accommodative debt market may still push commercial real estate values higher, “but growth looks poised to slow.”