REITs Well-Positioned for Changing Interest Rate Environment

In the latest edition of Fundamentally Speaking, Calvin Schnure, NAREIT’s senior vice president for research and economic analysis, said REITs are in a favorable situation to thrive in the interest rate environment in 2016.

“Equity REITs cash flows are really well-positioned for the interest rate environment ahead,” Schnure said.

To shed light on today’s environment, Schnure pointed to the last time the Fed raised short-term interest rates. In 2004, the Fed began raising rates from 1 percent to 5.25 percent, yet interest expense as a share of net operating income (NOI) increased only slightly, from 32 percent to 36 percent of NOI. Interest expense as a share of NOI is currently at a record low of 24 percent, Schnure observed.

Schnure explained that because REITs mainly use long-term debt, their interest expenses are not much exposed to the coming rise in short-term interest rates. At the same time, their NOI is being bolstered by good economic momentum, resulting in rising occupancy and rents.

“This gives REITs a really solid cushion in their NOI as interest rates continue to move up,” he said.

At the same time, balance sheets are “really quite solid,” according to Schnure. REITs raised a lot of equity capital to finance acquisitions in the past several years; total equity capital as a percentage of book assets is currently 5 percentage points higher than it was at the onset of 2004, he said.

Overall, REITs have relied more on equity capital than debt to finance their acquisitions, Schnure said. As such, higher interest rates are likely not going to have an impact on either their cash flows or their total balance sheet position, he added.