REITs Well Positioned for Rising Interest Rate Environment

6/29/2011 | By Matthew Bechard

Concerns over a potentially rising interest rate environment have investors double-checking their asset allocations. One asset that is well positioned for such an environment, according to Morningstar, is REITs. sat down with the team from Morningstar at REITWeek 2011: NAREIT's Investor Forum to discuss the state of the real estate investment marketplace and how REITs are positioned for what lies ahead.

Philip Martin, equities strategist with Morningstar, said REITs are very well positioned from a dividend growth standpoint. "Even if we do have rising interest rates or a worst-case scenario where the economic growth is slow we believe equity REITs are pretty well positioned in that kind of environment to boost dividend yields or at the very least maintain dividends," he said.

Jason Ren, senior equity analyst with Morningstar, said REITs have also demonstrated the ability to issue long-term fixed-rate debt at attractive rates, which will give them a nice cushion to grow dividends into the future.

Todd Lukasik, senior equity analyst with Morningstar, added that many REITs are writing in rent escalators that are more directly linked to inflation as opposed to fixed rents.

Job growth continues to be an issue across the commercial real estate industry to varying degrees, as does the continued residential housing slowdown. Lukasik said there was an immediate sharp decline in office occupancy rates surrounding the Great Recession. However, things have stabilized and begun to improve and should continue on that path unless a double-dip recession occurs, he said.

Looking at the apartment market, Martin said employment has historically been one of the key drivers. Coming out of the recession, Martin said there has been a shift in the thought process surrounding homeownership versus renting.

"Despite horrible employment right now, we are seeing excellent performance from the multifamily REITs because it is a great housing option. An alternative that will persist for some time," he said. "And the REITs do an excellent job from a professionally managed housing option."

In the retail sector, Lukasik said there are still issues with consumer confidence and consumer spending that need to be resolved, and might have fundamentally changed due to the financial crisis.

Martin added that necessity-based retailers and discount retailers continue to be well positioned in this economic climate.

When asked what advice he would give an investor looking at the REIT space, Lukasik said he would point to one of the key tenants of the Morningstar philosophy, which is to buy with a margin of safety.

Long-term, Martin said he believes that equity REITs need to be part of any investment strategy. However, he would advise investors that not all companies are created equally, and investors should study the long-term growth and operating sustainability for each company.

Ren's advice would be to look at what underpins revenues.