Interest Rates, REITs, and Brexit

This article is republished with permission from REITCafe.

Even as the broader equity markets fell, real estate investment trusts (REITs) posted positive returns last week as economic uncertainty once again took center stage. The Federal Reserve Board’s decision not to raise interest rates this month was good news for REITs in terms of keeping their cost of capital low, but also reflected some weak economic news that could mean economic growth is faltering. The Fed noted that it plans to raise interest rates more slowly than previously suggested. Some investors now believe the Fed will raise rates only once this year instead of the two increases that had been expected.

The British vote June 23 on whether to exit the European Union, which played a role in the Fed’s interest rate decision, is also contributing to broader market volatility. Polls suggest that the Brexit vote will be close. A U.K. decision to leave could affect the U.S. economy. If voters approve an exit, the United Kingdom, European Union, and United States will need to renegotiate trade agreements and treaties. Those negotiations would take time, so while the vote is already causing short-term disruption, the real impact more likely would be longer term.

In this period of uncertainty, REITs are attractive for investors because of their high yields and minimal Brexit-related risk. If the referendum passes, some businesses could relocate jobs. The biggest impact could be on office space, but would likely not impact US office REITs as few hold European offices. Health care and self-storage REITs, such as Welltower, HCP, and Public Storage, have significant U.K. investments, but these are population-serving sectors so a vote to exit the European Union would have minimal, if any, impact there.

For many U.S. REITs, U.K. investments represent a very small part of their portfolios. Industrial REIT Prologis owns 93 buildings in the United Kingdom totaling 22.6 million square feet (2.1 million sq m) that represent 2.6 percent of its portfolio. The properties are 98.8 percent leased. Simon Property Group, a regional mall REIT, owns 45 percent of one mall in the United Kingdom.

The longer-term impact of the Brexit on U.S. real estate markets would be determined by what happens in the broader economy. A loss of U.S. jobs or a drop in consumer spending would slow the economy and could cause real estate market fundamentals to weaken.

A vote to leave the European Union would support a nationalistic trend at the expense of free trade, which could soften support elsewhere in the world for increased global economic integration, which in turn could affect U.S. trade in other parts of the world.

If the Brexit referendum passes and U.S. equity markets, including REITs, fall as a result, a short-term, opportunistic REIT buying opportunity could emerge. However, over the longer term, a U.K. exit from would be unlikely to have a notable direct impact on U.S. real estate or REITs.

* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.

** - 10 yr. Treasury Yield as of 6/17/2016.