This article is republished with permission from REITCafe.
Last week, the Federal Reserve raised its target funds interest rate by 25 basis points to 0.50 percent—the first increase since 2006. The rate had been near zero since late 2008. The Fed board believes that the U.S. economy is in respectable shape and can withstand the impact of higher interest rates. The confidence expressed by the Fed, coupled with the market’s relief regarding the size of the rate increase, caused stocks to move higher on Wednesday, with real estate investment trusts (REITs) gaining 2.01 percent for the day.
Residential mortgage REITs gained 3.37 percent Wednesday on the belief that higher interest rates will benefit the sector. After the announcement, banks began to raise mortgage rates, which would benefit these REITs because they profit on the spread between short- and long-term rates.
The manufactured-homes sector also posted notably strong gains, totaling 2.41 percent on Wednesday. Traditional homes become less affordable when interest rates rise, increasing demand for the less-expensive manufactured housing.
Other REIT sectors had an unlikely response to the higher rates. Bond-like freestanding retail REIT investors stand to lose with higher interest rates because the REITs’ income levels do not increase with higher rates. Despite the prospect of stagnated income, the retail sector gained 2.49 percent on Wednesday.
Timber REITs rely on homebuilding, which could slow as rates rise and homeownership becomes less affordable. But instead of losing value on Wednesday, timber REITs gained 2.37 percent. The increase could mean investors are reacting positively to Fed Chair Janet Yellen stating that the Fed’s goal is to raise rates gradually. A gradual increase in rates could help the sector reach its long-term average by the end of 2018. Investors may also view the Fed’s positive outlook on the economy as a herald of good news for homebuilding.
In her comments Wednesday, Yellen noted that the U.S. economy has shown strength and resilience in spite of ongoing global risk, but that room for improvement exists. The workforce participation rate is below trend, and wage growth has yet to show sustained growth. The Fed is targeting 2 percent inflation, and a federal funds rate of 1.5 percent in late 2016 and 2.5 percent in late 2017. By late 2018, rates should return to normal long-term levels. However, the Fed will monitor financial developments and make changes if needed.
* 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 12/11/2015.
