REITs and the Latest Fed Rate Increase

This article is republished with permission from TreppTalk.

For the second time in the past four months, the Federal Reserve has upped the benchmark interest rate by a quarter point to a target range of 0.75–1.0 percent. The news of the rate hike caused government bond yields to drop, but added to gains across all three major stock indexes on Wednesday. According to a post on crowdsourced financial site Seeking Alpha, Real estate investment trusts (REITs) rallied by over 2 percent following the announcement, confirming that REIT investors should not overly fear potential interest rate increases.

The REIT market’s response to the impending March rate hike closely mirrored the response as the December rate increase approached: REITs tumbled leading up to that rate hike, dropping sharply this past October and November. Similarly, the REIT exchange-traded fund (ETF) indexes declined by 2 percent and then 4.5 percent in the two weeks leading up to the March rate hike. However, REITs immediately recovered both times, rising as soon as the rate was actually increased.

Furthermore, in the 16 periods since 1995 that experienced significant rate hikes, equity REITs generated positive returns in 12 of them, or 75 percent of the time, according to a report on the Investors Alley website. It appears that the market tends to overreact in anticipation of the rate hike, but regains buyer confidence after investors recognize that higher rates do not necessarily devalue REITs. The current growing economy supports superior business fundamentals for the sector, such as rising rent growth, occupancy levels, and cash flows.

Though the rate increase will have some negative impacts on REITs—such as reduced demand for acquisitions and higher cap rates—the fact that REITs have historically performed well after rate increases can assure investors that rate hikes reflect a healthy, growing economy, which is the core fundamental for real estate and REIT performance. This promotes a positive outlook for the year ahead because two more hikes are anticipated later this year.

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