Conventional wisdom has it that when interest rates rise,
real estate investment trusts and master limited
partnerships suffer. Thats in part because REITs and MLPs
compete with other fixed-income products on the basis of yield.
Another reason is that rising rates increase the cost of
capital of REITs and MLPs, both of which are generally heavy
But conventional wisdom isnt always the wisest.
Despite the fact that the Federal Reserve is poised to begin
interest rate normalization, some fund managers continue to
see the appeal in REITs and MLPs.
If you are concerned about quarterly performance,
there will continue to be volatility, but someone looking to
generate income can own something with a significant
Martin Fridson, chief investment officer of New
Yorkbased money management firm Lehmann Livian Fridson
MLPs and REITs already have seen their shares fall in
anticipation of rate hikes. The Alerian MLP index, which
consists of midcap and large-cap energy MLPs, has plummeted 16
percent so far this year, hurt also by the now year-long
slump in oil prices, and the FTSE NAREIT (National
Association of Real Estate Investment Trusts) index has slid 3
percent. As of July 30, the FTSE NAREIT All-REIT index yielded
4.15 percent, whereas the Alerian MLP index yielded 6.96
percent. Who knows what will happen when rates do go
up, says Fridson, though a lot has been discounted
Analysts concur with Fridson that with inflation under
control, theres a good chance that the yield curve will
flatten following Fed rate increases. Historically, REITs have
shown about a 60 percent correlation with interest rates. Tim
Ghriskey, CIO at Solaris Asset Management in Bedford Hills, New
York, says REITs tend to suffer going into Fed rate increases.
But once the hikes start, they do fine, as long as the
rate increases arent aggressive. As for MLPs, says
Jay Hatfield, CEO of Infrastructure Capital Management, a New
Yorkbased money management firm that specializes in
energy and real estate, the idea that rate hikes should hurt
them is something of a myth.
If the Fed raises rates, thats an indicator that
policymakers have confidence in the strength in the economy.
And that translates into stronger demand for real estate, which
would support or even push up prices, Fridson says. He
acknowledges that the retail sector of the real estate market
is weak, with some stores empty as consumers shift retail
purchasing to the Internet. Other sectors are stronger, though.
He likes REITs based on cell phone towers. With data usage
exploding on mobile phones, the towers that transmit cell
signals are sitting pretty. Fridson also favors REITs of
assisted living facilities, which stand to benefit by the
so-called silver tsunami of
baby boomers aging into retirement. In addition, both of
these REIT sectors are largely insulated from rising rates, he
Kevin Finkel, senior vice president for Resource America, a
Philadelphia-based alternative asset management firm
specializing in real estate, says properties that will be most
exposed to rising rates are ones with long-term leases, which
cant be adjusted to reflect higher interest rates.
Generally, hotels and apartments tend to have very short
leases, though, so in a rising-rate environment, they have
pricing power on their rent. Our focus now is on
multifamily apartment buildings because of the short
leases, Finkel says.
Hatfield says pension fund managers in need of
income-generating investments will be attracted to REITs.
Meanwhile, much of the MLPs decline over the past 11
months has stemmed from the plunge in oil prices, yet their
financial performance is largely immune to oil price
fluctuation. Thats particularly true of midstream oil and
gas pipeline companies, which transport those products. Some
MLPs now yield more than 9 percent, and many have recently
raised their payouts. Much of their decline stems from some
investors, particularly hedge fund managers, unloading
Their revenues arent affected by drops in oil
prices, Fridson notes. The companies have long-term
contracts for their pipelines, and even if oil and gas
companies dont use all the capacity they contract, they
still have to pay for it. That creates an opportunity
not necessarily one that will pay off next quarter
for value-oriented investors, says Fridson.
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