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REITs Could Be a Smart Bet in a Higher-Rate Environment

With interest rates set to rise in the U.S., real estate investment trusts may offer a safe haven.

The investors and executives who gathered Tuesday at the Hilton Midtown Manhattan for the kickoff of the National Association of Real Estate Investment Trusts’ annual REITWeek conference were full of questions. How long until pensions are comfortable investing in data centers? What will happen if the Internal Revenue Service changes its position toward timberland as real estate? One concern that few panelists raised on day one of the conference: interest rates.

As the Federal Reserve continues to dangle a rate hike in front of investors, many industries are worried about preemptive skittishness and an overreaction once the change comes. The REIT world doesn’t appear to be one of them.

“It’s generally a good idea to be invested in REITs when rates are going up — you’re investing in what houses the macro economy of this country,” says Brad Case, senior vice president of research and industry information at NAREIT in Washington.

It seems simple enough, but Case says this logic isn’t common among a significant portion of institutional investors in real estate who treat the asset class much like the bond market. Like their bond portfolios, many institutional investors’ real estate investments see relatively little capital appreciation over time, but Case and others argue that this has more to do with investment strategy than with the nature of the asset.

Using daily data on market yields starting in 1995, NAREIT found that REITs showed positive returns in 12 of the 16 periods during which rates increased, with strongly positive returns in nine. But what about the so-called taper tantrum of 2013, when bond yields jumped and prices plummeted after then–Fed chairman Ben Bernanke said that the central bank could begin reducing its quantitative easing bond buying program later that year? That’s the most recent memory most investors have of their REIT holdings weathering an interest rate storm. By the time the taper tantrum began that May, interest rates had already been inching up, and REITs produced positive returns through the end of that month. “If you take the entire length of time when rates were going up, it was still a positive experience for REIT investors,” says Case.

Many in the REIT world believe that positive experience will likely be repeated during the upcoming hike, because the macroeconomic factors behind a rise in interest rates should be good for real estate. If the Fed feels comfortable raising rates, the logic goes, that means it’s confident in the health of the economy, and occupancy, rent and operating income growth will follow. Those metrics in turn drive up the stock prices and dividend distributions for REITS, creating an overall positive environment for their investors.

David De La Rosa, a vice president in REIT research firm Green Street Advisors’ advisory and consulting division in Newport Beach, California, agrees with Case’s assessment. “If interest rates rise, the first question to ask is, ‘Why?’” he says. “If it’s because the economy is doing better, you can raise rents.” And if the pace of rising rates is slow and steady, as expected, real estate owners can “mark to market leases along the way,” adds De La Rosa. In other words, it’s unlikely that a rate hike will be a shock to any REIT’s system.

The improving fundamentals of the REIT market speak for themselves, at least according to many of the panelists at Tuesday’s REITWeek event, who also reminded attendees of the nontraditional opportunities in the sector. Paul Pittman, executive chairman, president and CEO at Farmland Partners, a publicly traded farmland REIT, is optimistic about his sector because of growing global food demand. Though farmland REITs “[march] to the beat of a different drummer” than many others, Pittman believes institutional investors are starting to come around to the idea of investing in the niche. And the sector is particularly protected from interest rate fluctuations because food inflation tends to justify rent increases whatever the rate environment.

Sean Reilly, CEO at Lamar Advertising Co. — a Baton Rouge, Louisiana, outdoor-advertising company that became a REIT only about a year ago — is also hoping to battle some investor misconceptions: “People tend to view us as more cyclical, but I’ve got 50 years of data that shows otherwise,” Reilly said during a panel discussion.

Some experts think the misapprehension about how REITs will fare when interest rates rise is part of the larger problem around how some institutional investors approach real estate, particularly those who treat it like the bond market. But REITs have, in fact, produced substantial capital appreciation over the past 35 years, even during high-rate periods, according to NAREIT. “Real estate is an equity investment,” says Case. “If it’s done right, it should be appreciating in value.”

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