If the National Association of Real Estate Investment Trusts were running for president, the group’s motto might be (a la Clinton), “It’s the economy, stupid!” Its second tagline would be, “And it’s not interest rates!”
As investors have run to REITs for yield, they’ve bolted when possible changes to interest rates made headlines earlier this year.
Economists at NAREIT, which is hosting REITWorld 2013 this week in San Francisco, say it would be good to break this cycle of behavior, since it’s self-fulfilling.
REIT returns were up 9% in the first quarter, before the talk of an end to tapering spooked investors. They fell 3.4% in Q2 and 2.4% in Q3, though they beat the S&P 500 in September.
Tapering concerns helped push REITs down 13.5% from May 22 to June 26. During that time, large-cap stocks weakened only 3.3%.
“The market reacts,” said Brad Case, head of research for the industry group, in an interview. “But usually with rising interest rates, that’s a sign of economic strengthening. If the Fed tapers, it’s because of this strengthening, which is good for REITs.”
He and other economists with Washington-based NAREIT point to 12 of 16 periods since 1995 when interest rates rose, and REIT returns improved concurrently. “Four periods is really not so much [down] time,” Case said. “And nine of these periods saw double-digit gains, which is the norm for the sector.”
Plus, the NAREIT economist says, interest rates started rising before May this year. And from July 2012 to September 2013, one period measured by NAREIT, REITs improved 2.7%. (They improved 24.4% from July 2012 to May 2013, only to drop 17.5% from May 2013 to September.)
While economist Ken Rosen described investors’ need to watch this situation at the conference, Case says, he also highlighted the strong fundamentals supporting the asset class.
The industry group says we’re really in “the third inning,” or year 6.5, of an 18-year cycle, the average length of a bull run in commercial real estate, going back to 1930.
As Case and Rosen point out, there’s rising occupancy and rent growth today. “REITs benefit from rising trade, increasing retail and more office jobs,” the NAREIT expert said.
Housing construction has been quite limited since 2008 — meaning that pent-up demand could be as high as 4 million units. “As people get jobs, we’ve seen tightness, and apartment vacancy rates are among the lowest we’ve ever seen,” said Calvin Schnure, an economist who works with Case, in an interview.
Another reason publicly traded REITs aren’t interest-rate sensitive, Case says, is that they can use equity rather than debt, which private-sector real estate investors are dependent on.
NAREIT economists also note that REIT income is not like that of bonds, since REITs pay out at least 90% of their taxable income as dividends (where were $29 billion, for instance, in 2012).
In terms of correlations, equity REITs are less than 50% correlated to the annual returns of large-cap stocks and less than 10% correlated to the annual returns of U.S. bonds.
And while Rosen argues that investors might want to wait for a shift in the market to jump into REITs, the NAREIT experts are less inclined to advocate market timing.
“REITs are pretty fairly valued over all right now in our opinion,” said Schnure. In fact, some of the highest-quality REITs are somewhat undervalued.”
Check out Look Out, Bubble Ahead (Thanks, Fed!): Real Estate Expert on ThinkAdvisor.