Rainier Trinidad Featured as a Guest Financial Panelist at the Rotary Club of Coronado
A client asked me recently what I thought about REITs now that interest rates were on the verge of rising.
It’s a good concern since traditionally, people look at REITs as extensions of the bond market: they can have long lease terms that can resemble bond cash flows, so it follows that higher interest rates will result in lower present values for those future cash flows.
One of the big differences between bonds and REITs, however, is that when interest rates rise, it tends to coincide with economic strength, and with that economic strength comes increased pricing power for REITs to adjust their leases when they roll over. This dampens the effect of rising interest rates, and when we look at in this context, it suggests REITs should do okay even when interest rates go up.
When we examine the historical performance of REITs during rising interest rates, this indeed ends up being the case. This paper written by Altegris looks at the historical evidence.
Some highlights:
In the last three rising rate environments, REITs actually had positive returns.
1993-1995: The Fed Funds rate increased from 2.9% to 6.1% during this period, and REITs including dividends gained 21%.
1999-2000: The Fed Funds rate increased from 4.6% to 6.5% during this period, and REITs including dividends gained 17%.
2004-2007: The Fed Funds rate increased from 1.0% to 5.3% during this period, and REITs including dividends gained 99%.
“Throughout the seven periods of rising rates since 1972: REIT (including dividends) share prices increased in five and declined in two. Therefore, unlike other traditional fixed income products, an increase in the Fed Funds rate will not necessarily cause falling prices. Rather, strong underlying assets, possible inflation, and increases in growth of key operating metrics drive increases in REIT prices.”
…and from the Morningstar:
“The majority of U.S. REITs have improved their balance sheets since the last downturn and appear as a group to remain more conservatively leveraged than the last boom in the mid-2000s. Moreover, upcoming maturities for many U.S. REITs over the next few years still carry interest rates that far exceed current borrowing costs, so even a 100-basis-point rise in rates from here would have a negligible impact on cash flow, at least over the medium term.”
“While we still view the potential for higher interest rates as a valuation risk for U.S. REITs, we would expect higher interest rates to have a negligible impact on our estimates of value.”
REITs have fallen 15% from their highs because of this fear of rising rates. That to me says a lot of the negative expectations may already be baked into current prices. The REIT market felt greedy in January (the weekly RSI indicator was overbought), and now it feels fearful (the weekly Slow Stochastic is oversold). Historically, fearful periods tend to be followed by above average investment returns, while greedy periods tend to be followed by below-average investment returns.
Given the historical performance for REITs when rates rose, plus its 3.74% dividend yield (symbol VNQ), it should make one less fearful of what lies ahead for REIT investors in a rising interest rate environment.
(Posted July 1, 2015)
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Rainier Trinidad, CFA
San Diego and Coronado’s Fiduciary Financial Advisor
Parabolic Asset Management
206 J Avenue
Coronado, CA 92118
rainier@parabolic.us
(619) 888-4070
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