Can REITs Predict Interest Rate Moves?
With all the recent chatter about the Federal Reserve tapering its bond buying program, coupled with the talk about interest-rate increases, I found that several of the large REIT ETFs have been underperforming the market in recent times. Of course, REITs in general are all sensitive to interest rate moves as higher rates translate to higher borrowing costs for the REIT, thereby affecting cash flow as the “cost of doing business” goes up. But can REIT performance actually predict when and how much interest rates will change? This may be a more difficult question to answer.
Historically, REITs have performed relatively well during times of interest increases. For instance, as the savings and loan recession was ending in the early 1990s, the Fed increased interest rates by more than 2.6% in a short period of time spanning about one year from late 1993 through 1994. REITs in general kept pace with the relatively flat S&P 500 during that time but eventually lagged when interest rates hit a high of 8%. Nevertheless, rising interest rates did not impact REITs adversely for quite some time.
Another period of interest rate hikes between mid 2004 through mid 2006, although more gradual than the previous rate hike mentioned, saw REITs perform more than three times better than the S&P during the same period. While history is no predictor of future outcomes, it does offer some guidance as to the manner in which REITs behave during times of interest rate hikes. Just citing these two examples would suggest small incremental interest rate hikes to be the most favorable condition for REITs in general.
Let’s take a look at some of the larger REIT ETFs that have been showing a poor performance ever since the Fed has been suggesting raising interest rates. These large ETFs basically invest in many of the same public REITs but vary greatly in their yield and expense ratios. Some notable names in their portfolios include Simon Property Group Inc. (SPG), Public Storage (PSA), HCP, Inc. (HCP), Ventas, Inc. (VTR), Avalonbay Communities Inc. (AVB), Vornado Realty Trust (VNO) and Prologis, Inc. (PLD), to name a few. As you can see, these REIT ETFs invest in a variety of REIT businesses from storage facilities to residential structures and health care spaces.
A quick rundown of the largest REIT ETFs:
Current yield 2.97%
Expense Ratio of 0.10%
YTD return of 21.44%
Current yield 3.46%
Expense Ratio of 0.45%
YTD return of 19.98%
iShares Cohen & Steers REIT (ICF)
Current yield 2.94%
Expense Ratio of 0.35%
YTD return of 22.89%
Current yield 2.95%
Expense Ratio of 0.25%
YTD return of 21.59%
Current yield 2.25%
Expense Ratio of 0.07%
YTD return of 21.64%
First Trust S&P REIT ETF (FRI)
Current yield 2.39%
Expense Ratio of 0.50%
YTD return of 20.75%
Investors clearly have many choices when it comes to the REIT space and REIT ETFs as well. As you can see, the above-listed ETFs all experienced amazing returns YTD and all offer decent yields while you wait. As income investors, we look to ideally capture capital appreciation coupled with an income return in the form of dividend payments and these ETFs do not disappoint. Just be careful when selecting a specific ETF as expense ratios vary widely among them.
Is this the time to jump into REITs or their ETFs as the Feds’ language of suggested interest rate hikes have certainly led to recent weakness in all the above ETFs? Or perhaps more volatility and weaker prices lay ahead? One thing seems to be certain: Any near term shock the Fed may deliver to the REIT space will definitely be offset by increased economic growth as suggested in times past. So perhaps just sit on the sidelines and watch the story unfold and jump in when overall weakness has hit this sector and slowly build a position that offers a decent yield and potential future growth.
Do you own any REITs or REIT ETFs in your portfolio? How do you feel about rising interest rates affecting these investment vehicles? Please let me know below.
Disclosure: Long NONE
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