The cautious economic outlook revealed by the Federal Reserve in its latest FOMC policy statement pleasantly surprised the real estate investment trust (REIT) industry. This is because though the apex bank eliminated its pledge to be “patient” on raising rates as expected, it pointed out the loopholes in the economy, cut its economic outlook and indicated a go-slow approach in raising rates in the future.
The Fed sounded dovish this time and suggested that economic growth has “moderated” since its previous meeting. The cut in projection of economic output and inflation has left the market wading in a pool of uncertainty. And the waters have been muddied by geopolitical issues, a struggling global economy, dollar strengthening and a dicey U.S. exports outlook.
Testifying to the volatility in the sector, a number of REIT stocks like General Growth Properties, Inc GGP, Host Hotels & Resorts, Inc. HST and Avalonbay Communities Inc. AVB turned red on Thursday, after a rise in Wednesday. Some other stocks – Simon Property Group Inc. SPG, Prologis, Inc. PLD, Public Storage PSA and Ventas Inc. VTR – managed to continue their upward ride even on Thursday.
Then again, dropping the assurance lays the groundwork for a rate hike in the months ahead. Though an April increase is “unlikely” according to the Fed, speculations are now rife about a raise in June or September.
Whenever the rate hikes take place, the REITs would feel the heat. This is because for these high yielders, a rate increase not only elevates their borrowing cost – something which they totally dependent on – but also makes their dividend yields less attractive than yields on fixed income and money market accounts.
But Would REITs Lose Ground?
Well, we believe that a rate hike backed by an improving economy would actually be a boon to the REITs. This is because an improving economy would obviously mean more economic activity, more jobs, higher consumer confidence and therefore greater purchasing power. This would perhaps lead to increased demand for space. And since supply has been slow with tepid economic recovery in the past, this increase in demand would lead to higher rents and occupancies.
After all, we cannot go back to the primitive era and live, work and dine under the sun and the moon everyday or fast forward to year 3000 and live in virtual space! So demand for real estate would always be there.
And encouragingly, the Fed cut its median funds rate forecast from 1.125% to 0.625% for the end of this year, implying that the pace of rate increase might be sluggish. This would give the REITs adequate time to adjust. Historically, REITs have a tendency of fitting with the market momentum and performing well over the long-term phase of rising rate. So if investors can gulp the short-term hiccups, the road ahead will drive up to gains.
But adjustments with the rate environment would be comparatively easier for sectors with the advantage of pricing power like hotel, storage and apartment REITs that have shorter-term leases. Long-term counterparts like certain health care REITs could on the other hand be sufferers.
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