Sluggish economy helping REIT performance

Demand overshoots supply, supporting higher occupancy and rents

Jul 8, 2014 @ 12:50 pm

By Jeff Benjamin

The strong first half of the year for real estate investment trusts has started to raise questions about how well the category can perform if interest rates start to rise. But industry pros are calling such analysis short-sighted and wrong.

“I don't think interest-rate hikes are a big threat to REITs, and I have a very optimistic and bullish outlook for real estate in 2014 and two years beyond 2014,” said Kevin Mahn, president and chief investment officer of Hennion & Walsh Asset Management.

While the real estate industry relies heavily on debt and leverage, any negative effects from a rising-rate cycle is likely to be offset by favorable supply-and-demand fundamentals, according to Marc Halle, managing director for Prudential Real Estate Investors.

“Right now we're seeing generational lows, in terms of the amount of new (commercial construction) product being delivered to the market,” he said. “REITs offer strong income and they are a natural hedge against inflation, and it is driven by supply and demand.”

Through June 30, REIT funds, as tracked by Morningstar Inc., had a category average gain of 16.6%, which compares with 7.1% for the S&P 500 Index. That's a big swing from 2013, when the S&P gained 32% and REIT funds rose just 1.6%.

REIT funds are also currently averaging 3.7% dividend yields, nearly double the S&P's 2%.

What is working and will likely continue to work in support of the REIT space is the sluggish pace of the economic recovery, which has reduced commercial development to a slow crawl over the past six years.

The average property occupancy rate across all REIT portfolios is now measured at 93.6%, which is closing in on the prior occupancy-rate peak of 94.3% in 2007.

This represents both market demand and pricing power for property owners.

“You've already seen hotel rates go up and you're seeing rental rates go up in self-storage and multi-family housing,” Mr. Halle said. “We haven't seen construction of any type since [the start of the financial crisis], and then you add to that the fundamental reality that, with real estate, you can't just create supply overnight.”

Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ, acknowledged the supply-and-demand scenario, but attributed much of the REIT category strength this year to low interest rates.

“As we've seen rates come down a bit this year, investors are looking for alternatives with steady income streams,” he said. “It's true that demand has been strong and supply has not kept up and that's a good thing for REITs.”

Meanwhile, Mr. Rosenbluth said investors should not be overlooking the risks associated with rising interest rates.

“The supply-and-demand fundamentals can stay strong, but if the yield on the 10-year Treasury moves up to 3% (from 2.56% today), the REIT yields will be less compelling because investors will be taking on risk they're not being compensated for,” he added.

But Mr. Halle insists that rising rates need to be considered in the context of what is essentially a fragile economy.

“In a market like today, if rates are going to be rising it's because the economy is doing better and markets are generally in equilibrium,” he said. “In that kind of increased activity, rents tend to rise.”

Burland East, manager of the Altegris/AACA Real Estate Long-Short Fund (RAAAX), said he welcomes rising rates because they would represent inflation and “inflation is real estate's best friend.”

“Inflation will drive interest rates higher, but it also drives prices higher,” he said. “Right now we have almost no inflation but rents are going up between 4% and 6% a year.”

0
Comments

What do you think?

View comments

Recommended for you

Upcoming Event

May 30

Conference

Adviser Compensation & Staffing Workshop

The InvestmentNews Research team will present exclusive data and highlights from its bellwether benchmarking study that will identify best practices for setting and structuring compensation and benefits packages throughout your... Learn more

Featured video

INTV

Behind the scenes of InvestmentNews' Best Places to Work

Benefits and vacation policies are important for hiring top talent, but giving employees a sense of ownership in decision-making is among the most important qualities, editor Fred Gabriel says.

Latest news & opinion

Why we must create a more diverse and sustainable financial planning profession

CEO explains how, why a firm should commit to conscious inclusion.

Pope Francis wants financial advisers to work like fiduciaries

Vatican bulletin admonishes advisers who act against the best interests of their clients.

Wells Fargo sees slowdown in advisers exiting this year

The 2016 banking scandal and public relations fiasco had alienated some of the firm's advisers.

States trying to save DOL fiduciary rule appeal rejection of effort to intervene

California, New York, Oregon ask for rehearing by full 5th Circuit Court of Appeals.

Employees at best places to work focus on the person — and the fun

Employees at best places to work firms focus on the person and fun.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print