All the chatter around Washington these days is about Federal Reserve Chairman Ben Bernanke.
Ever since the chairman commented in both May and June that the central bank may begin tapering its bond-buying program in the fall, stock markets have fallen and pushed interest rates up.
The real estate investment trust market was particularly impacted, according to Trepp’s latest report.
For instance the FTSE NAREIT All REIT return was 5.8% in April, but falling to negative 6.56% in May and negative 2.28% in June.
So far in July, the return has measured a slight uptick of .16%, bringing the year-to-date return to 5.97%.
"The REIT market may have retreated at least partially in response to over exuberance in the first four months of 2013, but higher interest rates have also played a significant role in the pullback," explained Susan Persin of Trepp.
She continued, "Interest rates are rising, yet they remain low by historical standards, so why is there such a significant impact on REITs?"
Data suggests that REITs can perform well in higher interest rate environments.
Looking back to 2000, the 10-year Treasury rate rose steadily to an average of 6.03%, up from 5.65% in 1999 and also up 5.26% in 1998.
Additionally, total returns for residential property types were solid, posting 34.3%.
This is in comparison to the June 2013 10-year Treasury rate, which was 2.3%, up 1.8% from the same time period last year.
The direct impact of higher interest rates on REITs’ borrowing costs seems to be less of an issue than the indirect of higher rates, Trepp explained.
For instance, higher interest rates will undoubtedly impact the economy, which will affect demand for commercial real estate.
Higher rates will also make housing less affordable and could impact or altogether derail the housing recovery, Persin argued.
"Higher rates could also lead consumers to cut back on purchases ranging from autos to travel to consumer goods," Persin stated.
She added, "Declining demand for these goods and services would affect corporate expansions and their demand for all types of commercial real estate, which would hurt market fundamentals and consequently affect REITs."
Investors looking for the greatest returns can be fickle and in recent years they have poured money into REITs whose attractive dividends helped them achieve the greatest yields.
However, as higher interest rates make yields elsewhere more attractive, investors will pull back on their REIT allocations to invest elsewhere.
"The REIT market’s negative reaction to higher interest rates seems disproportionate, given the nation’s consistent economic expansion and improving real estate market fundamentals," Persin stated.
She concluded, "The greater danger appears not to be higher borrowing costs, but rather any number of factors that could derail the nation’s economic recovery and make already skittish investors more nervous."
