Editor’s Note: The following perspective was submitted by Chase Reiter ’15.
Can REITs continue their post-recession momentum? Concerns over the strength of the economic recovery and uncertainty about rising interest rates have led skeptics to believe U.S. REITs, or Real Estate Investment Trusts, may be overvalued. Despite a strong first quarter, the FTSE NAREIT All REITs Index fell by 4.7% during the month of April. After several years of strong growth since the economic downturn of 2008, investors are beginning to worry if there is still value to be tapped within the asset class.
While demand conditions in the macro economy affect the rest of the stock market, supply conditions largely affect the real estate market. In fact, every property sector nationwide, with the exception of multi-family, is still below pre-recession levels for new construction. Experts believe we are nowhere near an over-constructed real estate market, which would be a valid cause for concern. In the first quarter of 2015 alone, REITs raised over $22 billion in new capital. This may be a sign that REITs are gearing up to make new acquisitions that are likely to increase future earnings.
A worry that interest rates could go up might have also weighed on REIT stock performance in April. Rising interest rates are generally viewed poorly amongst REIT investors since they raise the cost of capital. Because real estate is very much a capital-intensive business, cheap money is necessary for REITs to continue their recent growth rates. Indeed, if the cost of capital rises, acquisitions may slow down for REITs. However, certain experts believe these concerns are misguided, arguing that higher interest rates may actually reflect healthy conditions for real estate.
During time periods in which interest rates rise, REITs have historically underperformed equities. In the time periods immediately following increased interest rates, however, growth in cash flows usually enables REITs to outperform the market. A weaker economy will generally cause interest rates to fall, and a stronger economy generally means rising interest rates. For REIT investors, rising interest rates may actually be good news, since a stronger economy means higher occupancy rates. As a result, the rent growth is higher and the value for commercial properties increases, leading to positive returns.
Looking at different segments of the REIT market – the infrastructure segment, in addition to providers of commercial mortgage financing, actually saw gains during the month of April. While the residential segment went down, it is up 3.8% for the year to April 30. Similarly, the self-storage segment is up 4.4% for the year. It is evident that even after a turbulent month, there are signs of strength for U.S. REITs moving forward.
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