Rising rates turn investors away from REITs

REIT representatives are questioning how they will have to change their strategies should rates suddenly soar.

By MSN Money Partner Jun 6, 2013 5:28PM

CNBCCity high-rise © Photograph by yshrsrk/Flickr/Getty Images By Diana Olick


Several years of rock-bottom interest rates, fueled by the federal government, have had investors in a desperate search for yield. That was a plus for real estate investment trusts (REITs), which are required to pay 90% of their profits out in the form of dividends to investors. The minute rates began to rise, suddenly the darlings became the duds.


At an annual industry conference in Chicago this week, rising interest rates are front and center. Representatives of more than a hundred REITs are questioning how they will have to change their strategies should rates suddenly soar.


"REITs are highly sensitive to the interest rate environment, they're effectively bond substitutes on the equity side. They are enormous users of capital," says David Toti, a REIT analyst at Cantor Fitzgerald. "A change in rates impacts their cost of capital, and it impacts their ability to acquire aggressively."


After rising steadily through much of 2012, the Morgan Stanley U.S. REIT index is down nearly 8% since the middle of May. REITs underperformed the broader markets in May after beating them handily in April. That is largely because investors were rushing into the stock market.


"The issue with rising rates is that yield-sensitive products become less attractive potentially as investors move from bonds to stocks. REITs get caught in the downdraft," says Toti, who warns that the office and industrial sectors will be hit hardest by rising rates.


Multifamily REITs, which have been under-performing their peers of late, could actually see a benefit to rising rates, if they are really indicative of a brighter economic outlook.


"We have short dated leases, and as we see an improving economy and jobs, that's just going to bring more people into our apartments," says David Neithercut, CEO of Equity Residential, the nation's largest multifamily REIT.


Investors have been shunning multifamily REITs lately, pointing to an improving housing market and worried that a wealth of new apartment supply is in the pipeline. Multifamily housing starts have jumped dramatically, with the number of units currently under construction in April up 11% from a year ago, according to the U.S. Census.


"Rising interest rates and increasing cost of new supply will help keep that supply down and will allow us to continue to increase rates on our existing residents," says Neithercut.


A subset of multifamily, the lesser-watched student housing sector, could also benefit, specifically the largest, American Campus Communities (ACC). Since it has so little competition, it benefits from a cheaper cost of capital.


"We actually have a very favorable comparison in terms of yields. The development transactions that we're undertaking typically are 7 to 7.25 yield, a nice spread to multifamily, so we tend to have more cushion in that regard," says Bill Bayless, CEO of American Campus.


For the overall REIT space, however, analysts are questioning whether this is a long term cyclical change tied to improving gross domestic product. If so, sectors with shorter-term leases, like multifamily, self-storage and health care may fare better than office or industrial, which have longer-term leases.


More from CNBC

Jun 7, 2013 7:37AM

And Dr.'s suck money out of Ill people and down on their luck = so what's your point good Dr. ?

Feeling guilty because you ordered all those unnecessary diagnostic tests? Getting kickbacks from prescribing medications or Chemical therapy to patients all the while knowing it will just kill them sooner not extend their lives as you would have them believe ?


At least the Stock Market is more honest than you guys !

Jun 7, 2013 5:43AM
Hey Dr. speak for yourself ok. I am an options investor and I work for what I can get out of the markets, with a lot of research required. It's a challenging way to grow a retirement base.
Jun 6, 2013 7:18PM

Oh, eff the Dow and all of you who want to make money without working for it.  The Dow is up.  The Dow is down.  Just like a yo-yo and it drags all of us right along with it. 


And eff the effing Global Economy while you're at it. 

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