A version of this article first appeared in the CNBC Property Play newsletter with Diana Olick. Property Play covers new and emerging opportunities for real estate investors, from individuals to venture capitalists, private equity funds, family offices, institutional investors and large public companies. Register to receive future editions, go straight to your inbox.
Shares of real estate investment trusts, or REITs, have long been considered low-interest rate plays. That’s because it’s a high-dividend stock, and real estate values generally rise when rates fall. But some experts are making the case that current real estate fundamentals outweigh rising rates.
The correlation between REIT returns and changes in 10-year Treasury yields has changed over time, according to a new report from Cohen & Steers, which notes that the level or direction of rates alone is not a reliable predictor of REIT performance.
Higher interest rates are sure to hurt the commercial real estate sector from 2022 to 2024, as higher borrowing costs reduce asset values. There has also been a lot of new supply in some sectors, which has led to lower rents and cash flow growth. Higher rates make it difficult for new developments, but this is what helps the sector in the current rising rate environment.
“It’s definitely 100 basis points last year in 10 years [Treasury] is an impingement to the cost of debt and also means that every other asset class now has to compete with higher yields,” said Seth Laughlin, head of real estate strategy and research at Cohen & Steers.
“So you have to get better results from your alternatives, and real estate is definitely in that category. But at the same time, what we see is an acceleration of income up to 9% this year. It will be like next year. Let’s call it an 8% profit growth,” he added.
As new supply peaks, cash flow growth is improving and valuations are outperforming equities, according to Laughlin.
In fact, REITs for interest rate correlation are now at their lowest levels in about four years, according to David Auerbach, chief investment officer, Hoya Capital Real Estate. He noted that fundamentals are healthier than headlines, and 58 of the 98 REITs that provided full-year guidance improved their outlook.
“With the exception of Data Centers, REIT development pipelines are approximately 40% below the 2022 peak and 2019 levels; Data Centers remain the exception at seven times the 2019 level,” Auerbach wrote in a report titled “The Rate Shock That Didn’t Break REITs.”
“Solid fundamentals are growing, with healthy property-level cash flow, increased earnings visibility, strong dividend coverage, and an improved balance sheet helping REITs absorb rate shocks,” he said.
Annual REIT returns are over 6% according to the FTSE NAREIT All REIT Index. However, certain sectors saw greater gains. Hotels and lodging, data centers and senior housing lead with double-digit returns.
Multifamily apartment REITs are still in negative territory, as the sector continues to run through a period of oversupply and weaker rents. However, the demand for multifamily will grow along with interest rates, simply because fewer people can afford to buy a home.
Other sectors such as industry, regional malls, and even offices achieved positive results, although interest rates were higher.
“Basically, under the hood, the economy is really healthy, and I think about REITs as landlords for the broader economy,” Laughlin said.