03-07-2013, 10:50 PM
Rising rates could derail US real estate recovery
BY:A.D. PRUITT From: The Australian July 04, 2013 12:00AM
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REAL estate investment trust stocks in the US have had their worst quarter in nearly two years, as investors worry that rising interest rates could derail the commercial real estate recovery.
The big question now is: what's next?
If rates climb even higher, US REITs will have to pay more to borrow money, and their dividends will look less attractive to investors compared with the other high-yielding investments.
But some analysts believe that REIT investors may have overreacted to rising interest rates by dumping the stocks.
Indeed, they point out, since June 24, REITs have outperformed the broader market as investors have returned to the sector.
Most analysts still believe REITs will return 11 to 15 per cent this year, including dividends and stock gains, because the economy will keep expanding, though not fast enough to trigger a spike in interest rates.
"We still think the REITs are attractive in that environment," said Jeung Hyun, a portfolio manager at Adelante Capital Management.
The Dow Jones Equity All REIT Index, which tracks 141 real estate investment trusts, delivered a total return, including dividends, of negative 2 per cent for the second quarter.
That was the weakest performance since the third quarter of 2011 and marked a staggering about-face from the first quarter of this year, when REITs posted a gain of 7.9 per cent.
Analysts said REITs were set on a downward spiral in mid-May after Federal Reserve chairman Ben Bernanke signalled that the US central bank would phase out its quantitative easing program as early as the end of this year.
"It was a quarter for soul searching among REIT investors as the Fed comments filtered through the market," said Paul Adornato, an analyst at BMO Capital Markets.
He said investors were scrutinising individual companies very closely to determine which ones should continue to prosper even if interest rates rose. "Now is the time when investors really need to pay attention to operating fundamentals," he said.
Conditions improved, though, in recent days. The sector has outperformed broader equities since June 24, rising 5.8 per cent as the rate panic started to subside. The broader market rose 2.68 per cent during that same period, as measured by the Standard & Poor's 500.
REITs, which pay out hefty dividends, have been especially attractive to small investors because they typically carry higher yields than other types of investments. The average REIT dividend yield is about 3.4 per cent, according the Dow Jones REIT index, compared with an average of 2 per cent for the stocks that make up the S&P 500.
Low interest rates allowed commercial landlords to raise cheap capital to repay debt, pad war chests for acquisitions and, in a few cases, develop new properties, which boosted earnings. That could reverse if interest rates rise too high.
"Investors' greatest fear is that borrowing costs will rise so significantly in the near term that it would cause a serious dent in REIT earnings," said Jay Leupp, a managing director at Lazard Asset Management, of the rate concerns.
Nearly all REIT categories posted negative results in the second quarter, but mortgage REITs, which use short-term debt to buy longer-term mortgage securities, were pummelled with a total return of negative 18 per cent.
Mortgage REITs are at the greatest risk if interest rates rise because that would increase their short-term borrowing costs and cut the value of their mortgage-bond holdings, possibly resulting in losses and reduced dividends.
"A lot of the concern in the quarter was for the book values" of mortgage REITs, said Jason Arnold, an analyst at RBC Capital Markets. He added that despite the spike in longer-term rates in recent weeks, mortgage REITs remained profitable because short-term rates were still low.
Multi-family and self-storage landlords were the only main sectors that posted gains, in part because investors assume they are best-positioned to produce rent growth even in an environment of rising interest rates.
Multi-family REITs delivered a total return of 3.5 per cent in the second quarter, while self-storage posted a 2.34 per cent return.
Other sectors posting declines include healthcare REITs and strip mall companies.
Office REITs edged down 0.91 per cent.
BY:A.D. PRUITT From: The Australian July 04, 2013 12:00AM
Increase Text Size
Decrease Text Size
REAL estate investment trust stocks in the US have had their worst quarter in nearly two years, as investors worry that rising interest rates could derail the commercial real estate recovery.
The big question now is: what's next?
If rates climb even higher, US REITs will have to pay more to borrow money, and their dividends will look less attractive to investors compared with the other high-yielding investments.
But some analysts believe that REIT investors may have overreacted to rising interest rates by dumping the stocks.
Indeed, they point out, since June 24, REITs have outperformed the broader market as investors have returned to the sector.
Most analysts still believe REITs will return 11 to 15 per cent this year, including dividends and stock gains, because the economy will keep expanding, though not fast enough to trigger a spike in interest rates.
"We still think the REITs are attractive in that environment," said Jeung Hyun, a portfolio manager at Adelante Capital Management.
The Dow Jones Equity All REIT Index, which tracks 141 real estate investment trusts, delivered a total return, including dividends, of negative 2 per cent for the second quarter.
That was the weakest performance since the third quarter of 2011 and marked a staggering about-face from the first quarter of this year, when REITs posted a gain of 7.9 per cent.
Analysts said REITs were set on a downward spiral in mid-May after Federal Reserve chairman Ben Bernanke signalled that the US central bank would phase out its quantitative easing program as early as the end of this year.
"It was a quarter for soul searching among REIT investors as the Fed comments filtered through the market," said Paul Adornato, an analyst at BMO Capital Markets.
He said investors were scrutinising individual companies very closely to determine which ones should continue to prosper even if interest rates rose. "Now is the time when investors really need to pay attention to operating fundamentals," he said.
Conditions improved, though, in recent days. The sector has outperformed broader equities since June 24, rising 5.8 per cent as the rate panic started to subside. The broader market rose 2.68 per cent during that same period, as measured by the Standard & Poor's 500.
REITs, which pay out hefty dividends, have been especially attractive to small investors because they typically carry higher yields than other types of investments. The average REIT dividend yield is about 3.4 per cent, according the Dow Jones REIT index, compared with an average of 2 per cent for the stocks that make up the S&P 500.
Low interest rates allowed commercial landlords to raise cheap capital to repay debt, pad war chests for acquisitions and, in a few cases, develop new properties, which boosted earnings. That could reverse if interest rates rise too high.
"Investors' greatest fear is that borrowing costs will rise so significantly in the near term that it would cause a serious dent in REIT earnings," said Jay Leupp, a managing director at Lazard Asset Management, of the rate concerns.
Nearly all REIT categories posted negative results in the second quarter, but mortgage REITs, which use short-term debt to buy longer-term mortgage securities, were pummelled with a total return of negative 18 per cent.
Mortgage REITs are at the greatest risk if interest rates rise because that would increase their short-term borrowing costs and cut the value of their mortgage-bond holdings, possibly resulting in losses and reduced dividends.
"A lot of the concern in the quarter was for the book values" of mortgage REITs, said Jason Arnold, an analyst at RBC Capital Markets. He added that despite the spike in longer-term rates in recent weeks, mortgage REITs remained profitable because short-term rates were still low.
Multi-family and self-storage landlords were the only main sectors that posted gains, in part because investors assume they are best-positioned to produce rent growth even in an environment of rising interest rates.
Multi-family REITs delivered a total return of 3.5 per cent in the second quarter, while self-storage posted a 2.34 per cent return.
Other sectors posting declines include healthcare REITs and strip mall companies.
Office REITs edged down 0.91 per cent.