REITs globally have taken a beating in jittery markets over the past 4-5 weeks, registering as much as a 20% decline in response to rising interest rates and anticipation of further increases. Is this a needed correction to an overheating market or a glitch in otherwise great performance?
Market observers agree the trigger for the declines in REIT markets globally was uncertainty after the US Federal Reserve chairman Ben Bernanke announced at the end of May that stimulus programmes may wind down sooner than anticipated in light of an improving US economy. This statement was followed by a sharp, 13 basis point rise in the 10-year Treasury yield, despite anxious backpedalling by some of his colleagues.
The promise of rising US interest rates was enough to rock REIT performance, not just in the US but also in global markets. In Japan, for example, J-REITs began their decline in May after a 7bps increase in domestic interest rates influenced by economic engineering there.
The REIT declines have to been seen in the context of broader market movement, according to Calvin Schnure, vice-president of industry information at NAREIT. "Just about every asset class is falling, including bonds and corporate equities. REITs are not alone," he says.
However, the REIT tumble – 20% over two weeks – is of a magnitude not seen since the 2008 financial crisis, notes Scott Crowe, global portfolio manager at Resource Real Estate, a real estate investor and manager based in the US.
"What seems to have happened is that everyone assumed quantitative easing would be around this year and the next, and they built their portfolios around that," he says. "Bernanke surprised us all."
What was also surprising, says Schnure, is how quickly rates responded to Bernanke's statement. "He was not talking about tightening but about some easing in the stimulus, and there wasn't a huge amount of news there," he says. "There was some panic selling in the markets, but, where there's smoke, there's fire."
REITs do definitely benefit from low interest rates – not only do they experience low debt costs for refinancing, but, as yield-producing investments, rising interest rates mean competition from other asset classes. As a result, they are vulnerable from both sides.
At the same time, REITs benefit from a strong economy, especially since the supply of property is extremely low, a lingering hangover of the financial crisis. "Demand can change more quickly than supply, and if economic growth persists, we're headed towards a rental growth story," says Crowe. Schnure seconds this: "An upside risk for the economy is an upside risk for REITs, too."
Crowe also maintains that this was a healthy correction, although overdone. "The market was about to get out of control," he maintains. There are indications REIT values, like the broader markets, have stabilised, and it's always possible they'll recover.
"The important factor is that the US economy continues to get back to a more solid growth rate," says Schnure. And this is one reason why interest rates won't go much higher – many industry observers think that while rates might hit 3%, itself historically low, a rise above that would slow recovery in housing and the broader economy.
In a global context, the US meltdown may prove to be a benefit to US REITs, says Crowe. "Our view had been that the US was a little expensive, and we had been putting money into Europe. But this correction was so steep in the US compared with other places that the US is looking cheap relative to the rest of the world."
Resource remains cautious on emerging markets, taking the view that the level of growth there is slowing and inflation issues are rising to the fore. "The place to be," says Crowe, "is the developed world."