REIT ETFs: It's About More Than Interest Rates

When it comes to sectors investors believe are vulnerable to rising interest rates, real estate is near the top of the list. For example the iShares Core U.S. REIT ETF (NYSEARCA: USRT) is off 6.62% year-to-date.

USRT tracks the FTSE NAREIT Equity REITs Index, a cap-weighted index designed to measure the performance of U.S. listed equity real estate investment trusts, excluding timber, infrastructure and mortgage REITs. Still, it is important to note that interest rates are not the sole determinant of REIT performance.

“What about rising interest rate environments? As we’ve shifted to a normalizing US interest rate environment (based on the short term Federal Funds lending rate), the concern that REITs might be vulnerable to poor performance due to rising rates is of particular interest and concern for market participants,” said FTSE Russell. “It is important to understand, however, that interest rates are not the only driver of REIT performance.”

What’s Next for REIT ETFs

Conventional wisdom makes us think that most income assets are sensitive to rate changes because higher rates usually mean their prices fall and vice-versa. REITs, though, are much more complex. Interest rates typically rise during a strong economy,and while higher short-term rates may have a negative impact on real estate debt, the benefits of a stronger economy may also outweigh the downside from slightly higher rates.

Moreover, a stronger economy could also support profitability and yield of REITs. An improving economy could provide greater opportunity for income generation from each property within REITs as properties are more likely to appreciate due to greater demand. Furthermore, rising employment drives higher occupancy rates, which translates to greater rents and greater profitability or higher payouts for investors.

Since the start of the current tightening cycle, some REIT sub-sectors, such as industrial REITs, have held up well while others have languished.

“Regional Malls and Shopping Centers have suffered due to concerns that the related shift in consumer shopping preferences will ultimately hurt retail real estate operating performance. Manufactured Housing has enjoyed notable excess returns deriving from supply constraints as zoning laws and policies impede the development of new manufactured housing residential areas,” said FTSE Russell.

For more information on real estate investment trusts, visit our REITs category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.