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Why Do REITs Fear Rising Interest Rates?

Why Investors Are Anxious ahead of Fed Meetings

(Continued from Prior Part)

Fed delays rate hike

The results of the much-awaited Fed meeting was declared on September 18. In the wake of global uncertainty and softening economic fundamentals, the Federal Open Market Committee (or FOMC) has decided to delay a rate hike. But it did leave the window open for a possible rate hike in October or December.

Impact of a rate hike on REITs

Interest rates are inversely related to the REIT sector. This is because a rise in interest rates has a twofold impact of REITs. First, it leads to a rise in borrowing costs, which impacts their profitability and ability to make acquisitions. Second, a rise in interest rates makes REITs less attractive investments because REITs have been viewed as dividend-yielding investments.

REITs within the Financial Select Sector SPDR ETF (XLF) have a trailing 12-month dividend yield of 4.12%. When the yield curve steepens, spreads between Treasury yields and dividend yields tighten, thus making REITs less attractive.

When rates rise, a mass sell-off in REITs occurs. However, since the Fed has decided to postpone the rate hike, a short-term rally is expected since investors will be temporarily relieved.

How REITs have reacted to fears of a rate hike

In 2014, REITs within XLF rose 10.71%, while the ten-year Treasury yields fell from 3.03% to 2.17%. In 2015 so far, REITs have fallen 8.87%, while Treasury yields (TLT) have risen from 2.12% to 2.28% as of September 15.

While the rise in Treasury yields isn’t much, REITs have reacted to fears of rising rates. Host Hotel & Resorts (HST) has been the highest contributor to the fall in this sector, plunging ~29% year-to-date. Public Storage (PSA) and Essex Property Trust (ESS) have gained 10.57% and 4.59%, respectively, during this period.

Browse this series on Market Realist:

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