In his speech in Jackson Hole, Wyoming, Federal Reserve Chairman Jerome Powell made clear the need for higher interest rates to reduce high rates of inflation. The way this could affect real estate investment trusts (REITs) is at least three-fold — fewer real estate purchases due to higher prices, a stop or drop in rising prices, and losses to dividend-paying REITs whose prices may fall to keep up with the interest rate increases.
Some of the talk of higher prices has already been priced in as no one was surprised Powell and crew headed in that direction. The bond market has been sold off for weeks as yields rose in anticipation of the Fed’s chess moves. The question is — is news fully priced into REITs? What if rates go higher – possibly much higher – than expected? It doesn’t seem likely now, but it’s hard to know.
Those REITs that have borrowed money for long-term expansion will have lower interest rates for quite some time. This is good, but it is offset by the fall in real estate values that will almost certainly trigger a recession – a consequence of the Fed raising interest rates. Thinking that “this is just another one of those rate hikes that happen from time to time” is misleading. Powell’s wording that “pain” will be involved suggests the strong possibility that a recession with severe consequences is in store — not just a slowdown.
In Jackson Hole, it was evident that the Fed was pursuing a restrictive policy and warned against easing such policy prematurely. This message is the important piece for investors to consider when considering REITs.
The 2-year and 10-year Treasury yields have broken above long-term downtrend lines dating back to the year 2000. The bond market has sensed for months that rate hikes would continue at a decent pace. Related to this – and directly affecting real estate – is the upward, dynamic movement of mortgage rates.
Here is the 15 year fixed rate chart:
Note how close the percentage is to breaking above a downtrend line dating back many years. This trend illustrates the apparent beginning of a new era for the market.
Here is the 30 year fixed rate chart:
It’s another case of an upward movement in mortgage rates about to break above a long-term downtrend, suggesting a need to change assumptions. If this is the case and a recession is slowly unfolding, AEEAPs face some challenges.
Take the big hotel REITs if many Americans lose their jobs during a recession — will they spend more or less money on hotel stays? What about storage REITs — if the job losses pile up, will this growing number of unemployed affect the storage facilities economy?
Will the prices of the underlying properties fall?
Since dividend-paying REITs will sell off as interest rates rise, will long-term investors stick with it?
These ideas lead Powell to say that “some pain” is ahead.
Some economists assume the Fed will pivot soon—within weeks or a month or two—and begin the process of cutting interest rates once CPI and CPI data show serious declines in inflation. This action would require the price of oil to continue to fall and the price of natural gas at the pump to continue to fall. These are important, debatable assumptions.
It’s hard to see serious new money going into REITs under these circumstances, with a recession looming and interest rates higher (per Powell’s speech) for longer than most seem to expect.
Highlights of today’s real estate investment news
The Flagship Real Estate Fund by financing has acquired a townhouse rental community in Charlotte, NC, for approximately $6.3 million. The Flagship Real Estate Fund has returned YTD 6.9% so far in 2022.
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