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Quarter-End Insights

Real Estate Sector Outlook

REIT prices reset with rising interest rates.

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  • Although interest rates have risen, they remain well below historical averages.
  • Just as falling interest rates provided REITs a strong tailwind through early 2013, we would expect a rising interest rate environment to be a major headwind for REITs. 
  • Slow but steady macroeconomic improvement generally translates into slow and steady increases in demand for commercial real estate space without spurring too much construction or incremental supply, a favorable condition for REITs.

Aside from higher interest rates (and the fear of potentially even higher rates), the environment for equity REITs remains favorable, driving continued improvement in REIT fundamentals. The operating environment couldn't be much better for REITs. Slow and steady economic and job growth translates into incremental demand for commercial real estate, yet the macro economy is not improving enough for developers to aggressively add incremental supply to commercial real estate stock. As such, existing landlords should continue experiencing improved occupancy rates, greater bargaining power relative to tenants, and nice increases in same-store net operating income. In fact, we think a number of REITs, especially those with shorter-term lease structures, are performing at peak or near-peak levels of performance, and there is risk that deviation from the slow-and-steady macro improvement--either to the upside or downside--could alter the supply/demand picture and introduce weaker, but still positive, fundamental performance. 

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Todd Lukasik does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.