Real Estate: Rising Interest Rates Wreak Havoc on REITs
We prefer REITs with reasonable leverage, moaty assets, demonstrated historical success across economic cycles, identifiable growth drivers, and reasonable margins of safety.
We expect REIT prices to generally move inversely with changes in long-term government bond yields. Although higher interest rates would take some time to show up in REIT financial metrics, eventually higher rates could cause higher debt financing costs, put pressure on traditional after-interest expense measures of REIT cash flow (such as funds from operations, adjusted funds from operations, and funds available for distribution), and lead to higher cap rates, which could pressure investment spreads. Also, to the extent that low interest rates have diverted investor funds to REITs searching for higher yield, funds could flow out of REITs if interest rates rise, pressuring commercial real estate and REIT valuations.
Todd Lukasik does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.