In his Jackson Hole, Wyoming, speech, Federal Reserve Chair Jerome Powell clearly indicated the need for higher interest rates to bring down high inflation rates. How this might affect real estate investment trusts (REITs) is at least three-fold — fewer real estate purchases because of higher prices, a halt or drop in rising prices and damage to dividend-paying REITs whose prices may drop to keep up with rate increases.
Some of the talk about higher rates is already priced in as no one was really surprised that Powell and crew were headed in that direction. The bond market has been selling off for weeks as yields rose in anticipation of Fed chess moves. The question is — is the 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 be sitting on lower rates for quite some time. That’s good, but it’s countered by the drop in real estate values that a recession — a consequence of a Fed hiking of rates — will almost certainly cause. The thinking that “this is just another one of those interest rate hikes that happen from time to time” is misleading. Powell’s wording that “pain” will be involved indicates the strong likelihood that a recession of serious consequence is anticipated — not just a slowdown.
At Jackson Hole, it was evident that the Fed is implementing a restrictive policy stance and warned of loosening such a policy prematurely. This message is the not-kidding-around part that investors must now consider when contemplating REITs.
The 2-year and the 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 hikes in rates would continue at a decent pace. Related to this – and directly affecting real estate – is the upward, forceful move in mortgage rates.
Here’s the chart of 15-year fixed rate:
Note how close the rate is to breaking above a downtrend line that dates back many years. This trend depicts the apparent beginning of a new era for the market.
Here’s the chart of the 30-year fixed rate:
It’s another case of the upward move in mortgage rates about to break above a long-term downtrend, suggestive of the need for a change in assumptions. If that’s the case and a recession is slowly unfolding, REITs are faced with a few challenges.
Let’s take the big hotel REITs if many Americans were to lose their jobs during a recession — will more or fewer people be spending money for hotel stays? What about storage REITs — if job losses pile up, will that increasing number of unemployed people affect the economics of storage facilities?
Will the underlying properties drop in price?
Since REITs paying dividends will be selling off as rates go up, will long-term investors stick with it?
These ideas take Powell at his word that “some pain” is ahead.
Some economists assume that the Fed will pivot soon —within weeks or a month or two — and begin the interest rate reduction process once the CPI and PPI figures show serious reductions in inflation. This action would require the price of oil to continue going down and the price of gas at the pump to continue to drop. These are significant, questionable assumptions.
It’s hard to see serious new money heading into REITs under these conditions with a recession imminent and with higher rates in place (per Powell’s speech) for longer than most seem to be expecting.
Today’s Real Estate Investing News Highlights
- The target IRR has been increased to 18.4% for the Baypoint Apartments offering on RealtyMogul . The investment has a target cash yield of 7.9% and an estimated hold period of 4 years.
- The Flagship Real Estate Fund by Fundrise has acquired a townhome rental community in Charlotte, NC, for approximately $6.3 million. The Flagship Real Estate Fund has produced YTD returns of 6.9% so far in 2022.
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