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NEW YORK (Reuters) - Investors puzzled over whether U.S. interest rates are rising due to a stronger economy or because of fears about inflation might want to look at the recent gains in REITs for some useful guidance.
Real estate investment trusts typically perform poorly in an environment of rising interest rates, as they are used by some investors as a proxy for bonds when fixed income returns pale.
Thus, when yields turn higher, REITs are sold among other reasons on expectations of a higher cost for financing real estate acquisitions, and as their dividend yield becomes less competitive against the risk-free return of Treasuries.
In the period between the bottoming of the 10-year Treasury note yield near 1.3 percent in early July and the U.S. election four months later, the vanguard REIT exchange-traded fund (VNQ.P) -- a popular way for investors to get exposure to the sector -- fell nearly 10 percent. The benchmark S&P 500 index gained almost 2 percent during the same time period.
But since the Nov. 8 election of President-elect Donald Trump, and despite a rapid increase in the 10-year yield from about 1.8 percent to near 2.4 percent, the REITs ETF has gained 4.8 percent and the S&P added 6.5 percent.
"REITs are a derivative of credit and the economy so as long as one of those is doing well, REITs will do well," said Alex Goldfarb, the senior REIT analyst at Sandler O’Neill Partners in New York.
"If there’s a view that rents will improve, as long as the move in interest rates is not too significant REITs will still perform."
Stocks on Wall Street have rallied since Trump's surprise victory as economic indicators have improved and on bets that the incoming administration will lower taxes, slash regulations and introduce a fiscal stimulus in the form of a massive infrastructure plan.
Trump's policies are also seen as likely to boost inflation, however, which could force the Federal Reserve to raise rates at a faster clip this year than previously expected.
On Friday U.S. Treasury debt yields rallied after data showed a rebound in U.S. wages last month. That may put more pressure on the Fed to consider raising interest rates as early as the first quarter.
Among the REITs that have performed the worst through the election rally are those specializing in retail, as the sector continues to struggle against online stores. Earlier this week Kohl's (KSS.N) and Macy's (M.N) reported lower than expected holiday sales and cut their yearly forecasts.
The backdrop of rising rates could make it ideal for stock pickers within REITs, said Art Hogan, chief market strategist at Wunderlich Securities in New York.
Vornado Realty Trust (VNO.N), with office and rental exposure in the high-end markets of New York and Washington, has gained more than 20 percent since Nov. 8.
Said Hogan: "To say REITs are going to do poorly in a rising rate environment is true simplistically, but if the economy is improving that's going to be cash flow generating for REITs in the right place."
Reporting by Rodrigo Campos; Editing by Tom Brown