April 30, 2018 / 5:18 PM / a month ago

REFILE-REITs outperform broader market in rising rate environment

(Refiles to spell acronym as Nareit instead of former NaREIT in pargaraphs 8,9)

By Herbert Lash

NEW YORK, April 30 (Reuters) - Rising interest rates this year are helping property-linked stocks outperform the broader U.S. equity market as investors bet real estate investment trusts (REITs) will provide a better return as the Federal Reserve tightens monetary policy further.

Higher rates can crimp corporate profit margins, a concern that led to a brief sell-off on Wall Street last week, but rents can be raised in a growing economy, which is helping lift REITs.

“Rising rates usually indicate a strengthening economy, which nearly always results in increased demand for all types of commercial property across the board: apartments, office, industrial and even retail,” said Jay Leupp, a managing director of Global Real Estate Securities at Lazard Asset Management.

The Fed is expected to raise rates at least twice more this year after an increase in March, but the strong U.S. economy may lead to a fourth hike, which could rattle equity investors.

Yields on the 10-year U.S. Treasury note, a global benchmark for borrowing costs, briefly rose above 3 percent for the first time in four years last week and U.S. stocks initially fell before closing the week little changed.

The S&P 500 real estate sector has been in decline since the start of the year, but in recent weeks has trended higher, suggesting a shift in investor sentiment. Last week it rose 2.7 percent while the broader S&P 500 closed flat.

Since February, when a U.S. employment report heralded quickening wage growth, real estate sector stocks have declined at just half the rate of the overall market.

If inflation remains moderate amid economic growth, REITs may outperform the broad stock market, research by the National Association of Real Estate Investment Trusts (Nareit) shows.

Over the past 25 years the total return of REITs in rolling four-quarter periods was positive 87 percent of the time when interest rates were also rising, Nareit said.

REIT total returns exceeded that of the S&P 500 index 53 percent of those periods, it said.

Rising demand can drive rents higher and boost net operating income from property, which ultimately will result in increased returns, said San Francisco-based Leupp.

REITs tend to briefly fall in the face of rising rates as yield-sensitive investors halt new investments as they wait for higher rates to provide for greater returns, he said.

Most property types, with the exception of retail, are experiencing growth in rents, Joi Mar, an analyst at Green Street Advisors, wrote in a recent report.

With supply and demand roughly in balance, inflationary-type rent growth can be expected for the near future, she said.

Rates are rising because the economy is doing well and that should translate into better real estate valuations, said Lainie Minnick, head of finance at Denver-based Black Creek Group, a developer and investor in commercial real estate.

“Real estate is effectively valued based on where your rents are, quite frankly, and you’re getting yield on the rents,” Minnick said. “There’s some point if rates go up too much, obviously this changes.”

Black Creek favors the industrial sector because of the strong demand for warehousing that e-commerce is driving and the relatively short time - about nine months - it takes to build a facility compared to years for building an office building.

“Industrial has the strongest fundamentals in the market today and that’s definitely where we’re spending our time,” she said. “You can shut off the industrial overbuilding faster, because your lead time is faster.”

Reporting by Herbert Lash; editing by Daniel Bases; editing by Jonathan Oatis

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