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REIT Returns and Interest Rates: Correcting an "Urban Legend"

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An article in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303819704579320581924300124) focused on whether REIT stock prices typically decline when interest rates ...

An article in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303819704579320581924300124) focused on whether REIT stock prices typically decline when interest rates increase. They usually don't, because the pace of economic growth is generally more important--and interest rates generally increase as a result of improving economic conditions. When demand conditions (employment, income, consumer spending, etc.) are strengthening, commercial real estate usually becomes more valuable because prospects improve for future growth in rents and occupancy levels.

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REIT Returns and Interest Rates: Correcting an "Urban Legend" Presentation Transcript

  • 1. “Urban Legend or Not?” U.S. Listed Equity REIT Interest Rate Sensitivity January 2014 National Association of Real Estate Investment Trusts®
  • 2. Key Takeaways Equity REITs are not bonds – so why have they been punished on fears about interest rates? • Publicly traded equity REITs outperformed stocks and bonds for most periods in the past 20 years and are only moderately correlated with both. But since May 2013, REITs have underperformed the stock market. The same fears about Federal Reserve tapering and interest rate increases that sparked the bear market in bonds have hit sentiment on REITs. Equity REIT sensitivity to interest rates is a more complicated story. • Financial media and market participants frequently assert REIT sensitivity to interest rates, but analysis of rate increases since 1995 fails to show a relationship – in fact, REIT returns performed well in 12 out of 16 cases. Equity REIT income is not “fixed income” – GDP growth underpins commercial real estate demand and fundamentals. • Data show that economic growth, demand for commercial real estate and fundamentals like occupancy rates, FFO and rental income are strongly linked to REIT performance. We are in the “third inning” of a long real estate cycle – with supply of new properties near record lows. • Commercial real estate cycles are long – 18 years on average from peak to peak, a period that was observed at least as far back as 1930. The current cycle began in 2009, and new construction is way below average, constraining supply of new properties. Five factors in addition to interest rates will drive the future performance of equity REITs. • Economy / commercial real estate demand • Limited supply of new commercial space • Rental income and dividend growth • Higher property asset values • Long run for real estate cycle Equity REITs offer benefits of both stocks and bonds – and the power of diversification – to deliver better returns with lower risk.
  • 3. Strong Decade for Equity REITs, Strong Recovery Since Financial Crisis… Growth of $10,000 initially invested on 12/31/2002 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 Dec-02 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 FTSE NAREIT All U.S. Equity REITs TR Jan-09 Jan-10 S&P 500 TR Jan-11 Jan-12
  • 4. Equity REITs Underperform in 2013 YTD – Interest Rate Fears Get the Blame 1.3 5/22/13 - 6/26/13: Tapering concerns drive returns down 13.5% for listed equity REITs 5/22/13: FOMC minutes suggest Fed but just 3.3% for large-cap stocks asset purchases could begin tapering as early as June 1.25 1.2 Through 5/21/13: Economic recovery drives returns up 17.6% for listed equity REITs 1.15 1.1 1.05 6/27/13: Clarifications by Fed officials ease concerns about tapering 1 0.95 12/31/12 1/31/13 3/3/13 4/3/13 5/3/13 FTSE NAREIT All U.S. Equity REITs TR 6/3/13 S&P 500 TR 7/3/13 8/3/13 9/3/13 10/3/13 BC US Aggregate Bond Index TR
  • 5. Equity REITs and Interest Rates Market Commentary on Interest Rate Sensitivity Rising Rates Hit REITs Hard, CNBC, By Diana Olick, 6/6/13 “REITs are questioning how they will have to change their strategies should rates suddenly soar. ‘REITs are highly sensitive to the interest rate environment, they're effectively bond substitutes on the equity side. They are enormous users of capital,’ says David Toti, a REIT analyst at Cantor Fitzgerald. ‘A change in rates impacts their cost of capital, and it impacts their ability to acquire aggressively. REIT Share Slump Deepens in U.S. on Rising Interest-Rate Concern, Bloomberg Businessweek, By Brian Louis, 6/20/13 “This sector is going to woefully underperform in a rising rate environment,” Jonathan Pong, an analyst at Robert W. Baird & Co. in New York, said in a telephone interview. “History proves that out.” Investors Turn From Once-Hot REITs, The Wall Street Journal, By Robbie Whelan, 10/8/13 “REITs, which pay little or no corporate income tax and usually pay steep dividends, are sensitive to rising interest rates because they depend on borrowed money to expand their businesses. As a result, when borrowing costs rise, REITs get dinged twice: their cost of capital goes up, and their dividend payments become less appealing compared with other high-yielding investments.” 5
  • 6. Equity REITs and Interest Rates Market Commentary on Interest Rate Sensitivity REIT Share Slump Deepens in U.S. on Interest-Rate Concern, Bloomberg News, By Brian Louis, 6/20/13 “U.S. real estate investment trusts plunged, capping the worst two-day decline since October 2011, as investors sold shares of the companies vulnerable to rising interest rates.” Five REITs to Buck Rising Rates, Barron’s – Investor’s Soapbox (Online), 9/18/13 “Rising interest rates in the medium to longer term, we believe, will likely represent a headwind to real-estate investment trust/property performance.” Rising Interest Rates Pull REIT ETFs Toward Bear Market, ETF Trends, 8/25/13 “„The biggest risk to the sector is the prospect of rising interest rates,‟ according to Morningstar analyst Abby Woodham. „When rates rise, REITs will have to allocate more cash to debt servicing and less to business reinvestment and dividend payouts to investors. Higher rates will also make REIT yield less attractive, putting downward pressure on the sector’s valuation. 6
  • 7. Listed Equity REIT Total Returns During Episodes of Rising Interest Rates Show Gains for Most Periods Since 1995 • January 18, 1996 – July 5, 1996 • • • • • • • • 10-year yield 4.22% → 5.44% REITs ↑ 15.71% (+46.1% annualized) • • • • 10-year yield 1.43% → 2.98% REITs ↑ 2.70% (+2.5% annualized)  July 25, 2012 – May 21, 2013 • •  • 10-year yield 6.28% → 6.98% REITs ↓ 2.01% (-12.6% annualized) 10-year yield 3.70% → 4.89% REITs ↓ 7.02% (-26.0% annualized) 10-year yield 1.94% → 2.98% REITs ↓ 17.45% (-47.9% annualized) December 1, 2006 – June 12, 2007 • • • 10-year yield 1.43% → 1.94% REITs ↑ 24.40% (+31.3% annualized) May 21, 2013 – September 5, 2013 • • 10-year yield 3.99% → 4.64% REITs ↑ 1.94% (+4.7% annualized) March 16, 2004 – June 14, 2004 10-year yield 2.41% → 3.75% REITs ↑ 9.47% (+30.4% annualized) July 25, 2012 – September 5, 2013 10-year yield 3.13% → 4.61% REITs ↑ 8.13% (+43.1% annualized) February 14, 1997 – April 11, 1997 • • • • 10-year yield 3.21% → 4.01% REITs ↑ 29.43% (+67.5% annualized) October 6, 2010 – February 8, 2011 • • October 25, 2004 – March 28, 2005 • • • • 10-year yield 3.34% → 4.27% REITs ↑ 9.18% (+42.9% annualized) October 1, 2009 – April 5, 2010 • • June 13, 2003 – September 2, 2003 • • • • 10-year yield 3.89% → 5.25% REITs ↑ 20.70% (+19.2% annualized) March 17, 2008 – June 13, 2008 • • 10-year yield 4.73% → 5.54% REITs ↑ 7.33% (+47.4% annualized) November 7, 2001 – April 1, 2002 • • • 10-year yield 4.16% → 6.79% REITs ↑ 2.02% (+1.6% annualized) March 22, 2001 – May 29, 2001 June 2, 2005 – June 26, 2006 • • 10-year yield 6.06% → 6.69% REITs ↑ 10.66% (+92.4% annualized) October 5, 1998 – January 20, 2000 • • • 10-year yield 5.53% → 7.06% REITs ↑ 6.18% (+13.8% annualized) November 29, 1996 – January 27, 1997 • • • 10-year yield 4.43% → 5.26% REITs ↓ 5.38% (-10.2% annualized) December 18, 2008 – June 10, 2009 • • 10-year yield 2.08% → 3.98% REITs ↓ 0.74% (-1.6% annualized) Source: NAREIT® analysis of data from Federal Reserve Board, MSCI U.S. REITs Index, and FTSE NAREIT All U.S. Equity REITs Index. 7
  • 8. Muted Impact of Higher Interest Rates on Equity REITs Case Study: Economic growth and rising REIT cash flows and dividends drove a 99% REIT total return performance from Q4 2003 to Q4 2006, a period when the Fed raised interest rates dramatically Dec-06 Oct-06 $8,000 Aug-06 0% Jun-06 $10,000 Apr-06 1% Feb-06 $12,000 Dec-05 2% Oct-05 $14,000 Aug-05 3% Jun-05 $16,000 Apr-05 4% Feb-05 $18,000 Dec-04 5% Oct-04 •An initial $10,000 investment in the FTSENAREIT All U.S. Equity REIT Index doubled to nearly $20,000 over that same period $20,000 Aug-04 •Equity REITs delivered total returns (share price appreciation plus reinvested dividends) of 26% per year or 99% for the period 6% Jun-04 •Equity REIT Funds From Operations (a supplemental industry measure of earnings) increased 12% per year or 41% for the period $22,000 Apr-04 •Equity REIT dividends increased 6% per year or 18% for the period, in line with GDP 7% Feb-04 •Nominal GDP increased 6% per year or 19% for the three-year period Increase in Fed Funds Rate and Growth of $10,000 Investment in FTSE-NAREIT All U.S. Equity REIT Index from 2003 Q4 to 2006 Q4 Dec-03 •Fed Funds Rate rose five-fold, from 1.0% to 5.25% from Q4 2003 to Q4 2006 Fed Funds Rate (left axis) Growth of $10,000 Initially Invested on 12/31/03 (right axis)
  • 9. Equity REIT Income Is Not “Fixed Income”! GDP Growth Supports REIT Dividend Growth Twenty Years of Dividend Growth •REITs pay out at least 90% of taxable income as dividends REITs paid out $423 in 2012 for every $100 they paid out in 1992 $450 $300 $250 $200 $150 $100 $50 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 $0 1994 •REITs paid out a record $29 billion in dividends in 2012. $350 1993 •For every $100 of dividends in 1992, REITs paid out $432 in dividends in 2012 $400 1992 •REIT dividend payouts have increased more than four-fold over the past 20 years
  • 10. Five Drivers of Equity REIT Performance in Addition to Interest Rates Economy / Limited supply of commercial real new commercial estate demand space Rental income and dividend growth Higher property Long run for real asset values estate cycle
  • 11. Growing Economy Supports Commercial Real Estate Demand and Equity REIT Returns Nominal GDP Growth Rate and U.S. Listed Equity REIT Total Returns (FTSE-NAREIT All U.S. Equity REIT Index) 40% 30% 20% 10% 0% -10% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 -20% -30% -40% GDP Growth Rate FTSE NAREIT All U.S. Equity REITs TR
  • 12. REITs are Raising Equity Capital 80 70 60 Debt IPO Preferred Common 50 40 30 20 10 0 2005 2006 2007 2008 * Includes data through September 2013 2009 2010 2011 2012 2013* 12
  • 13. “Third Inning” of Multi-Year Real Estate Cycle Growth of $10,000 Initially Invested at the Start of Each Real Estate Market Cycle •Commercial real estate cycles are $110,000 long –18 years on average from peak to peak, a trend that holds true going $100,000 back all the way to 1930 $90,000 •For the 17-year real estate cycle from 1972-1989, an initial $10,000 investment in the FTSE-NAREIT All U.S. Equity REIT Index grew to more than $90,000 $80,000 $70,000 $60,000 $50,000 •For the 17 ½ year real estate cycle from 1989-2007, an initial $10,000 investment in the FTSE-NAREIT All U.S. Equity REIT Index grew to more than $100,000 $40,000 $30,000 $20,000 $10,000 •We are 6 years into the current cycle, which is off to a slower start than historical cycles $0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Years After Start of Real Estate Cycle 9/72 - 8/89 (17 years) 8/89 - 1/07 (17½ years) 1/07 - present (6½ years)
  • 14. Decline in Completions Signals Decreased Supply 180 160 Apartment 100 = Completions in 2008 140 Office Retail 120 100 80 60 40 20 0 2008 2009 2010 2011 2012 2013 14
  • 15. ‹#›
  • 16. Disclaimer NAREIT is the worldwide representative voice for REITs and listed real estate companies with an interest in U.S. real estate and capital markets. Members are REITs and other businesses that own, operate and manage income-producing real estate, as well as those firms and individuals who advise, study and service those businesses. NAREIT is the exclusive registered trademark of the National Association of Real Estate Investment Trusts, Inc.®, 1875 I St., NW, Suite 600, Washington, DC 20006-5413. Follow us on REIT.com. Copyright© 2014 by the National Association of Real Estate Investment Trusts, Inc.® All rights reserved. This information is solely educational in nature and is not intended by NAREIT to serve as the primary basis for any investment decision. NAREIT is not acting as an investment adviser, investment fiduciary, broker, dealer or other market participant, and no offer or solicitation to buy or sell any security or real estate investment is being made. Investments and solicitations for investment must be made directly through an agent, employee or representative of a particular investment or fund and cannot be made through NAREIT. NAREIT does not allow any agent, employee or representative to personally solicit any investment or accept any monies to be invested in a particular security or real estate investment. All REIT data are derived from, and apply only to, publicly traded securities. While such data are believed to be reliable when prepared or provided, such data are subject to change or restatement. NAREIT does not warrant or guarantee such data for accuracy or completeness, and shall not be liable under any legal theory for such data or any errors or omissions therein. See http://reit.com/TermsofUse.aspx for important information regarding this data, the underlying assumptions and the limitations of NAREIT’s liability therefore, all of which are incorporated by reference herein. Performance results are provided only as a barometer or measure of past performance, and future values will fluctuate from those used in the underlying data. Any investment returns or performance data (past, hypothetical or otherwise) shown herein or in such data are not necessarily indicative of future returns or performance. Before an investment is made in any security, fund or investment, investors are strongly advised to request a copy of the prospectus or other disclosure or investment documentation and read it carefully. Such prospectus or other information contains important information about a security’s, fund’s or other investment’s objectives and strategies, risks and expenses. Investors should read all such information carefully before making an investment decision or investing any funds. Investors should consult with their investment fiduciary or other market professional before making any investment in any security, fund or other investment. For more information please visit: www.reit.com 16