Author Topic: REITs 101 : the relationship with Interest Rates?  (Read 3755 times)

birdman2003

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REITs 101 : the relationship with Interest Rates?
« on: August 03, 2015, 01:11:13 AM »
I'm going to lay out some logic that may or may not make sense.  Feel free to jump in and help sort it out.

1. Rising interest rates mean that fewer individuals can afford to buy property, thus a REIT would have more renters / less vacancy which translates into higher share prices for the REIT.

2. Rising interest rates mean that REITs will spend more to acquire new property (assuming they want to grow larger), which translates to lower share prices for the REIT.

3. Rising interest rates are typically a response to inflation, and inflation is why a lot of people own REITs, thus more people seeking to buy the REIT would translate to higher share prices for the REIT.

Am I seeing the relationship correctly?  Any of these (or one I didn't think of) particularly stronger than the others?

Thanks for your input.
« Last Edit: August 03, 2015, 01:13:00 AM by birdman2003 »

mrpercentage

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #1 on: August 03, 2015, 01:54:58 AM »
1. Restrictive credit means there are fewer people that can "afford" to buy property
2. Not necessarily. And Im not sure of the spending to share price relationship there
3. Rising interest rates are because they can. If they can make more money off of you they will. If it will kill themselves doing it, they wont. But yes, the story they sell you is it is to "cool down" the ecomony and "slow down" inflation by sucking the life [I mean money] out of you.

I think share price might be hit because a REIT could be a "bond equivalent" and once bonds with higher rates appear people will sell the stock and buy the bonds. For an income investor that doesn't matter as long as the dividends are safe. The dividends will just buy more shares giving you more dividends. Its hard to say what the market will do exactly.

According to CNBC
Don't buy bonds they are going to take a hit
Don't buy bond equivalents they are going to take a hit
Don't buy stocks because people will just sell and go to bonds
Build cash
Invest now
Build cash
Hey a rise in inrates could be a good thing.
Build cash
Does anyone know-- does this expert know
Bogle-- buy an index
Hey isnt an index stocks
build cash

forummm

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #2 on: August 03, 2015, 07:14:44 AM »
The price of REITs already has the effects of the expected interest rate changes priced in. Given that the Fed has said repeatedly that interest rate hikes will be slow and low, I don't think it's too troublesome for investors.

josstache

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #3 on: August 03, 2015, 08:54:26 AM »
In order to maintain their LTV at their desired level, REITs are constantly borrowing new money or refinancing their old loans as they become due.  Higher interest rates mean higher interest expenses for them, which eats away at their distributions.  Higher interest rates could lead to higher rents, or they might not if the real estate market is weak.  Higher interest rates means the equity market demands a higher yield from REIT shares, and so equity offerings also become less effective at raising cash.  If the REIT's creditworthiness deterioriates because of the above, they may be forced to lower their LTV (further lowering yield), or borrow money at higher interest rates (further lowering yield).
« Last Edit: August 03, 2015, 09:02:50 AM by josstache »

Aphalite

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #4 on: August 03, 2015, 08:57:49 AM »
I'm going to lay out some logic that may or may not make sense.  Feel free to jump in and help sort it out.

1. Rising interest rates mean that fewer individuals can afford to buy property, thus a REIT would have more renters / less vacancy which translates into higher share prices for the REIT.

2. Rising interest rates mean that REITs will spend more to acquire new property (assuming they want to grow larger), which translates to lower share prices for the REIT.

3. Rising interest rates are typically a response to inflation, and inflation is why a lot of people own REITs, thus more people seeking to buy the REIT would translate to higher share prices for the REIT.

1. This only affects mREIT (dealing with mortgages), and only barely at that. When interest rates rise, it means monthly payments go up slightly, but the major barrier to purchasing a home is credit situation and availability of savings, a couple extra hundred dollars (you can go to bankrate and enter in different interest rates to find how payments will be affected - a rise from 4% to 5% is an extra $120 per month on a 200k loan). The main reason share prices will be affected is because most REIT investors are investing for YIELD. When interest rates rise, that means the risk free rate of treasury bonds increases. To hold the equity premium, either dividend payout must increase or share prices on REITs must drop. That's the compensating factor

2. Interest rates have nothing to do with acquisition pace (with the exception of negligible effects on interest expense but down the line when companies have to refinance debt), either the REIT has extra cash or it doesn't

3. You have it reversed, if interest rates go up, people are less likely to buy REITs that have the existing 5% yield, since now the risk free treasury rate is 5% or higher (investors would have to also consider the growth component inherent in REITs but not bonds, of course). They would demand REITs pay them a higher percentage to compensate them for risk of loss

The price of REITs already has the effects of the expected interest rate changes priced in. Given that the Fed has said repeatedly that interest rate hikes will be slow and low, I don't think it's too troublesome for investors.

I strongly disagree with the affinity for efficient market hypothesis/theory around these parts, even though I think forummm usually makes very intelligent points. If assets are always perfectly priced, we wouldn't have random daily fluctuations (sometimes due to how sunny it is in New York, literally) and we wouldn't have Wells Fargo sitting there in 2009 for less than the cash it's holding. It's a nice theory that fits the needs of mathematicians, but doesn't reflect reality

forummm

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #5 on: August 03, 2015, 10:01:17 AM »
The price of REITs already has the effects of the expected interest rate changes priced in. Given that the Fed has said repeatedly that interest rate hikes will be slow and low, I don't think it's too troublesome for investors.

I strongly disagree with the affinity for efficient market hypothesis/theory around these parts, even though I think forummm usually makes very intelligent points. If assets are always perfectly priced, we wouldn't have random daily fluctuations (sometimes due to how sunny it is in New York, literally) and we wouldn't have Wells Fargo sitting there in 2009 for less than the cash it's holding. It's a nice theory that fits the needs of mathematicians, but doesn't reflect reality

I agree that the EMH is flawed. It models reality but not perfectly in all cases. What I was trying to say is that while the market may be getting the price wrong, it usually reflects the best judgment of the crowd. So the crowd's expectations are priced in. The crowd is frequently wrong of course. It takes a lot to say with confidence that you as an individual know better than the crowd. If you're Buffett and you spend all day looking at numbers for 60 years you may be right a lot. I do believe it's possible for someone to pick up an edge over the long run. But it's a lot of work. And a game where overconfidence can kill you.

Aphalite

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #6 on: August 03, 2015, 10:08:32 AM »
I agree that the EMH is flawed. It models reality but not perfectly in all cases. What I was trying to say is that while the market may be getting the price wrong, it usually reflects the best judgment of the crowd. So the crowd's expectations are priced in. The crowd is frequently wrong of course. It takes a lot to say with confidence that you as an individual know better than the crowd. If you're Buffett and you spend all day looking at numbers for 60 years you may be right a lot. I do believe it's possible for someone to pick up an edge over the long run. But it's a lot of work. And a game where overconfidence can kill you.

Good points, I agree you should always be aware of your own limitations

foobar

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #7 on: August 03, 2015, 12:35:58 PM »


1. This only affects mREIT (dealing with mortgages), and only barely at that. When interest rates rise, it means monthly payments go up slightly, but the major barrier to purchasing a home is credit situation and availability of savings, a couple extra hundred dollars (you can go to bankrate and enter in different interest rates to find how payments will be affected - a rise from 4% to 5% is an extra $120 per month on a 200k loan). The main reason share prices will be affected is because most REIT investors are investing for YIELD. When interest rates rise, that means the risk free rate of treasury bonds increases. To hold the equity premium, either dividend payout must increase or share prices on REITs must drop. That's the compensating factor


It all depends on what you expect rates to do.
100k@4% is 477
100k@6% is 599
100k@8% is 733

Are we going to back to the 8% mortgages that we had in 2000? Probably not. The 6% of 2008 on the other hand is in the realm of feasibility if you are looking for a 5 year projection and if lenders start asking for more of a risk premium. Does an extra 200-300/month matter? Sure. You might get buyers choosing to go with the 200k instead of 250k house.

For reference REITs did fine in the high inflation/high interest world of the 70s and early 80s.  You can decide if that is coincidend or not.

Personally I think most  this rate hike is stuff is garbage. They might raise rates .5% or so over the next couple of years but that isn't enough to change anything. Expecting rates to go up 2%+ just seems unlikely. No inflation and a borderline world economy doesn't scream raise rates.  And if you compare our rates to the rates in the 40s/50s they don't seem crazy low. It is only when you look at the bubbly 70s/80s/90s when they seem crazy low.

JetBlast

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #8 on: August 03, 2015, 02:21:44 PM »
Aphalite covered it nicely. The only thing I have to add is in regard to the second question. One way REITs often raise funds for acquisitions is through secondary offerings. One of the best known REITs, Realty Income (O), has raised around $800 million in the last two years through secondary offerings to fund additions to their portfolio.

birdman2003

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #9 on: August 03, 2015, 06:18:48 PM »
Thanks all.  This is helpful.  I guess I did have my thinking reversed on #3 and the first two were not as significant as I thought.

REfinAnon

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #10 on: August 04, 2015, 04:51:35 PM »
Low interest rates drive up commercial real estate prices just like they drive up stock prices.

Rising interest rates should relieve some of the current RE pricing pressure.

Also, regarding #1 and #3 more generally, REIT prices tend to fall when interest rates rise. REITs are very bond-like, so when interest rates rise they are less appealing compared to owning bonds. Furthermore, REITs are users of debt. You might say debt is one of their inputs. When debt prices rise it becomes more difficult for them to deliver the same return.

So in summary, I would say OP has #1,#2, and #3 in reverse.
« Last Edit: August 04, 2015, 04:58:16 PM by REfinAnon »

leighb

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Re: REITs 101 : the relationship with Interest Rates?
« Reply #11 on: August 06, 2015, 10:57:51 PM »
My understanding is that's it's not the interest rate that matters but the spread. What they get verse what they can sell.