Long-Term Impact of High Interest Rates on REITs

Impact on Borrowing Costs and Financial Health

High interest rates have led REITs to manage borrowing costs through various strategies. BXP reduced its term loan, saving 75 basis points. Realty Income benefits from low borrowing rates due to strong ratings. Prologis saved 60 basis points via a commercial paper program. AvalonBay faces higher costs for new debt, while Ventas maintains strong liquidity.

"The all-in rate, including fees is approximately 5.75%. We've used the proceeds to pay down our term loan from $1.2 billion to $700 million, which will reduce our borrowing cost on $500 million by 75 basis points or about $0.01 per share in 2024." --- (BXP, earning call, 2024/Q1)

"These ratings enable us to enjoy low borrowing rates relative to peers. We ended the 1st quarter with a net debt to annualized adjusted EBITDAR of 5.5 times. Our debt maturity schedule for the remainder of the year is moderate approximately $469,000,000 of remaining maturities excluding $342,000,000 of short term commercial paper and revolver borrowings on our $4,250,000,000 revolving credit facility." --- (O, AGM, 2024/05/30)

"Outside of this total, we also launched our $1 billion commercial paper program, which has thus far saved an average of 60 basis points on our short-term borrowing costs in the U.S. In terms of our markets, there are several encouraging signs for demand, including port volumes on both the East and West Coast, as well as increased volume of proposal activity." --- (PLD, earning call, 2024/Q2)

"The $250 million are basically effectively struck at a 3.7%, 10-year rate. So if we were to do a small debt deal, we'd probably be looking at the cost of debt today, somewhere in the low 5% range versus an unhedged 10-year debt deal that would be more like ." --- (AVB, earning call, 2024/Q1)

"As of March 31, 2024, the Company had $3.4 billion in liquidity, including availability under its unsecured revolving credit facility and cash and cash equivalents on hand, with no borrowings outstanding under its commercial paper program." --- (VTR, press release, 2024/05/01)

Effect on Property Valuations

High interest rates are causing a gradual reset in rents and property valuations, with stabilized assets taking time to adjust (AVB). Despite this, some REITs are seeing an uptick in valuations and transaction activity (PLD). However, commercial office properties face challenges due to changing assessments and occupancy rates (BXP).

"And the impact on stabilized assets takes time as rents are reset to a new sort of market clearing price." --- (AVB, earning call, 2024/Q1)

"And putting timing aside, we are encouraged by the outlook for supply in the back half of this year and '25, have tremendous lease mark-to-market to harvest in the interim, and are pleased to see valuations, fundraising and transaction activity all picking up. With that, I'll turn the call over to the operator for your questions." --- (PLD, earning call, 2024/Q1)

"As assessments change and residential assessments go up and commercial assessments go down, obviously, we all know understand what's going on with regards to overall environmental issues associated with interest rates, valuations, occupancy, capital cost, it's very hard for us to think it would be a good thing for the commercial office property sector to bear a higher proportion of those expenses than they currently are bearing." --- (BXP, earning call, 2024/Q1)

"Acquisition Capitalization Rate or Cap Rate – NOI that the Company anticipates receiving in the next 12 months (or the year two or three stabilized NOI for properties that are in lease-up at acquisition) less an estimate of property management costs/management fees allocated to the project (generally ranging from 2.0% to 4.0% of revenues depending on the size and income streams of the asset) and less an estimate for in-the-unit replacement capital expenditures (generally ranging from $100-$450 per apartment unit depending on the age and condition of the asset) divided by the gross purchase price of the asset." --- (EQR, press release, 2024/04/23)

"There's a lag as it relates to property tax assessed values. So our expectation would be there'll probably be more pressure on the Sunbelt based on the run-up that occurred sort of through COVID that's still working its way through the system before you see it in the next couple of years maybe start to move the other direction." --- (AVB, earning call, 2024/Q1)

Influence on Dividend Yields

High interest rates create uncertainty around maintaining current dividend levels for REITs like Realty Income (O), despite their history of increasing dividends. However, companies like Boston Properties (BXP) show resilience, maintaining stable dividend levels. Realty Income projects a 6% annualized dividend yield, reflecting confidence in their value proposition despite economic challenges.

"Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period." --- (O, sec filing, 2024/Q1)

"So to summarize, in the face of strong negative market sentiment, BXP continues to display resilience and stability and occupancy FFO and dividend level." --- (BXP, earning call, 2024/Q1)

"Our approximately 4% AFFO per share projected growth rate, paired with our estimated annualized dividend yield of approximately 6% is why we believe our platform offers one of the most compelling investment opportunities in the S&P 500. With that, I would like to open it up for questions." --- (O, earning call, 2024/Q1)

"and increased the dividend 125 times. As a result, we are proud to be one of only 67 companies in the exclusive S and P 500 Dividend Aristocrats Index for having raised our dividend for the last 25 consecutive years." --- (O, event transcript, 2024/05/30)

"Our projected 2024 operational return profile of approximately 10%, which comprises an anticipated dividend yield close to 6% and AFFO per share growth of approximately 4.3%, assuming the midpoint of guidance is a validation of our value proposition." --- (O, earning call, 2024/Q1)

Sector-Specific Impacts

High interest rates impact REIT sectors differently. Industrial REITs like Prologis see reduced same-store growth due to occupancy declines and lower rent changes. Diversified REITs like Realty Income benefit from portfolio diversification, insulating them from interest rate disruptions. Healthcare REITs like Ventas face challenges in accessing cost-effective capital. Residential REITs, including Equity Residential and AvalonBay, experience concerns over cap rates and shifts in private capital sentiment.

"Same-store growth on a net effective basis will range between 5.5% and 6.5%, a reduction of 150 basis points, which accounts for the average occupancy decline, slightly lower rent change for the year as well as 30 basis points of annualized impact from the one-time items in the first quarter mentioned earlier." --- (PLD, earning call, 2024/Q1)

"Consequently, we would highlight the diversification of our portfolio, which today consists of over 1,500 clients in all 50 states, the UK and six other countries in Western Europe, all of which helps insulate us from potential disruptive interest rate and credit events that could impact the durability of our cash flow." --- (O, earning call, 2024/Q1)

"Our ability to access capital in a timely and cost-effective manner is critical to the success of our business strategy because it affects our ability to satisfy existing obligations, including the repayment of maturing indebtedness, and to make future investments." --- (VTR, sec filing, 2024/Q1)

"And I think there's some fear now that if the Fed was to raise rates or stay higher for longer, that would affect cap rates in a way adverse to their interest." --- (EQR, conference, 2024/06/04)

"This illustrates the continued attractiveness of our sector to private the capital and perhaps marks a shift in sentiment that might bring increased deal flow as the year progresses." --- (AVB, earning call, 2024/Q1)

Impact on Tenant Demand and Occupancy Rates

Higher interest rates have led to increased tenant demand and occupancy rates across various REIT sectors. AvalonBay and Equity Residential reported stronger lease rates and higher occupancy, while Simon Property Group and Ventas Inc. saw significant occupancy growth. Orion Office REIT highlighted a stable occupancy rate with investment-grade tenants.

"The increased outlook is primarily driven by stronger lease rates as higher occupancy at the start of the year has allowed us to begin to achieve higher rental rates than we originally anticipated as we move into the prime leasing season." --- (AVB, earning call, 2024/Q1)

"Three months ended March 31, 2024 vs. Three months ended March 31, 2023 Lease income increased $54.5 million, due to an increase in fixed lease income of $55.2 million primarily due to an increase in fixed minimum lease consideration and higher occupancy, partially offset by a decrease in variable lease income based on tenant sales of $0.7 million." --- (SPG, sec filing, 2024/Q1)

"Our efforts to build occupancy in the fourth quarter of 2023, coupled with continued strong demand and high resident retention, have resulted in both slightly above average rent growth since the beginning of the year and a 50-basis point quarterly sequential gain in physical occupancy." --- (EQR, earning call, 2024/Q1)

"And so from that incredible supply demand imbalance in our favor, we saw 120 basis points of occupancy growth in our portfolio last year, 170 in the 4th quarter, $240,000,000 in Q1 and quarter to date, we're over $300,000,000 year over year." --- (VTR, conference, 2024/06/04)

"The Company's Occupancy Rate was 75.8%, with 70.1% of Annualized Base Rent derived from Investment-Grade Tenants, and the portfolio's Weighted Average Remaining Lease Term was 4.1 years." --- (O, press release, 2024/05/08)

Strategic Responses to High Interest Rates

REITs are strategically responding to high interest rates by evaluating asset sales and market conditions, managing interest expenses, anticipating future opportunities, rebalancing portfolios, and refinancing debt to extend maturities. These actions aim to optimize capital allocation and mitigate the impact of rising interest rates.

"And second question, going back to your comments on strategic capital. Where do you think cap rates are selling out at for good assets and good markets?" --- (PLD, earning call, 2024/Q1)

"Kevin O'Shea: Yes, John, this is Kevin. Really, the $0.02 from better-than-expected capital markets activity was primarily driven by a combination of favorable interest expense and interest income as well as slightly higher budgeted -- higher-than-budgeted capital interest expense." --- (AVB, earning call, 2024/Q1)

"If you're asking for an opinion, I do believe that especially here in the U.S., the second half of the year, when there is a little bit more clarity in terms of where interest rates are going, et cetera, there will be more opportunities." --- (O, earning call, 2024/Q1)

"And while pricing in most of the apartment transaction market is strong, buyer interest is not yet fully evident for some of the large urban West Coast assets that we want to dispose of as part of our strategic rebalancing." --- (EQR, earning call, 2024/Q1)

"Prior to the current rising interest rate environment, we were able to take advantage of lower interest rates through our refinancing activities and substantially addressed our debt maturities until 2026." --- (PLD, sec filing, 2024/Q1)

Regulatory and Policy Impacts

Regulatory reforms and pressures are significantly impacting REITs. Equity Residential highlights the need for housing-related regulatory changes to improve public safety and market conditions. Boston Properties notes increased scrutiny on commercial real estate exposures and new climate-related disclosure requirements, further complicating the regulatory landscape for REITs.

"Right now, our opinion is you need to have some regulatory reforms away from housing just to make public safety better in some of those places and both to sort of encourage employers to relocate or to stay located in those markets." --- (EQR, earning call, 2024/Q1)

"Under regulatory pressure to reduce commercial real estate exposures. They're being choosy about who they're doing business with." --- (BXP, conference, 2024/06/04)

"So regulatory risk in the apartment industry really started to go up in 2017 with the advent of a ballot measure in California that failed on rent control. So that was sort of the advent of" --- (EQR, conference, 2024/06/04)

"companies with more than $1,000,000,000 of annual revenue. And these this regulation will require disclosure not only of Scopes 1 and 2, but also Scope 3 emissions and climate related risks aligned with again, aligned with TCFD or IFRS." --- (BXP, event transcript, 2024/05/15)

"year? So regulatory risk in the apartment industry really started to go up in 2017 with the advent of a ballot measure in California that failed on rent control." --- (EQR, conference, 2024/06/04)

Investor Sentiment and Market Perception

Investor sentiment and market perception of REITs in a high interest rate environment are influenced by factors such as financing conditions, market exposure, dividend policies, and actual performance versus media sentiment. Despite confusion over rates, companies like AVB, PLD, O, BXP, and EQR emphasize strategic priorities to maintain investor confidence.

"Our ability to obtain additional financing will depend on a variety of factors, such as market conditions, the general availability of credit, the overall availability of credit to the real estate industry, our credit ratings and credit capacity, as well as the perception of lenders regarding our long or short-term financial prospects." --- (AVB, sec filing, 2024/Q1)

"In other words, companies use 3PLs as a way of flexing up and down. So markets that have a bigger exposure to 3PLs are likely to feel the impacts of shifts in sentiment sooner than other markets on the way down and on the way up." --- (PLD, earning call, 2024/Q1)

"Even more than the lease structure, Bill and Jones' insistence to pay a monthly dividend to their investors has resonated with those investors since the founding of the company and has been a hallmark of conveying in a tangible way the belief that the investor or shareholder always comes first at Realty Income." --- (O, event transcript, 2024/05/30)

"Over the past several years, BXP’s experience and performance has diverged from the larger market and media sentiment, as premier workplaces have outperformed the broader office market consistently and substantially." --- (BXP, sec filing, 2024/Q1)

"One thing that hasn't changed, although the rate environment is confusing to many investors, is the amount of product that's delivering, particularly in the expansion markets that we're excited about." --- (EQR, earning call, 2024/Q1)