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REITs and Interest Rate Fluctuations: Future Outlook

July 23, 2024

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

  • Interest rate fluctuations historically impact REITs' cash flows, cap rates, and customer decisions, with diversification helping to mitigate some effects.
  • Current market conditions show uneven transaction activity and mixed inflation data, with interest rate changes affecting financial aspects like credit facilities.
  • Sector-specific impacts include increased income for some REITs and refinancing benefits for others, with significant period-to-period fluctuations in financial metrics.
  • Investor sentiment is influenced by market exposure to third-party logistics, commitment to dividends, and profitable investments, highlighting the importance of stability and value creation.
  • Regulatory reforms and policy shifts, especially in election years, significantly impact REIT strategies, with rent control measures and migration data influencing capital redeployment decisions.

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Historical Impact of Interest Rate Changes on REITs

Interest rate fluctuations have historically impacted REITs by affecting cash flows, cap rates, and customer decision-making. Diversification has helped some REITs mitigate these effects, while others have seen higher interest rates offset improvements in net operating income.

"Derivatives and Hedging In the normal course of our business, interest rate fluctuations affect future cash flows under our variable rate debt obligations, loans receivable and marketable debt securities, and foreign currency exchange rate fluctuations affect our operating results." --- (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)

"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)

"The interest rate environment and its associated volatility have weighed on customer decision making, especially as the 10 year has increased 70 basis points from its level just 90 days ago and expectations for Fed rate cuts have moved from potentially six to now possibly zero." --- (PLD, earning call, 2024/Q1)

"The increase in our midpoint can be explained by a $0.03 per share improvement in organic SHOP NOI, partially offset by higher interest rates." --- (VTR, earning call, 2024/Q1)

Current Market Conditions and Interest Rate Impacts

The current market for REITs is characterized by uneven transaction activity due to uncertain interest rates and mixed inflation data. Interest rate changes, such as the transition from LIBOR to SOFR, impact financial aspects like credit facilities. Declines in effective market rents and high housing costs also shape the market conditions.

"In summary, activity in the transaction market remains uneven. Many potential sellers of real estate remain sidelined, given this uncertain interest rate environment, which is amplified by mixed inflation related data over the last six months." --- (O, earning call, 2024/Q1)

"Based upon our current credit ratings, the interest rate on the Credit Facility is SOFR plus 72.5 basis points, plus a spread adjustment to account for the transition from LIBOR to SOFR." --- (SPG, sec filing, 2024/Q1)

"Globally, we estimate that effective market rents declined 2% during the quarter, with 75% of the decline attributed to SoCal.Because there is so much conflicting data available to investors, it's worth mentioning that we measure market rent growth by evaluating effective rents achieved, not asking rents before concessions, a difference that can be as wide as 5% to 10%." --- (PLD, earning call, 2024/Q2)

"Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, prospects for capital and other factors." --- (VTR, sec filing, 2024/Q1)

"Strong demand and high single-family housing costs are consistent conditions across both our coastal established markets that represent 95% of our company's NOI and our new expansion markets of Dallas-Fort Worth, Atlanta, Denver, and Austin, that collectively represent 5% of our NOI." --- (EQR, earning call, 2024/Q1)

Sector-Specific Impacts of Interest Rate Fluctuations

Higher interest rates have led to increased income for REITs like EQR, while PLD leveraged lower rates for refinancing before the rise. SPG's cash flow and investment decisions are also influenced by rate changes, and PLD's FFO shows significant period-to-period fluctuations due to these rates.

"Interest and other income increased during the quarter ended March 31, 2024 as compared to the prior year period, primarily due to a net unrealized gain of $7.1 million on various investment securities as well as short-term investment income on cash and restricted deposit accounts due to a higher rate environment and higher overall invested balances, partially offset by decreases in insurance/litigation settlement proceeds received during 2023 as compared to 2024." --- (EQR, sec filing, 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)

"So we went from $8 million of cash flow to $70 million just selling that. So we look at every aspect of it, pre-tax after-tax, what does it mean to the portfolio, what is -- we don't want volatility, but we'll have -- we'll certainly accept it if we think it's going to be a good investment, and it all kind of goes into the analysis." --- (SPG, earning call, 2024/Q1)

"While not infrequent or unusual, the additional items we adjust for in calculating FFO, as modified by Prologis and Core FFO , both as defined below, are subject to significant fluctuations from period to period." --- (PLD, sec filing, 2024/Q1)

Investor Sentiment and Market Reactions

Markets with higher exposure to third-party logistics (3PLs) are more sensitive to shifts in sentiment, while Realty Income's commitment to monthly dividends bolsters investor confidence. Ventas presents a compelling value creation opportunity, and Simon Property Group's profitable retailer investments highlight the impact of volatility on investor sentiment.

"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, AGM, 2024/05/30)

"And we have a great demand driven business. And at this moment in time, it's Ventas represents a really interesting and I think compelling value creation opportunity in terms of and you must agree because you have a buy on the stock, but the growth and the multiple combination is really something that screens incredibly well for investors, and we're just getting going." --- (VTR, conference, 2024/06/04)

"David, just want to go back to Caitlin's question. In response to the retailers, you said that it brings a lot of volatility, obviously, we all like volatility the right way, but you can't deny that you guys have made a ton, I guess, I could use a French word to describe the ton, but you guys have made a ton of money, billions, from these retailer investments." --- (SPG, earning call, 2024/Q1)

"We may also fund our cash needs from the issuance of equity securities, subject to market conditions, and through the sale of a portion of our investments in co-investment ventures." --- (PLD, sec filing, 2024/Q1)

Regulatory Environment and Policy Impacts

Regulatory reforms are essential for improving public safety and encouraging business stability in key markets. The election year heightens the focus on regulatory changes, which have been significant since 2017, particularly with rent control measures in California. Policy shifts and migration data also influence strategic capital redeployment decisions.

"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)

"It's an election year, and so I'd be remiss not to ask a little bit about just kind of the regulatory environment." --- (EQR, conference, 2024/06/04)

"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)

"Do those policy changes or anything new in data as far as net migration or any other items potentially reconsider your views on either the timing or the strategy of redeploying capital into the Sunbelt?" --- (EQR, earning call, 2024/Q1)

See also