Listed property is well-positioned to withstand a rising rates environment despite a potential short-term hit to returns, Harbour Asset Management portfolio manager, Shane Solly, argues in a new paper.
Solly says historical data suggests while real estate investment trust (REIT) returns may fall as interest rates begin to rise, the sector tends “to perform better as rate hike cycles mature”.
“This difference in performance partly reflects rotation in ownership from yield-focused investors to investors focused on total return and inflation protection,” he says.
According to Solly, pure yield-play REIT investors ignore the longer-term benefits of the asset class that include inflation-protection and low volatility growth even as interest rates spike higher.
“For investors looking at REITs to deliver long-term, low volatility growth – to capture earnings growth as economies shift and grow and real estate goes along with it – short term moves in interest rates have less impact,” he says. “In fact, as interest rate increases hit earnings of more cyclical sectors (for instance housing and consumer-related stocks), the defensive nature of REIT earnings is reinforced.”
The US listed property market has delivered positive returns in four out of the last six lengthy rising interest rate cycles since the 1970s, the Harbour paper says, while outperforming the broader equity index in three of those episodes.
NZ data shows local REITs have a weak inverse correlation with official cash rate (OCR) moves, although the relationship can “decouple”.
Solly says “other factors such as inflation, economic growth, physical commercial property supply and demand factors, and the nature of commercial property leases may influence REIT returns”.
However, he says investors need to carefully assess REITs for debt exposure and underlying asset quality in a sector that has seen much structural reform and diversification in recent times.
“In Harbour’s view, REITs are more akin to ‘hard assets’, and hard assets tend to perform better than cyclical assets in volatile and uncertain markets,” Solly says. “REITs tend to get hit early in a rate hike cycle and can perform well over long periods of time if the assets are underpinned by structural demand. This reinforces the need to invest in a diversified portfolio of REITs and other hard asset REIT-style stocks with structural tail winds that can ride through the cycle.”