Dependence of REITs on debt for their business makes investors wary of their performance in a rising rate environment. Also, the investment world’s treating them as bond substitutes for their high and consistent dividend-paying nature makes them susceptible to rising rates. This is why their price performance tends to fluctuate when the Federal Reserve is optimistic about rate hikes.
Chairman Jerome Powell opened his innings with a 0.25% interest rate hike yesterday but this time we should perhaps think twice before looking at the REIT space with a skeptic’s eye. Over the years, REITs have managed their balance sheets efficiently and are now well prepared for a rising rate environment. In fact, instead of looking for debt to finance their portfolio, these have strategically resorted to equity capital in recent years.
This helped the balance sheets of the overall REIT industry to become less leveraged in decades. Per the Nareit T-Tracker, the ratio of debt-to-book assets came at 47.6% in fourth-quarter 2017, denoting a 95 basis-point decline over the past year while market leverage ratio is hovering around its record low achieved in 2016. Moreover, interest expense as a share of Net Operating Income (NOI) of 22.3% in the fourth quarter came close to its record low of 21.7% and well below 38% before the financial crisis.
Not only have the REITs reduced their exposure to interest rate hikes, they have opportunistically used the low-rate environment to make their financials more flexible, which is encouraging down the line for their operational efficiencies. REITs have made borrowings at a fixed rate and extended the average maturity of their debt outstanding to more than six years, thereby locking the low rates for an elongated period.
And finally, along with the much anticipated quarter-point rate hike this time, the GDP forecast for 2018 was raised to 2.7% from 2.5% in December while the same for 2019 has been revised north to 2.4% from 2.1%. Moreover, in a post-meeting statement, the committee said that the “economic outlook has strengthened in recent months.”
