This past quarter was the worst quarterly performance in a year for real estate investment trusts. REITs lagged behind the stock market in the third quarter due to the expectations that interest rates would rise over the next year.
Higher interest rates create alternative investments for investors to collect yields similar to real estate returns. Alternative investments have lower demand for REITs. Standard & Poor’s 500 Total Return Index increased by 1.13 percent, while FTSE NAREIT all REIT Index dropped by 2 percent in the third quarter. In the first eight months, real-estate stocks had high performance due to low interest rates and an improving economy. This past month REITs took a dramatic decline.
REITs acquire warehouses, shops, office buildings and other commercial real estate assets that are sensitive to rising rates. The trusts are required to pay at least 90 percent of their profits to shareholders and are not required to pay corporate tax on the profits they distribute. Not only do rising rates make alternative investments have equal or higher yield than REITs, but the increase cost of debt will make it more difficult for REITs to acquire and develop new properties. Rising rates signal a strengthening economy, which can benefit REITs in the future.