REITs and Rates: The Real Story

Focus: REITs

Tim Plaehn Image Tim Plaehn Investment Research Analyst, Investors Alley

You may be hearing that rising interest rates will hurt the value of real estate investment trusts. While the news bites make it sound simple, the real story has a lot more detail, explains Tim Plaehn, editor of The Dividend Hunter.

Here are some of the actual factors that could affect REIT share prices in the short to longer-term future.

Reasons why higher interest rate will hurt REIT values:

1. A move to a higher yield means an investment's value must fall. This reason puts a strong correlation between REIT yields and yields on fixed income securities like bonds.

2. Rising rates will increase the interest expenses for REITs, reducing net income and the ability to continue to pay dividends.

3. Higher interest rates will lead to higher cap rates on commercial properties. The cap rate is the cash yield on a property based on the price paid and the rent payment amounts. A higher expected cap rate results in a lower property value if it needs to be sold.

4. The belief that with higher fixed income security yields, investors will sell their REIT shares to invest the money in "safer" bonds and bond funds. To me this is not logical, because reason 1 definitely applies to bonds.

5. Uninformed REIT investors believe the issues listed above and sell their REIT shares.

Reasons why higher interest rates will not be a negative for REITs:

1. Higher interest rates will allow REITs to raise their rental rates, increasing revenue and the ability to grow dividends. Profits will increase, especially if a REIT has locked in long-term debt at the previously lower interest rates.