Impact of a rate hike on REITs
Interest rates are inversely related to the REIT sector (RWR). This is because a rise in interest rates has a twofold impact on REITs. First, it leads to a rise in borrowing costs, which impacts profitability and the ability to make acquisitions. Second, a rise in interest rates makes REITs less attractive investments, as REITs have been viewed as dividend-yielding investments.
REITs within the Financial Select Sector SPDR ETF (XLF) have trailing-12-month dividend yields of 3.9%. When the yield curve steepens, spreads between Treasury yields and dividend yields tighten, thereby making REITs less attractive. If rates do rise in December, as most experts are expecting, a mass selloff in REITs will likely occur. However, if the Fed decides to postpone the rate hike, a short-term rally is expected, as investors will be temporarily relieved.
REITs have reacted to fears of a rate hike
During 2014, REITs within the XLF ETF gained 10.7% while ten-year Treasury yields fell from 3.0% to 2.2%. In 2015, so far, REITs have lost 0.6% while Treasury yields have climbed from 2.1% to 2.2% as of November 30. While the rise in Treasury yields is not much, REITs have been volatile due to fears of rising rates. Host Hotel & Resorts (HST) has fallen the most at 29.4% year-t0-date. Meanwhile, Iron Mountain (IRM) and HCP have lost 27.8% and 18.3% during the same period.