Academic journal article Journal of Real Estate Portfolio Management

On the Interest Rate Sensitivity of Reits: Evidence from Twenty Years of Daily Data

Academic journal article Journal of Real Estate Portfolio Management

On the Interest Rate Sensitivity of Reits: Evidence from Twenty Years of Daily Data

Article excerpt

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The 1991 initial public offering (IPO) of Kimco Realty is often taken as the starting date of the ''modern era'' for publicly traded real estate investment trusts (REITs). Investors' speculations and debates about how changing interest rates affect REIT share prices predate Kimco's IPO, continued during the 1990s wave of REIT offerings, and are ongoing. In this article, we provide empirical evidence on the topic. Our study builds on and extends Shulman (2015), who found a high degree of interest rate sensitivity for equity REITs during 2013 and 2014. We use a formal model to measure interest rate sensitivity from 1995 through early 2016, a period that covers several economic, capital, and real estate market cycles.

Investors, of course, expect that changes in yields on risk-free securities, such as U.S. Treasury issues, affect valuations of most investments. For example, the value of a U.S. Treasury bond, which makes prespecified payments on a known schedule, is determined by its yield, so a change in its required yield will explain nearly all its price change over a short interval. However, a bond with identical expected payments but subject to credit risk may experience a larger or smaller change in price, depending on how much its credit spread changes.1 Equities, including REITs, should, in principle, be affected by changing required yields on risk-free investments. Of course, other factors might affect equity prices at the same time.

Some investors conjecture that REIT values and returns might exhibit a higher degree of interest rate sensitivity than the average stock because:

1. Equity REITs values in large part reflect holdings of long-lived tangible assets, which are bought and sold in a large and fairly observable market.

2. REIT assets are more capital intensive than those held by the average public company.

3. REITs are more highly leveraged in that their debt level typically ranges from five to ten times EBITDA, compared to three times EBITDA for the average investment-grade industrial company.

4. REITs typically offer dividend yields that are notably higher than the average publicly traded stock. As a result, REITs often appeal to incomeoriented investors who might ''chase yield.''

Our analysis is intentionally limited. We do not seek to examine REIT returns in a broad asset pricing framework or a general equilibrium theory that simultaneously values other asset classes, such as bonds, non-REIT stocks, and direct or privatemarket real estate. Our focus is interest rate sensitivity; however, as we discuss below, we believe it is relevant to include the effects of factors beyond pure interest rate changes in seeking to assess sensitivity.

Literature Review

Shulman (2015) found a high degree of interest rate sensitivity for equity REITs in 2013 and 2014, using daily data. He examined variability in the performance of the price-only version of the MSCI REIT Index relative to Standard and Poor's 500 Index as a function of the ten-year U.S. Treasury note yield.

Other than Shulman (2015), we found that there has been little detailed empirical work focusing on the interest rate sensitivity of REITs in over a decade. Glasscock, Lu, and So (2000) found that REIT returns were most sensitive to returns on small cap stocks. Swanson, Theis, and Casey (2002) found that REITs were more sensitive to the term structure of interest rates than to the level of interest rates. He, Webb, and Mayer (2003) observed that REIT returns were more sensitive to changes in Baa yields than to changes in yields on U.S. Treasuries.

Clayton and MacKinnon (2001) examined the timevarying nature of the relation between equity REIT returns and returns on financial assets, including bonds. Although they do not focus on interest rates per se, interest rate changes obviously were a factor in bond returns. One of their contributions is to acknowledge and measure dynamic interactions among asset classes. …

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