Tags: Interest | Rates | REIT | invest

Falling Interest Rates Provide Ballast for REITs

Thursday, 31 May 2012 01:18 PM

By Dan Weil

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U.S. interest rates continue to slide amid concern about Europe’s debt crisis and slowing global economic growth. That’s good news for real estate investment trusts (REITs), experts say.

Investors are flocking to Treasury bonds as a safe haven, pushing the 10-year yield down to a record low of below 1.55 percent Thursday.

With the possibility of additional easing from the Federal Reserve and a worsening of Europe’s turmoil, many expect the rate decline to continue. Marc Ostwald, a strategist at Monument Securities, tells The Wall Street Journal that the 10-year yield could drop as low as 1.35 percent.

Editor's Note: The Final Turning Predicted for America. See Proof.

Falling yields help REITs in two ways. First, REITs must borrow heavily to finance their projects, and a decrease in rates makes this borrowing cheaper.

And second, sliding Treasury yields make REIT yields more attractive in comparison. That helps draw investors to REITs, boosting their prices and thus making them more valuable to investors.

“REITs have continued to take advantage of low interest rates to boost earnings and increase dividends for investors,” according to an analysis by Paragon Report, an investment-research firm.

REIT dividends could climb an average of about 6 percent annually for the next five years, producing a dividend yield of 3 to 4 percent and a total return of 9 to 10 percent, Michael Hudgins, a real estate strategist for JP Morgan Asset Management, writes in a report obtained by Barron’s.

To be sure, the huge returns generated by REITs over the past three years mean they “do not currently offer value versus equities,” Hudgins writes.

But dividend growth, U.S. economic expansion and a stronger commercial real estate market “should support positive returns, even while U.S. REITs underperform the broader equity market and, perhaps, international REITs.”

Hudgins sees foreign REITs as a strong investment play now. “The diversification benefits of investing in multiple markets combined with lower levels of company leverage in Asia appears to have a beneficial impact on volatility in the international sphere,” he writes.

Other experts are more enthusiastic about U.S. REITs.

The decline of mortgage rates to record low bodes well for REITs that buy residential mortgages, writes Ry Frank, a former real estate manager, on Seeking Alpha. That includes Annaly Capital Management (Ticker: NLY) and American Capital Agency (AGNC).

The 30-year fixed-rate mortgage hit a new trough of 3.75 percent in the week ended May 31.

New home sales rose 3.3 percent in April, and the dip in mortgage rates could encourage more home buying. That should help REITs such as Hatteras Financial (HTS), AG Mortgage Investment (MITT), and Two Harbors Investment (TWO) that invest in home mortgage securities, Frank says.

Some experts say the strong rental market makes apartment REITs a compelling investment. Royal Shepard of S&P cites Avalon Bay Communities (AVB), Home Properties (HME), Essex Properties Trust (ESS), and UDR (UDR).

“As employment expands, the rental market is tightening,” he writes in a report.

Editor's Note: The Final Turning Predicted for America. See Proof.



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