Since Donald Trump has been elected as the president, something incredible has happened with shares of real estate investment trusts (REITs). Trump has assured to lower taxes and concentrate on pro-business policies, raising expectations among investors that the economic expansion will continue — and maybe even accelerate. Although with rising interest rates and slowing fundamentals in property investments, investors are wary about the future outlook for REITS moving ahead in 2017. But there are some real reasons for optimism and hope.
After the election, the U.S treasury yield has been pushed to above 2 percent from 1.86 percent on Election Day. Despite of this sharp rise in the treasury yield, the REIT shares have not declined in value. The asset class generated a total return of 5.74% from November 8 up to January 9 as measured by the MSCI U.S. REIT Index. The net lease/single-tenant sector was the only sector that was marginally negative. A shift has been observed from longer-duration property types such as the net lease/single-tenant REITs to property types with shorter lease durations.
“An individual investor might ask: Why would I want to invest in REITs to generate income in a higher interest-rate environment? It’s a valid question because higher interest rates raise debt-financing costs, and REITs are known for carrying debt due to their acquisitive nature. Ask investment professionals the question and you get this answer: REITs can do quite well in a rising interest rate environment, so long as rates are going up as a result of a strengthening economy. That seems to be the case now.” Ken Shreve
With the expectations of higher economic growth, the demand for property will go up. This will increase the occupancy rates and will help the landlords to generate more profits. This in turn will assist in taking the share prices of REITS to go up.
The large scale infrastructure development promised by the newly elected Trump administration will likely increase the demand for labor and building material with a resultant increase in their prices. With increased prices, the newly constructed properties will require a higher rate of return to recover the costs which will reduce the pace of new construction. The President elect Donald Trump has made his opinion about U.S. infrastructure clear, pointing out in a Twitter post May 13: “Our roads, airports, tunnels, bridges, electric grid [are] all falling apart.” Trump and the Republican-controlled Congress will have plenty of work to do during 2017, including a fix or replacement, for the Affordable Care Act (Obamacare), as well as tax reform. So it may be a tall order to sell a major infrastructure expenditure bill, but who can disagree that Trump continues to surprise?
Investors may increase their required rate of return with an increase in borrowing costs. Borrowing costs will rise with an increase in interest rates on construction loans and permanent debt financing. Investors will require higher return on equity instead of reducing their risk premium. The result will be a downslide in new construction activity that will give more power to the existing property owners who will be able to earn more revenue and generate more cash from their existing properties. The additional capital obtained may will be utilized for new acquisitions or developments. We are already seeing this in the Canadian real estate market.
The above mentioned positive catalysts are showing signs of improvements for equity REITS moving ahead in 2017. Property rents may will increase to reflect the higher costs of construction and required rate of returns. The development activity for the property sector although will take some time to reaccelerate. The supply – demand imbalances that used to produce the boom and the bust in the sector in the past is going to have little impact as the regulations are much strict now with the advent of modern REITS and commercial mortgage backed security market. All this indicate positive outcomes for the REIT market in 2017.
The bottom-line is that don’t give up on REITs just yet. While there’s some uncertainty about how President-elect Trump’s policies will unfold, it shouldn’t affect underlying strong fundamentals in the REIT sector. Analysts and fund managers point toward an improving economy as a catalyst in the coming quarters.
About the Author: Chris Porteous has significant experience in the financial markets with stints at Goldman Sachs, UBS Securities and DBRS. At DBRS, Chris extensively covered the Mortgage Backed Securities market, Covered Bonds and regulatory changes involved in the real estate markets. Chris currently runs a personal Real Estate Investment Trust with over 15 properties located in South Florida.