What Happens to Real Estate When the Fed Raises Rates?
The Federal Reserve seems likely to raise interest rates in December, barring a collapse in the economy. How will that affect real estate?
Despite its reluctance to raise the federal funds rate in September, the Federal Reserve seems likely to raise interest rates in December, barring a collapse in the economy. In the past, when interest rates have risen, real estate as a whole has tended to underperform, but that may not be the case this time around.
“U.S. real estate will probably trade off a bit [when the Fed raises rates], but Latin America will probably be relatively cushioned against any policy move,” said Jamie Anderson, managing principal of Tierra Funds.
Part of the reason the Federal Reserve, led by Janet Yellen, has been so reluctant to raise interest rates is the effect it would have on global markets, particularly in light of the economic volatility seen in Europe, following Brexit. “The Committee continues to closely monitor inflation indicators and global economic and financial developments,” the Federal Open Market Committee stated in its September 21 release.
Looking further out, Anderson thinks U.S. real estate, in particular real estate investment trusts, will have more time to adapt and adjust, since the Fed is likely going to take a longer time frame to adjust to normal policy — in this case two to three years — easing the pressure on real estate. “The risk for U.S. REITs is investors may not get the appreciation they’ve seen over the past one to two years — dividend growth will be there and you can get a decent coupon, but there may not be a lot of upside,” Anderson said.
Real estate finally has its own sector in the S&P 500, which gives the $2 trillion asset class a clearer and more transparent way to benchmark. It’s not a one-size fits-all category, and some parts are likely to be less sensitive to a rate hike, chief among them, multi-family real estate.
“Multi-family real estate is going to be a little less reactive to interest rate changes because it’ll provide a better bump in rents as the economy gets better,” Anderson explained. The Vanguard REIT ETF (VNQ) holds residential REITs in its portfolio as well as commercial and specialized REITs. VNQ may also continue to outperform because of its exposure to the industrial economy, which because of the nature of the business, is more closely tied to the global economy and can surpass some of the interest rate-tied headwinds seen in other portions of real estate.
Conversely, areas that are more sensitive to interest rate rises, such as malls, are likely to underperform, Anderson explained, because of “an increase in the cost of capital which will be another headwind for an already struggling sector.”
Other areas around the globe, including the Middle East and specifically Turkey, are quite interesting to Anderson because of young demographics. “Any country that has favorable medium or long term demographics is going to be very good for real estate,” Anderson said.