As central banks across the globe raise their rates, REITs are directly affected. But do they benefit or suffer from it ? In theory, there is a whole body of contradictory research to support one point or the other, so it is quite difficult to see clearly. Research includes the white papers of the North American REIT association, NAREIT and S&P global... It is important to note that neither party has any interest in scaring off investors! NAREIT defends its members of course and S&P has a big business of rating REITs... So it's a bit like the projections produced by investment bank analysts: They can't be objective because they have something to sell!

With that in mind, those who say that rate hikes have a positive impact on REITs point out that rate hikes generally occur during periods of economic expansion. They believe that increased activity translates into increased money supply mainly via increased credit, and so inflation must be kept under control.  During an economic expansion, tenants are in good shape, which means rents are well covered. Moreover, there is a strong demand for rental properties, and occupancy rates are at their highest. Of course, the cost of financing increases for the REIT, but as business is booming for all economic agents, real estate companies can pass this on to the rents and thus defend their margins and ensure the ROI of their investments. So much for the positive THEORY.

The looming recession complicates things

We can see that this does not quite correspond to the current situation, as rate hikes are carried out in parallel with the beginning of a general recession, after 15 years of extraordinarily "flexible" monetary policy and irrational exuberance, to use Greenspan's very well-found formula... In addition to the context of economic recession, there is a major shift in several sectors caused primarily by the technological revolution: retail is struggling because of the expansion of e-commerce and offices are increasingly deserted since the pandemic and the rise of home-based work... In short, the current rate hikes do not seem to be part of an economic euphoria, which largely invalidates the above theoretical postulate.

Those who say that a rise in interest rates has an unfavorable impact on REITs are basing themselves on the obvious: this increases financing costs - and therefore reduces growth investments – and this also mechanically reduces the value of the REIT's real estate assets.

On the whole, very capital-intensive industries do not benefit from the increasing IT and this of course concerns REITs. But it is wise to remain humble: Forecasts often say more about those who make them than about what it will really be... Approaching an entire sector only in an empirical and general way is always a bad idea. Not all REITs are equal, first of all because they operate in different sectors, each with its own dynamics and in different markets, with management following different strategies.

There's no one-size formula

As with any business sector, investors interested in REITs must understand the nature of the assets held/managed and the dynamics of their respective markets. They must also assess the financial position, so as to measure the risk involved in case of a recession: debt structure, maturities, hedges, etc. Preference should be given to conservatively financed companies with strategic assets in healthy markets with growth potential and strong rental demand

It's also important to evaluate the history of value creation over the long term, in particular via the FFO/per share rather than the NAV per share which, as experience proves, is of little interest.

Finally, as elsewhere, it is preferable to choose companies where the management is highly invested and has proven its qualities.

Overall, especially in a context of rising rates, it's best to avoid REITs with too much debt, large maturities with close maturities, a large proportion of variable rate debt (you'll be hit directly in the teeth by rising rates), poor assets (such as outdated shopping centers) in difficult markets where rental supply is higher than demand, all managed by a management team that is paid handsomely by the company's shareholders... Distrust in particular of those who have made a lot of dilutive AKs, since they have made growth in turnover and pseudo NAV, but this growth is not reflected in the FFO/share.

So, a lesson in common sense, here as elsewhere in life: beware of postulates and conclusions that are too quick. There is no substitute for an individual case study... Let's keep a cool head without being hypnotized by the often-tempting dividend rates! As Raymond F. DeVoe famously said, "More money has been lost reaching for yield than at the point of a gun."