Swedroe: Rising Rates Don’t Doom REITs

December 09, 2015

As we have discussed many times, much of the “conventional wisdom” on investing is simply wrong. For our purposes, we can define conventional wisdom as those ideas that become so commonly accepted that they go unquestioned. Today we’ll look at the idea that rising interest rates would doom returns to real estate investments, specifically the returns to real estate investment trusts (REITs).

This assumption, that returns from REITs will indeed tank if interest rates rise, is one I have been hearing a lot about lately as people speculate on the future actions of the Federal Reserve and projections for short- and long-term rates. This speculation seems to have reached even higher pitch (it that’s possible) ahead of the Dec. 16 meeting in which the Fed is expected to decide to raise interest rates.

As regular readers of my books and blog posts know, my writing isn’t based on my personal opinions, or anyone else’s for that matter. Instead, it is built upon findings from academic research, data and the historical evidence. However, before we dive into the data on interest rates and REIT returns, there’s an important point we have to cover, and that’s the difference between information and value-relevant information.

Information Vs. Value-Relevant Information

If you have information you think should impact the market—unless it happens to be inside information, on which it’s illegal to trade—that information is already embedded in the market’s prices. Thus, if the market expects interest rates to climb, the impact from rising interest rates is already reflected not only in the current yield curve, but also in the prices of REITs. It’s already too late to act on such information, because while it may be important information to have, it’s not “value-relevant” information.

To see evidence of the market’s expectation regarding rising interest rates, just examine the current yield curve. It’s about as steep as the historical average, with the difference between one-month bill rates and 10-year Treasurys now at about 2.3%.

With this understanding about the difference between information and value-relevant information, we can now turn to the evidence on the relationship between interest rates and REIT returns.

The Relationship Between REIT Returns And Interest Rates

To determine whether the conventional wisdom on the relationship between REIT returns and interest rates is correct, we can check the historical correlation of the returns between the Dow Jones U.S. Select REIT Index and five-year Treasury bonds.

For the period January 1978 to October 2015, the monthly correlation of returns was actually a positive 0.076. If we look at quarterly correlations, for the period January 1978 through September 2015, the correlation was 0.089. The semiannual correlation for the period January 1978 through June 2015 was even lower, at 0.023. And the annual correlation from January 1978 through December 2014 was lower still, at just 0.019. With correlations of close to zero, there’s really no basis for the belief in the conventional wisdom that rising rates are bad for REITs.

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