REITs Up Over the S&P 500 and the Russell 2000 Last Week

The good news, REITs as a category have been doing well of late. According to BTIG Research, as of last Friday, they were up 4.2%. That compares with 3.6% for the S&P 500 and 4.0% for the Russell 2000 stock indexes.

But then there was this statement: “With significant inflation measures on tap for this week’s economic calendar (CPI prints on Tuesday, and PPI prints on Wednesday), rates are likely to be in focus again for REIT.”

And the CPI prints—more commonly called inflation numbers—that came out on Tuesday were brutal to expectations. Even with oil down, most everything else was up. Core inflation, without food or energy, hit 6.3%, growing double the rate economists had expected. Basics hammered consumers. Food was up 0.8% month over month. Shelter grew at 0.7% month-over-month. Transportation was up 0.5% from July to August.

This is pretty much a guaranteed 75-basis point increase in the benchmark interest rate when the Fed meets next week, with a 1 percentage point jump possible.

Normally, inflation can be good for REITs, according to a Nareit post early in 2022. “REITs have historically provided protection against inflation and outperformed the broader stock market during periods of moderate and high inflation,” the firm said, where it defines moderate inflation as between 2.5% and 7.0% and high inflation being more than 7.0%.

But then there are interest rates and the Fed has been aggressive in pushing them up to slow economic growth and push inflation back to around 2%.

“REITs as a sector have substantially cleaned up their balance sheets since the GFC,” BTIG says in its report. “However, the weighted average rate on REIT debt is at an all-time low in 2022, as is the ratio of interest expense to NOI. This sets up a risk to estimates and results if rates continue to climb.” Which they will.

“Indeed, rates have been so low for so long, and have had so many false starts, we think there is a risk that interest expense has become anchored in consensus estimates,” the firm continued. “For context, the current forward curve for SOFR shows an average rate in 2023 of 3.84%, before accounting for any credit spreads. Thus, the average 1-month rate in 2023 is higher than the current weighted average rate for total REIT debt across the sector. This will present a headwind for unhedged variable-rate balances and potential volatility for external growth as buyers are forced to recalibrate their financing expectations.”