REITs No Longer Resistant to Rate Increases

By Jerry Knight
Monday, April 17, 2006

Fifteen times in a row the Federal Reserve cranked up interest rates and real estate investors stood their ground.

Despite the conventional wisdom that rising rates are bad for real estate investment trusts (REITs) and home-building stocks, both industries held their own on Wall Street.

Housing stocks were essentially flat for the year's first quarter, and REITs were the best-performing segment of the stock market, with the Standard & Poor's REIT index up 14 percent.

But after the Fed's most recent rate hike on March 28, real estate investments reverted to a more familiar pattern. The S&P home-building index slipped 1 percent since the Fed meeting. The REIT index retreated by 8 percent, wiping out half of the first-quarter gains.

Most of the more than a dozen local REIT stocks have traded lower along with the industry. Not all are down, which suggests investors are looking at the companies on a case-by-case basis rather than as pigs in a poke.

The market clearly is rethinking the role of interest rates, deciding that as they keep inching up, they may matter to the real estate industry after all.

One reason real estate stocks responded differently to the most recent Fed hike is that the bond market finally seems to be falling into step with the Fed's efforts to boost rates. The Fed sets only short-term rates; longer rates are determined by the market, which last year paid little attention to what the Fed was doing.

Last week, however, rates on 10-year Treasury bonds climbed over 5 percent for the first time in almost four years.

That is not high by historical standards, points out James W. Paulsen, chief investment strategist for Wells Capital Management. The Fed has boosted rates "from 'depression lows' back to what only a few years ago would have been considered levels not that much higher," he notes.

Paulsen argues that most people are overestimating how restrictive the Fed's monetary policy is. He figures there is plenty of room for the Fed to boost rates even higher, without hurting economic growth.

Interest rates on long-term bonds are not going up simply because the Fed boosted short-term rates, contends Steven H. East, chief economist for Friedman Billings Ramsey in Arlington.

East says foreign bond buyers -- or the lack thereof -- probably account for the recent increase in bond rates.

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