Stock indexes hit records as market anticipates rate cut. Here’s what that means for real estate

It’s a 180-turn from the start of the year when many analysts expected rate hikes

Jul.July 12, 2019 02:40 PM
(Credit: iStock and chart via MarketWatch)

(Credit: iStock and chart via MarketWatch)

After Federal Reserve Chairman Jerome Powell hinted at an impending interest rate cut, stock indexes hit record highs Thursday — and real estate is going along for the ride.

At a congressional hearing this week, Powell said global uncertainty “strengthened the case for a somewhat more accommodative policy.”

The Dow climbed after, closing at an all-time high of over 27,000 Thursday. The S&P 500 also set a record, closing at 2999.91. The Real Estate Select Sector SPDR Fund, an index which tracks real estate management and development companies as well as REITs, saw a midweek uptick following Powell’s comments. (This followed a gradual selloff after the Fed’s June policy meeting, in which officials signalled possible interest rate cuts, and another sharp drop off last week after the jobs report was released.)

John Guinee, a REIT analyst at Stifel, explained the selloff and subsequent rally as a simple, consensus rule: “REITs do well in a declining interest rate risk-off environment. Conversely, they do very poorly in a risk-on rising interest rate environment,” he said.

“This feels very much like the second quarter of 2016, which was pre-Brexit,” he added. “Essentially you’ve got a lot of things on peoples’ minds worldwide and income-oriented hard asset stocks do well and where REITs are right now does not surprise us one bit.”

The broader situation is a bit of a contradiction for real estate — the potential for a near-term rate cut means the Fed isn’t confident in the economy but lower rates mean cheaper debt. It’s also an about-face from the Fed’s previous plans to raise rates this year.

REIT analysts say that the strong economic data — an increase of the consumer price index in June and strong July jobs report — and the expectation of rate cuts bode well for REIT stocks. The industry has already seen a strong year on the stock market, with a quarter of the 32 real estate companies on the stock market in June reaching their highest levels of the year.

“If you look at jobs, what businesses are doing, what consumers are doing, everything is still positive,” said Alexander Goldfarb, an analyst at Sandler O’Neill, “but the longer you go in an economic cycle, you’re going to have normal oscillation of economic data, and not everything is going to be great all the time.”

“So the market is grappling with that,” he continued, “but with interest rates going lower and real estate fundamentals remaining healthy, then the stocks are going to do well, and you’ve seen that.”

Goldfarb said that compared to the beginning of the year, when it was widely believed the Fed would look to hike interest rates, “the backdrop is more favorable” now for REITs.

John Kim, a REIT analyst at BMO Capital Markets, said the year has exceeded his expectations with the availability of cheaper capital, a good economy and now the prospect of lower interest rates.

“Entering the year we thought there would be refinancing that would be more expensive, certainly real pressures on cap rates going forward,” he explained.

Kim admitted that the Fed’s concerns about a coming recession was on his mind, but he maintains confidence in REIT stocks.

“I certainly fear that’s going to slow down but the fundamentals for most asset classes are kind of peaking or near their peaks,” he said.

Kim described the risk-reward ratio for REITs as “pretty compelling” for investors and attributed that in part to supply for most asset classes has been “relatively in check.”

Guinee said most people would describe the overall U.S. equity market as stretched “because there are so few other opportunities out there that make sense.” And within that market, REITs are known as “very defensive,” he added.

But what if interest rates don’t get cut? “We think it lasts until it doesn’t,” said Guinee.

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