Research

Our View on Fed Lift-Off and the US REITs

Richard Anderson
Managing Director, Americas Research
December 17, 2015

MIZUHO SECURITIES USA INC.  |  US EQUITY RESEARCH

Summary

The Fed's decision to raise short-term interest rates this week came too early, according to MSUSA Chief Economist Steve Ricchiuto, and it could prompt increased risk that the US economy will eventually fall into deflation. While it may take time for this thesis to fully sink in, the consequences for the US REIT market could be quite positive based purely on the idea that lower (not higher) longer-term interest rates will showcase the REIT dividend yield in an incrementally more positive light. Longer-term, we expect positive commercial real estate fundamentals to begin steering the ship.

Key Points

Questionable Economy: At-trend US GDP growth in the 2.0% to 2.5% was doing so at zero interest rates, while declining oil prices and a strong dollar are keeping a wide distance between current inflation and the 2% target. It is hard for us to see how raising rates now helps either of these metrics. It is true labor markets are firming, but the quality of jobs remains a question, as do several other economic indicators such as retail sales and the housing market.

Curve Flattens? If we are right about the weight that lift-off will have on the economy, then a flattening of the interest rate curve would be a likely consequence -- a declining 10-year Treasury yield based on deflation fears and continued appetite for yield from foreign investors. This should resonate positively with the income orientation of the US REITs (average dividend yield of 3.8%, or about 160bps above the 10-year Treasury).

Transition to Fundamentals as the Key Driver to REIT Performance: While day-to-day volatility will likely enter into the equation, we see this interest rate trade relative to the REITs playing out over the next 2 to 3 months. Afterwards, we believe generally positive real estate fundamentals (i.e., manageable supply growth) across the continuum of the commercial real estate sectors, will become the main determining factor in REIT stock performance. All of this assumes any negative implications on the US economy are within a reasonable band, and don't overwhelm the positive demand trends that are currently in place. As with any external force, the scale of the change is the main risk from the US REITs perspective.

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