REIT share prices, like the broader stock market, have been sensitive to changes in the outlook for interest rates, including both the short-term rates set by the Federal Reserve and the long-term rates that are governed more by market forces. In the current inflationary environment, the Federal Reserve has signaled it will be increasing short-term rates throughout 2022 to address concerns about inflation.
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Historically, REITs have performed well during periods of rising long-term interest rates with average four-quarter return in periods with rising rates of 16.55% compared to 10.68% in non-rising rate periods from the first quarter of 1992 to the fourth quarter of 2021. Additionally, REITs outperformed the S&P 500 in half of the periods when Treasury yields were rising. The positive association that has historically been observed between periods of rising rates and REIT returns is consistent with an improvement in the underlying fundamentals.
Market interest rates typically increase during periods when macroeconomic conditions are strengthening, the same strengthening that often drives positive REIT investment performance. Strengthening macroeconomic conditions typically lead to higher occupancy rates, stronger rent growth, increased funds from operations (FFO) and net operating income (NOI), rising property values and higher dividend payments to investors. While a Fed tightening cycle due to inflation creates additional uncertainty about whether the correlation between REIT returns and long-interest rates will remain positive, it is noteworthy that REITs have historically outperformed during periods of above average inflation.