The rising interest-rate environment and an aging real estate cycle have taken a toll on the performance of real estate investment trusts (REIT) in 2017. In fact, since the beginning of the year through Dec 22, 2017, the industry has underperformed the broader market, as indicated by the FTSE/NAREIT All REITs Index’s total return of 7.7% over this time frame versus the S&P 500’s 22.2% gain.
In addition, the Fed’s recent decision to hike benchmark interest rates by a quarter point to a target range of 1.25-1.5% along with the tax reforms remain the biggest near-term challenges for REITs heading into 2018. Since REITs are heavily dependent on debt for acquisitions, development and redevelopment, higher interest rates raise the debt-financing costs and impact the profitability from such endeavors. Also, since REITs are seen as bond substitutes, amid a rising rate environment, dividend paid to investors might appear less attractive.
Furthermore, with corporate taxes being significantly slashed, the valuation premium, which REITs previously enjoyed on account of tax advantages, shrinks. Specifically, lower taxes are anticipated to accelerate earnings growth for the broader markets but the same might not be beneficial for REITs.