Interest Rate Scare Slams REITs

Only 9 trading days ago the REIT index (Vanguard REIT ETF NYSE:VNQ) that we follow as a proxy for the entire Real Estate Investment Trust market hit a new 52 week high and now, in a blink of an eye (or 3 days), the index has fallen by 5%.

In our opinion the REIT sector was overheating again as investors continued to turn over every rock they could in a search for yield. It was in February, 2015 that the REIT sector reached an all time high before falling 25% in the next 6 months.  As is usual in all stock markets prices move to extremes on pure momentum before falling to more reasonable values.  Unfortunately many less sophisticated investors aren’t prepared for these moves and in the end they carry out a “buy high and sell low” transaction as they panic at any whiff of a correction.  For instance many investors were no doubt buying REIT giant Realty Income (NYSE:O) because of the safety that comes with owning a blue chip company. Unfortunately on the 10th of May O was trading at $64.22 and today (Thursday) shares traded as low as $58.50-near a 10% loss in 9 days.  We understand that a newbie income investor might panic and sell at the low, but at this moment there is no reason to believe that the shares will keep tumbling.  The shares may turn around and head higher tomorrow so maybe adding more shares is a better answer than panicking and selling out?  On the other hand some of the more financially dicey REITs such as Ashford Hospitality Trust (NYSE:AHT), which announced reasonable earnings just 2 weeks ago (and which we have written about in the past here) has fallen 16% which is more disturbing and the levered balance sheet is obviously a concern to common shareholders.

The impetus for the move lower in REITs is that investors decided  that the FED may move on interest rates in June.  Nothing new here–June has been on the table.  Sure there was more concrete evidence that the rate may be moved higher, but NEVER was it taken off the table that we are aware of except by some of the talking heads. In the end you have to play the hand that you are dealt and that means some disruption in the income markets.

It wasn’t only REITs that took a shellacking this week.  Preferreds and exchange traded debt were marked down by about 1% (on average).  Like REITs the prices on these shares had been driven higher than reasonable (at least in our opinion) been by desperate yield seekers.  This is hardly a disaster for investors, in fact a correction in pricing is desirable as nothing grows to the sky and we would prefer minor corrections to massive panics (although we are prepared with some cash if there is a massive panic).

Our Blended Income Portfolio is off .8% from where it was a week or two ago which was better than many other benchmarks, but like all investors we would prefer to not incur losses.  Fortunately we take these setbacks in stride and understand that share prices had been on a hot streak for a number of months.  While we have cash available for purchases when shares go on sale, the sale prices right now aren’t to our liking. We want the “blue light sale”, the sale with the 20 or 25% off sticker, not a run of the mill 5% off sale.

We recommend that investors sit back and not panic or bail out of the market based on short term moves.  Obviously if you are holding securities that are poor quality you need to evaluate these and see if they will hold up in a higher interest rate environment.  For instance mREITs will be hurt further if the FED funds rate moves up and longer term rates (i.e. 10 year treasury) remain flat as the “spread” will continue to narrow putting the squeeze on income. Of course eventually the income squeeze could pressure the preferred shares as investors begin to worry about longer term viability.  Each investor has their needs and hopefully they have positioned themselves to serve their needs.