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REITs: Playing Defense in an Uncertain Market

Despite the recent rise, U.S. interest rates are expected to remain historically low in the near term, which we view as a plus for real estate in general

Morningstar Equity Analysts 11 April, 2017 | 16:34
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Morningstar's real estate coverage looks fairly valued, trading at a 3% aggregate discount to our fair value estimate. Investors should continue to be particularly discriminating, as we expect actions by the new administration, as well as potential for increased central bank interest-rate activity throughout the remainder of the year, to continue to affect property and capital markets activity, asset pricing, and overall volatility in the near term.

As the new administration settles in, details surrounding proposed policy changes are still vague. Speculation regarding potential trade policy, healthcare reform, infrastructure spending, and general deregulation, among many other matters, had the markets hitting all-time highs on the increased expectation for overall economic growth while also sending 10-year U.S. Treasury yields beyond 2.6% by mid-March.

Upward movement in Treasury yields, often used as a benchmark for real estate valuation, and interest-rate expectations have thus hurt REIT share prices over the quarter. Given the circumstances, many investors continue to wonder whether we are near the peak of the commercial real estate cycle; higher interest rates could put pressure on growth rates, cap rates, return expectations, and ultimately asset prices. Also, to the extent that low interest rates have diverted investor funds to REITs searching for higher yield and capital preservation, the same funds could flow out of REITs if interest rates rise, further pressuring commercial real estate valuations.

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About Author

Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.

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