Senior Housing REITs to Feel the Impact of Rate Hikes in 2017

As expected, the Federal Reserve updated its policy to effectively raise short-term interest rates Tuesday, and said it will impose as many as three rate hikes in 2017. Senior housing real estate investment trusts (REITs) saw swift losses, despite the decision coming as no surprise.

Fortunately, the impact of the announcement is unlikely to negatively impact REITs in the long term, but how some of the biggest players in the senior living industry will act in 2017 is still up in the air as interest rate hikes are due to come at a faster pace.

‘Vote of Confidence’

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The Central Bank expects the economy “will continue to perform well” as part of its reasoning for increasing the number of potential rate hikes in 2017 from two to three, Federal Reserve Chairman Janet Yellen (pictured above) told reporters following the announcement.

The policy aims to increase the federal funds rate 25 basis points before the end of the year, bringing the federal funds rate to 0.5% to 0.75%. Future increases will also be “modest” and “tiny adjustments,” Yellen said.

The decision comes at a time when indexes have continually reached new all-time highs in anticipation of the incoming Trump administrationwhat some have dubbed the “Trump Rally.” While indexes took an immediate hit after the announcement, the Dow Jones Industrial average remains just below a value of 20,000, a milestone that would signify the fastest ascent of the index in history, according to MarketWatchThe decision to raise rates should be taken as a “vote of confidence” in the U.S. economy, Yellen said Tuesday.

When the Fed increased short-term rates a year ago, the impact on REITs contributed to fewer acquisitions for the first part of the year. In the third and fourth quarter, several large deals were announced from the biggest senior housing real estate owners, including HCP Inc. (NYSE: HCP), Welltower (NYSE: HCN) and Ventas Inc. (NYSE: VTR).

Heading into 2017, higher rates will again increase the cost of capital and potentially put a damper on new deals, as REITs could take on a wait-and-see attitude.

“In the near term, I think we will see a slight slowdown in M&A activity,” Chris Honn, senior management director/head of seniors housing at real estate services company Berkadia, told Senior Housing News. “I think it will be temporary, as everyone watches the markets.”

However, with the potential for three more interest rate hikes to come in succession next year, efforts to finance deals quickly is also a possibility.

“[We could also see] folks decide to finance quicker,” Honn said. “[Before] there was no incentive for a borrower to borrow, and folks were willing to take their time to get their financing closings. That’s not going to happen anymore with rates going up.”

In the short term, REITs may feel a sting in their share prices. However, REITs can still be bullish of their business, says Rick Matros, CEO and chairman of the board of senior housing REIT Sabra Health Care REIT, Inc. (Nasdaq: SBRA)

“The impact is on stock price, which can affect cost of capital obviously, so that would be the concern,” Matros told SHN. “That said, pricing on assets should adjust to any change in cost of capital, so the business will continue to grow. There will be some lag there, though.”

Justin Hutchens, CIO and incoming president of HCP, also said there should be a lag, during a recent Senior Housing News webinar.

Inflation, if tied to overall economic growth, could benefit asset classes like senior housing, Hutchens said. And the impact of rising interest rates probably is not a “near-term consideration” as much as one that’ll play out over the longer term, in conjunction with other economic forces. He does not believe cap rates, for example, will rise “in lockstep” with interest rates.

Rising Tides Lift All Boats

Historically, REITs have taken an immediate hit once interest rates spike, but they typically perform well in higher interest rate environments, according to NAREIT. Though REIT share prices may see a blow, the long-term response is likely to be positive because rising rates are an indication of a stronger economy.

The Federal Reserve has kept several economic benchmarks in mind when deciding its change its policy and effectively raise short-term interest rates, including lower unemployment rates, rising wages and higher inflation rates.

As of November, unemployment rates reached their lowest point since August 2007, at 4.6%, according to the Labor Department. The labor market strength adds to the conviction of the Fed’s decision to raise interest rates, Beth Burnham Mace,  chief economist for the National Investment Centers for Seniors Housing & Care (NIC) wrote at the beginning of December.

“Our decision to raise rates is certainly to be understood as a reflection of the confidence we have in the progress the economy has made, and our judgment is that progress will continue and the economy is remarkably resilient,” Yellen said Tuesday.

As the Fed shifts away from its stimulus policy, with interest rates hovering near zero, to a more neutral policy characterized by low rates, it is thought that REITs will likely still benefit.

“History shows that share prices of listed equity REITs have often increased during periods when the Fed shfits from a stimulative to policy stance to a neutral position,” according to NAREIT. “For example, listed equity REITs posted a cumulative total return of nearly 80%, outperforming the S&P 500, when the Fed raised its target for short-term interest rates from 1% to 5.25% in 2004-2006.”

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However, history doesn’t seem to be repeating itself as the Fed makes moves this time around, according to a recent brief from NAREIT. Equity REITs, which include senior housing REITs, have had a four-month downturn in returns.

“REIT returns underperformed the broader equity market in November as investors concerned with rising rates shifted assets out of REITs and other income-oriented investments,” the brief read.

As the S&P 500 gained 3.7% during the month, equity REIT indexes mostly dropped, according to NAREIT. The divergence of equity REITs from other parts of the market is “difficult to explain,” Brad Case, senior vice president for research and industry information, said in a recent interview on REIT.com.

“If you look at historical data that has proven to be very valuable in terms of predicting REIT returns…they’re all very bullish,” he said. “I can’t understand why investors have not seen the value in the REIT space, especially after these four consecutive months of negative returns have really put REITs in sort of inexpensive, cheap territory.”

However, now that rates on are the rise at a faster pace, activity could pick up.

“My experience has been that volatility in interest rates creates activity,” Honn said.

Other economic fundamentals suggest that REITs stand to gain in 2017, irrespective of the rising rate environment. As a needs-driven real estate asset class, senior housing could also be shielded from changes in demand and oversupply concerns should activity pick up across asset types.

“Given that senior housing has shorter-term leases than most commercial real estate, it should theoretically fare better under rising inflation expectations than other property types, although any meaningful pickup in economic activity, should it happen, would arguably be less beneficial to demand than other property types given that the industry largely caters to need-driven residents,” Michael Knott, analyst with Green Street Advisors, told Senior Housing News.

Written by Amy Baxter

Photo credit: “The Fed’s New Year’s resolution” by Day Donaldson, CC BY 2.0

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