How REITs React to Monetary Policy Changes
Real Estate Investment Trusts (REITs) have long been a popular investment vehicle, offering exposure to real estate markets without the need to directly own property. But how do these assets respond to shifts in monetary policy? Are they as interest rate sensitive as people believe? In this article, we break down the findings of a recent paper by Carlo Rosa in the Journal of Real Estate Finance and Economics that explores the nuanced relationship between REITs—both equity and mortgage-based—and monetary policy changes announced by the Federal Reserve.
Key Insights: Types of Monetary Surprises
The research categorizes monetary surprises into three types:
- Target Rate Surprises: Unexpected changes to the federal funds target rate.
- Forward Guidance: Unanticipated shifts in the Fed’s future rate expectations.
- Large-Scale Asset Purchases (LSAPs): Surprises regarding the Federal Reserve’s large-scale purchases of assets, often used when interest rates are near zero.
By analyzing high-frequency Exchange Traded Funds data from 2000 to 2022, the study highlights that these monetary surprises have profound effects on REITs, though the type and magnitude of impact vary between equity and mortgage REITs.
Equity vs. Mortgage REITs: Different Sensitivities
The study found that equity REITs (eREITs), which primarily invest in physical properties, are highly sensitive to both target rate changes and unconventional monetary policy tools like forward guidance and LSAPs. For instance, a 25-basis-point cut in the federal funds rate could increase equity REIT prices by about 2%. This is because lower rates reduce borrowing costs, boosting the profitability of property ownership and management.
On the other hand, mortgage REITs (mREITs), which invest in mortgage-backed securities, react differently. They rely heavily on leverage, meaning changes in interest rates can greatly affect their financing costs. The study shows that while mREITs are significantly impacted by target rate changes, they are less sensitive to LSAPs compared to eREITs. This distinction is crucial for investors who hold mREITs, as these assets carry more exposure to interest rate risks than their equity counterparts.
Volatility Around Fed Announcements
Monetary policy announcements, especially from the Federal Open Market Committee (FOMC), cause a significant increase in REIT price volatility. According to the study, volatility spikes immediately following FOMC announcements and remains elevated for about an hour afterward. This suggests that traders quickly adjust their positions in response to new monetary policy information, driving sharp price movements.
Are REITs Just Like Stocks?
Interestingly, the study finds that during periods of monetary policy announcements, equity REITs behave much like common U.S. stocks, especially those in the S&P 500. Their returns are heavily influenced by overall stock market movements. In contrast, mREITs maintain distinct sensitivities to interest rate changes, differentiating them from traditional equities. For investors, this means that equity REITs may offer less diversification from stock market risk during times of monetary uncertainty, while mREITs provide exposure to more unique risk factors, especially in relation to interest rates.
The Bottom Line for Investors
For those invested in REITs, it’s essential to understand how monetary policy shifts can impact these assets. Equity REITs may benefit from rate cuts and unconventional monetary easing, while mortgage REITs’ sensitivity to interest rate hikes and leverage makes them more volatile and risk-sensitive.
As the Federal Reserve continues to navigate economic challenges, staying informed about how monetary policy impacts different asset classes—like REITs—can help investors make more informed decisions about portfolio allocation and risk management.
This research underscores the importance of paying close attention to Federal Reserve announcements, especially if you’re heavily invested in real estate through REITs.
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Franklin Carroll
Franklin Carroll is Kukun's VP of Modelling and Analytics; After finishing his studies at the University of Chicago, he worked at Fannie Mae where he helped build Collateral Underwriter, roll out the Value Verify initiative, and specialized in collateral related and credit related policy.
Published September 12, 2024
