REIT sensitivity to Interest rates : Evidence from the United States
Kaisko, Mikko (2022-11-21)
21.11.2022
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi-fe2022112166379
https://urn.fi/URN:NBN:fi-fe2022112166379
Tiivistelmä
This paper studies the interest rate sensitiveness of real estate investment trusts (REITs) in the United States market. The interest rates have started to rise after a historically long period of trendline declining interest rates. This should in theory impact the cost of debt capital for new investments and thus the total value of the investment as real estate is traditionally a highly levered asset class. Also, this market situation is unique because the interest rates are increasing at a much faster pace than forecast because of the rapidly rising inflation rates.
The rising interest impacts the cash flows of real estate assets which is one of the two main sources of value creation during the holding period in real estate investing. The other is value increase through yield compression. With higher monthly costs of debt through interest payments, the total value of investment decreases as the cash flow diminishes. Not only is inflation causing the phenomenon of diminishing returns and value for real estate investments but also increases the operational expenses and thus impacts the cash flows. Therefore it is also important to understand how well real estate investments perform against inflation and how much are they impacted by changes in interest rates.
The hypotheses of this study are tested by using the Generalized AutoRegressive Conditional Heteroskedasticity (GARCH) test’s specification model, the GARCH-in-the-mean (GARCH-M). The data will be derived from the U.S markets as it is viewed as the most efficient market and the largest REIT market and thus should be the best representation of the current market situation. REITs performance will be measured by the MSCI US REIT index, the interest rate proxy will be U.S. 10-year treasury yield and the S&P 500-index is used as the public market proxy. The data is daily level data and the periods of study are 2015-2022, 2015-2022, and 2021-2022.
The results indicate that REITs are not strongly sensitive to the daily changes in interest rates. The conditional variances do correlate with each other and thus there were statistically significant results that indicate the correlation. Strong evidence was found between overall market condition sensitiveness to REITs.
The rising interest impacts the cash flows of real estate assets which is one of the two main sources of value creation during the holding period in real estate investing. The other is value increase through yield compression. With higher monthly costs of debt through interest payments, the total value of investment decreases as the cash flow diminishes. Not only is inflation causing the phenomenon of diminishing returns and value for real estate investments but also increases the operational expenses and thus impacts the cash flows. Therefore it is also important to understand how well real estate investments perform against inflation and how much are they impacted by changes in interest rates.
The hypotheses of this study are tested by using the Generalized AutoRegressive Conditional Heteroskedasticity (GARCH) test’s specification model, the GARCH-in-the-mean (GARCH-M). The data will be derived from the U.S markets as it is viewed as the most efficient market and the largest REIT market and thus should be the best representation of the current market situation. REITs performance will be measured by the MSCI US REIT index, the interest rate proxy will be U.S. 10-year treasury yield and the S&P 500-index is used as the public market proxy. The data is daily level data and the periods of study are 2015-2022, 2015-2022, and 2021-2022.
The results indicate that REITs are not strongly sensitive to the daily changes in interest rates. The conditional variances do correlate with each other and thus there were statistically significant results that indicate the correlation. Strong evidence was found between overall market condition sensitiveness to REITs.