In March 2022, the Federal Reserve launched an increase of the Effective Federal Funds Rate (EFFR), the first since late 2018. Since that time, the Fed raised interest rates seven times, with the most recent effort putting the federal funds target rate between 5.00% and 5.25%.

There’s been some discussion about a potential rate-hike pause, though a recent article in Reuters is casting doubt on this, given continued strong economic data. Still, whenever the Fed stops its tightening cycle, CenterSquare anticipates that this will be good news for public REITs, relative to private real estate and public equities.

In its insights brief entitled “Once the Fed is Done Tightening, How will Real Estate Perform?” CenterSquare analyzed public REIT performances following four rate-hike cycles that took place within the past three decades. The data shows that public REITS outperformed private real estate and public equities in the 90-day, 180-day and one-year periods following the end of Fed rate increases.

This is because when rate rise, public markets “tend to discount rate-sensitive assets such as real estate,” the analysis said. The markets build in an associate risk premium, resulting in a true discount and subsequent upside opportunity when things change. “The steeper the REIT net asset value discount at the end of the rate-hiking cycle, the wider the outperformance of the REIT versus private real estate in the one year that follows,” CenterSquare pointed out.

The brief went on to say that REITs today are trading at 87% of their underlying forward net asset value, which is below the historical average. The reason is because of accelerated repricing due to higher debt costs in the public real estate market. But that repricing has “yet to fully occur in the private market,” the brief commented, “rendering a 15.6% difference in total returns over the trailing 12 months between public and private markets.”

The discounted REIT valuations and changing monetary regime mean that REITs can offer an attractive entry point today, and “are poised to generate meaningful outperformance with a regime change,” CenterSquare said.

Meanwhile, when discussing the relationship between REITs and equities, CenterSquare noted that the cheaper REITs trade versus equities on a multiple basis with a regime change, “the stepper the REIT market outperforms those equities following the end of a rate-hiking cycle.” REITS today are trading slightly cheaper than equities, meaning the potential for “moderate outperformance” compared to the S&P 500 in the 12 months following the end of the current rate-hike cycle.

The brief did acknowledge that historical results aren’t necessarily tied to future performance. However, we do believe favorable fundamentals coupled with balance sheet strength and discounted valuations across the U.S. REIT market sets up an attractive opportunity for investors in listed real estate,” CenterSquare said.