As the economy improves, the Federal Reserve continues to normalize interest rates. This may feel new to investors who have navigated declining rates for the last 30 years. So, what’s the next step? After a period of uncertainty, markets have started pricing in these increases, so investors must adapt.
Bond and equity markets typically face obstacles as rates rise. Real estate, however, has the potential to perform well in this environment. During the last prolonged interest rate increase, from 2004 to 2006, REIT stocks outperformed equities. Real estate also held its own against fixed-income assets, like U.S. Treasuries and corporate bonds, during periods of rising rates.
Why is this? Let’s look at apartments as an example. In a growing economy, potential buyers have more capital, but may shy away from buying because of higher mortgage rates. As these potential buyers become renters, vacancy rates may fall, and rents may increase. These rents have the potential to generate income for investors.
As rates begin to rise, real estate may suffer from short-term shocks, but the downturn is typically brief, if rates are climbing with a growing economy. That’s because real estate starts trading on positive real estate fundamentals, instead of interest rate reactions. And today, those fundamentals are strong. Supply growth remains mainly moderate, rent growth remains positive, and vacancy rates remain low.
The outlook for real estate is promising, even as we start navigating today’s rising interest rates.