10 year treasury yield over 3%

With the 10 year treasury yield ticking back up over 3%, this may be a good time to review how this impacts REITs, but let us first look at the nature of the rise.  The Fed does not directly control the ten year treasury yield, instead controlling the Fed Funds rate.  Over recent quarters, they have consistently hiked this rate each quarter.

Source: SNL Financial

While it does not directly control the short end of the curve, it tends to move in tandem with these increases.  For quite some time, the short end of the curve was rising while the 10 year yield remained low, resulting in significant flattening.

Source: SNL Financial

Fear of inversion was starting to weigh on the broader market, but recently, the long end of the curve finally began responding.  Note how the current yield curve is actually quite a bit steeper than that of 1 month ago.

In recent years, movements in the 10 year yield have triggered an inverse response in REITs.  When the 10 year treasury yield move up, REIT market prices drop.  However, this price drop has been increasingly short lived.  REITs are still dropping on the day the 10 year treasury yield rises, but often REITs are bouncing back the following day.  Note how there is only a loose spread between REIT yields and the treasury yield.

Source: SNL Financial

The widening and shrinking of this spread indicates that REITs are trading on other factors, more than on interest rates.  Ultimately, I think they will decouple entirely which is healthy for the REIT market.

Fundamentally, rising rates are a mixed bag for REITs.  Higher treasury yields hurt REIT NAV, but improve REIT growth.  Given the roughly 8% discount to NAV at which REITs currently trade I think investors are well prepared in the event the 10 year yield goes as high 3.50%.

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