To a certain extent, all of the headwinds confronting the asset class are still gusting against the bow of USS REITs but perhaps the 13% decline to start the new year was overdone. Retail REITs still comprise 18% of the Index but sentiment has certainly shifted in favor of the tenants and, by extension, the landlords. The message coming out of RECon, ICSC’s (International Council of Shopping Centers) annual convention, was one of optimism – attendance was lower but mood and deal making was better than in 2017. On June 3, Evercore ISI, a prominent sell-side firm, came out with a research piece titled The “Retailpocalypse” is Over suggesting that retailers are learning to adapt in the digital era, something not priced into their very reasonable valuations. On June 21, The Supreme Court ruled in South Dakota vs. Wayfair, Inc. that states have the authority to make internet retailers collect state taxes, leveling somewhat the playing field between e-commerce and bricks and mortar. All in all, Second Quarter was a good one for retailers and their landlords; while America is still over-retailed, perhaps not every shop is going to go out of business.
As for interest rate sensitivity, since the sharp spike at the beginning of the year, the yield on the 10-Year Treasury Note has been on a steady decline. With the FOMC on a steady course to raise the federal funds rate three if not four times this year, the yield curve has flattened noticeably; the spread between the yields on the 2-Year and 10-Year Treasury Notes has gone from a high of 78 bps in First Quarter to end the Second at 33 bps. While Fed Governor Brainard points out that in the current environment of historically low term premium (defined in a recent Bloomberg article as “the difference between what you get for locking up your money for an extended period and what you
would get if you simply kept rolling over short-term instruments for the same amount of time”), even a modest tightening of monetary policy will lead to a flattening (and even inverted) yield curve, her suggestions are more descriptive than explicative. Why is the term premium heading lower despite the unwinding of the Fed’s balance sheet and prospects for a ballooning fiscal deficit? Whatever the reason, the fact that regulators can take comfort in the one time (out of seven) since 1960 that an inverted yield curve did not lead to a recession smacks of “this time is different” and certainly heightens the risk of policy error. As mentioned in last quarter’s REITView, the stubbornly low yield on the 10-Year Treasury Note does suggest some value for REITs; however, given the continued outflows from dedicated REIT funds, it may be the generalist investors and private equity (think Blackstone/LaSalle Hotel Properties, Greystar/EDR) that may have first mover status in taking advantage.