Third Quarter 2017 is the fifth in a row that the Wilshire US REIT Index has underperformed the S&P 500 Index, an unprecedented losing streak based primarily on the assumption that deregulation and tax cuts at home and a broad based economic recovery abroad will jump start an economy (and earnings) in its eighth year of expansion, leading to outsized benefits for the tenants rather than the landlords. The sharp rally in the S&P 500 Index is somewhat surprising in the face of geopolitical turmoil and dysfunction in Washington D.C.; when interviewed on Bloomberg Television, the newly minted Nobel Laureate in Economics, Richard Thaler, stated, “We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping; I admit to not understanding it.” Most likely, bond investors are having trouble understanding the equity market rally as well. Once the euphoria of the 2016 election wore off, the yield curve has actually been flattening with the spread in yield between the 10-Year Treasury Note to the 2-Year going from a high of 135.5 bps on December 22, 2016 to a low of 76.3 bps on October 16, 2017.

Yet, despite these signals from the bond market and a lack of a clear consensus among the members of the Federal Open Market Committee on their own inflation expectations, Chair Yellen and her cohort seem determined to begin the long path to balance sheet normalization and to gradually remove monetary accommodation; current odds of a rate hike in December stand at 76.7%.  Certainly the hawks on the Committee were emboldened by the October Employment Situation Summary released by the Bureau of Labor Statistics which showed another tick down on the unemployment rate to 4.2% and a 2.9% increase in average hourly earnings for the past 12 months.

Given the intention of the FOMC to normalize its balance sheet and to tighten policy, albeit slowly, it is surprising to see the yield on 10-Year Treasury Note continue to decline. Perhaps some caution on the equity market euphoria is in order. And, while the 2.4% return on the Wilshire REIT Index pales in comparison to the 14.2% delivered by the S&P 500 Index, year-to-date, the underperformance has certainly made the REITs more attractive in terms of relative valuation. REITs are still projected to deliver positive same-store NOI growth for 2017 and aggregate construction as a percentage of total stock remains well below the historical average. Trading at double digit discounts to private market valuations (and thus attractive to private equity investors who are flush with cash), what is not to like about REITs except for potentially misplaced concerns about interest rate sensitivity?