CONTRIBUTORS
Daniel Scher
Portfolio Manager, Research Analyst
Franklin Equity Group
Blair Schmicker, CFA
Portfolio Manager, Research Analyst
Franklin Equity Group
Amid recent market disruptions and heightened risk aversion, interest rates remain significantly lower following a series of central bank rate cuts that began in 2024. With the potential for further reductions due to slowing economic growth, global real estate investment trusts (REITs) could be a particularly attractive asset category. In this paper, Franklin Equity Group portfolio managers Daniel Scher and Blair Schmicker emphasize the historical outperformance of REITs following rate cuts as a compelling reason to consider allocating to this asset class.
Key takeaways:
- Historical outperformance: Historically, REITs have typically outperformed during and following—periods of declining interest rates.
- Lower federal funds rate: The Federal Reserve has cut rates three times since September 2024, setting the current federal funds rate at 4.25% to 4.5%, with the potential for additional cuts in the latter half of 2025 and 2026.
- Gradual easing bias: Many central banks, including the European Central Bank, Reserve Bank of Australia and the Bank of Canada, are maintaining a gradual easing bias due to slowing economic growth. Additional rate cuts are being considered in response to recent tariff-driven market disruptions.
REITs & rates: Understanding the connection
While REITs have historically performed well following declines in short-term interest rates, long-term rates have had the most significant impact on their returns. The correlation between slowing economic growth and declining long-term rates has historically driven REIT outperformance, with several factors contributing to this relationship:
- Economic outlook: Long-term rates reflect investor expectations regarding economic growth and inflation. Today’s lower rates reflect expectations for a global economic slowdown. REITs can serve as a defensive allocation, given the visible contractual nature of the income stream.
- Valuation: The 10-year US Treasury yield serves as a benchmark for discounting future cash flows from REITs. Lower rates have historically made future REIT cashflows more attractive, enhancing valuations.
- Cost of capital: REITs typically finance their operations with long-duration debt. Lower long-term rates reduce the cost of capital, improving profitability.
- Dividends: REIT dividend yields are often compared to long bond yields (the interest rates paid on 10-year US Treasury bonds). In lower rate environments, REIT dividends may become more attractive.
Conclusion
We believe further declines in interest rates could create tailwinds for global REITs. In our view, their historical outperformance, driven by factors such as economic outlook, valuation, cost of capital and dividends, makes them particularly attractive in the current lower interest-rate environment. Given the heightened risk aversion and potential for further rate cuts from central banks around the world, global REITs could offer stability and strong returns, making them a valuable addition to investment portfolios.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
Real estate investment trusts (REITs) are closely linked to the performance of the real estate markets. REITs are subject to illiquidity, credit and interest rate risks, and risks associated with small- and mid-cap investments.
Risks of investing in real estate investments include but are not limited to fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by local, state, national or international economic conditions. Such conditions may be impacted by the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, and environmental laws. Furthermore, investments in real estate are also impacted by market disruptions caused by regional concerns, political upheaval, sovereign debt crises, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Investments in real estate-related securities, such as asset-backed or mortgage-backed securities are subject to prepayment and extension risks.
Dividends may fluctuate and are not guaranteed, and a company may reduce or eliminate its dividend at any time.
The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
WF: 4422064