A common market sentiment is to assume higher interest rates automatically spell bad news for real estate. Debt becomes more expensive, affecting real estate returns, and Treasury yields start to look attractive in comparison to real estate yields. If higher rates slow economic activity more broadly, that can trickle down and affect demand for space.
But some new analysis from Nareit, looking over the past 30+ years, finds that while interest rates, of course, do affect the market, commercial real estate has generated yields in both high and low interest rate environments and that public REITs, in particular, have outperformed.
It’s the first of several pieces of research Nareit plans to publish in the coming days and weeks looking at the effects of interest rates on real estate as the market grapples with the Fed sending signals that it may not lower its target rates and with 10-year Treasury yields still in the mid 4% range.
In other REIT news, the FTSE Nareit All Equity REITs index started the year on a positive note, posting total returns of 1.03% in January. Gains by industrial (total returns up 10.13%) and healthcare REITs (4.21%) helped offset a drop for data center REITs (down 4.87%) that largely seemed like a response to uncertainty to the AI market introduced by the DeepSeek model, which may change the calculus and reduce some demand for future data center space.
WealthManagement.com spoke with Edward F. Pierzak, Nareit senior vice president of research, and John Worth, Nareit executive vice president for research and investor outreach.
This interview has been edited for style, length and clarity
WealthManagement.com: Start with January results. What stood out to you?
John Worth: January was a very solid month in terms of total returns, just over 1% for the month. That has continued into February, with REITs sitting up on year-to-date basis about 2% for the all-equity index. When we look down to property sector performance, the best-performing segment in January by far was industrial and logistics, which were up over 10%, after a tough performance down almost 18% in 2024.
Healthcare REITs were up 4.2%, following a strong 2024 when they were up 24%. That’s continued into February, with healthcare REITs up 6.5% on a year-to-date basis. Other strong performers were Timberland REITs, which were up more than 8%, which followed a weak 2024 with those REITs down over 16%.
In terms of underperformance, the most notable was data centers, which were down 4.9%. That was really a reflection of the news of DeepSeek and investors trying to understand what the follow-on effects to data center and chip demand were going to be.
It’s worth noting that data centers bounced back in February and trimmed losses, so they are now down 2.7% year-to-date. One thing that will be interesting to see is that, to date, not much of the client base for data center REITs is from AI direct demand. There is some prospective demand built into valuations, but it’s not affecting current operations.
WM: That’s an interesting point. I suppose it’s good to remember that data centers do a lot of things, from cloud computing, to serving content, etc. AI was seen as an additional demand driver, but not the only area of demand. And even if DeepSeek has an effect of making AI more efficient, that doesn’t mean potential demand goes away, it just be a bit less. Is that fair?
JW: A lot of analysts have looked and said that this might temper enthusiasm for the amount of demand for bandwidth and processing power that you thought before DeepSeek, but, on balance, demand is still higher than it was a year ago. Even if DeepSeek’s promises are going to play out as predicted, there is still going to be enhanced demand for data centers and processing power.
Ed Pierzak: Green Street had a recent conference call, and I liked their analogy: If you look at demand and previously thought it was the equivalent of an extra-large pizza, assuming everything pans out with DeepSeek, that means demand will drop to a large pizza.
JW: The broader data center story is about digitization—the amount of our daily lives, business activity and GDP that is digital in one form or another. All of that flows through data centers. Of the data centers that are in the public real estate space today, not much of that square footage is doing what we could call AI processing. It’s very much a broad line of business.
WM: Pivoting back to another sector, was there anything that drove the substantial industrial number for the month? Was there something specific that triggered that, or was it more of a market recalibration?
JW: Industrial as a broad sector had a couple of years of historically good returns in terms of rent growth, and that was followed by historic supply increases, and then slower rent growth. January was a recalibration of where we are in terms of supply and demand.
EP: I agree with John’s point. Ultimately, even if you look at fundamentals, you have seen there had been a softening, but overall occupancy and rent growth remained positive. It certainly was not a situation where the industrial market was challenged.
JW: The rent growth was slower than it was before as the market is consuming the supply that was generated. The general sense from REITs who have reported earnings so far is that have had an optimistic outlook for the rest of the year.
WM: And with healthcare REITs?
JW: The strong performance of healthcare REITs was mostly driven by the seniors housing component. It continues to be an interesting story of what it means for a sector when you have a real slowdown in supply, what you might see a few years later. In terms of senior housing, there was very little supply starting in 2020 to 2022. As demand has reactivated for that sector and occupancies have gone up, you’re seeing the impact of low supply as demand steps back to normal levels, and returns have been quite good. Today, we’re not seeing a lot of new starts across a number of sectors, and that could have some implications down the road in terms of REIT returns that mirror what we’re seeing in healthcare REITs today.
WM: Ed, you also have a new piece out analyzing REIT performance in different interest rate environments. Can you talk about that?
EP: When we finished last year, the 10-year yield was starting to ramp up. At the beginning of 2024, it was 4.1%, and we saw it escalate as high as 4.8% before retreating a bit to around 4.4% today. As we saw that rise in a short period of time, we got a lot of reactions from investors who were worried and wondered how it could impact REIT performance and, more broadly, real estate performance.
This is the first of several pieces we will publish on interest rates and REITs. We took the analysis back to 1992, the start of the modern REIT era. In that historical context, current interest rates are not particularly high—they were middle of the pack in that period.
The challenge we have is that over the last decade, we have been in a low interest rate environment—11 years with sub-3% 10-year treasury yields. A lot of times, there’s this kneejerk reaction that if rates are going up, cap rates are likely to go up, and valuations are going to go down.
But that’s very much an oversimplification. A lot of factors can offset the higher rates.
We looked at performance on average and put them in three buckets, or tertiles. There are low-yield years (with rates between 0.89% and 2.91%), mid-yield years (2.95% to 4.63%) and high-yield years (4.80% to 7.09%).
What we found is that REITs have performed quite well across the board. There are positive returns in all instances, and REITs have outperformed private real estate in all instances as well. If you look at different average REIT total returns and average private total returns, they are all positive, but as we go from low to high tertiles, the spread gets larger.
In the lowest instance, the spread is 1.64%; the middle category is 3.65% and the high group is 5.5%. I think, in some ways, we hope that investors see this, and it alleviates some concerns about a higher rate environment. It shows that real estate can perform well across the board. When we talk about REITs, more specifically, they are well positioned.
This is telling folks a few things. No. 1, yields are higher than in the not-too-distant past, but that said, they are not that high. But depending on when you started your career, you may not have seen higher rates. In addition, just because there are higher rates, that does not have to equate to weak performance. Real estate can perform well across the board.
