Markets & Economy

Since the U.S. recession ended in 2009, the real estate sector has outperformed the broader equity market. The MSCI US REIT Index has returned over 20% on an annualized basis versus the S&P 500’s 15% return. Further, Real Estate Investment Trusts (REITs) have been the best performing asset class in the market over the past 15 years, returning an average of 12% per year. Meanwhile, valuations remain in line with their historical average, providing plenty of opportunities for discerning investors.

The question on many investors’ minds today is whether or not this outperformance can continue in the event that U.S. Federal Reserve policymakers proceed with their rate hike campaign. Investors are concerned that rising interest rates will lead to increased borrowing costs and constrain activity in the sector. The real estate market is complex, however, and dependent on many factors for its growth. Property supply and demand, the housing market, and retail activity all play a role.

Indeed, some of the intrinsic characteristics of REITs are likely to contribute to a link to interest rates. REITs pay out the majority of revenue as income in the form of dividends, and often need to borrow in order to improve or purchase properties. When rates rise, income generated by a REIT may become less attractive, and rising rates may mean increased borrowing costs for REITs.

At the same time, there are reasons that REITs can achieve favorable investment returns in a rising rate environment. REIT returns depend on a diverse set of economic drivers, and may perform well in a rising rate environment if corresponding to an economic expansion or if benefiting from an inflationary trend. Additionally, REIT returns are the product both of income and capital appreciation. In contrast, bond returns have historically been more a function of income than capital appreciation, and as a result beginning yields are the primary determinant of future bond returns, making the link between bonds and interest rates much stronger.

One additional consideration is that the sensitivity of REITs to interest rates has tended to change over time, and has recently been more elevated. Sensitivity may be higher when investors are emphasizing the income component of REITs, and closely comparing REITs to other yield-oriented sectors of the market such as bonds and dividend paying stocks. It is expected that at times, rates will be influential in the REIT market, and this may be particularly true when there is a sharp increase in yields over a short period, or when investors are focusing on the current yield of REITs. Historically, REITs often underperform stocks when rates rise sharply, or over short periods such as a month or quarter when rates are rising. However, over more drawn out, gradual periods of rising rates, REITs and stocks have performed more similarly, as seen in the table below.

While the current income produced by REITs may be particularly important to investors with ongoing withdrawal needs, REITs are principally growth-oriented securities. Over the long-term, investors should consider not only current income, but also future income and growth, which will depend substantially on a diverse set of factors in addition to interest rates. As such, the rationale for investing in REITs likely goes beyond expectations for interest rates in the future, and should be based on the growth and income needs of the investor, as well as considerations of diversification from a total portfolio perspective.

For more information about any of the Manning & Napier Fund, Inc. Series, you may obtain a prospectus at www.manning-napier.com or by calling (800) 466-3863. Before investing, carefully consider the objectives, risks, charges and expenses of the investment and read the prospectus carefully as it contains this and other information about the investment company.

Sources: FactSet, Morningstar.

Returns for periods greater than one year are annualized.

All investments involve risks, including potential loss of principal. Investment in real estate, including REITs, is subject to risks associated with the direct ownership of real estate: interest rate risk, liquidity risk, and changes in property value, among others. Additionally, investments concentrated in a specific industry or sector may be less diversified and subject to a higher degree of risk than the overall market. There is no assurance or guarantee that companies which issue dividends will declare, continue to pay, or increase dividends.

Morningstar, Inc. is a global investment research firm providing data, information, and analysis of stocks and mutual funds. ©2017 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.

The MSCI U.S. Real Estate Investment Trust (REIT) Index is a free float-adjusted, market capitalization-weighted index that is comprised of equity REITs that are included in the MSCI U.S. Investment Market 2500 Index, with the exception of specialty equity REITs that do not generate a majority of their revenue and income from real estate rental and leasing operations. The Index represents approximately 85% of the U.S. REIT universe. The Index returns do not reflect any fees or expenses. The Index returns are net of withholding taxes. They assume daily reinvestment of net dividends thus accounting for any applicable dividend taxation. Index returns provided by FactSet.

The S&P 500 Total Return Index is an unmanaged, capitalization-weighted measure of 500 widely held common stocks listed on the New York Stock Exchange, American Stock Exchange, and the Over-the-Counter market. The Index returns assume daily reinvestment of dividends and do not reflect any fees or expenses. Unless otherwise noted, Index returns provided by FactSet. S&P Dow Jones Indices LLC, a subsidiary of the McGraw Hill Financial, Inc., is the publisher of various index based data products and services and has licensed certain of its products and services for use by Manning & Napier. All such content Copyright © 2017 by S&P Dow Jones Indices LLC and/or its affiliates. All rights reserved. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and none of these parties shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.

¹REIT returns data is reflective of the FTSE NAREIT All Equity REITs Index, which is a free-float adjusted, market capitalization-weighted index of U.S. Equity REITs. Constituents of the Index include all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property.

²Stock returns data is reflective of the S&P 500 Total Return Index.

³Bond returns data is reflective of the Ibbotson Associates SBBI U.S. Intermediate-Term Government Bond Index, which is an unmanaged index representing the U.S. intermediate-term government bond market. The index is constructed as a one bond portfolio consisting of the shortest-term non-callable government bond with no less than 5 years to maturity. The Index returns do not reflect any fees or expenses.

The Manning & Napier Fund, Inc. is managed by Manning & Napier Advisors, LLC (Manning & Napier). Manning & Napier Investor Services, Inc., an affiliate of Manning & Napier, is the distributor of the Fund shares.