Interest rate risk of Australian REITs: A panel analysis

Australian REITs adopt either internal or external property management structures. The sector's returns have been rewarding until the Global Financial Crisis, when rising costs of debt and years of aggressive borrowing eroded REIT values. Externally managed trusts had relatively higher levels of debt than internally managed counterparts, thus increasing the sensitivities to interest rate risks. Yet internally managed REITs engage in a wider set of operating activities which compound market and financial risks. This study uses panel and panel quantile regressions to examine the joint impact of financial leverage and management structure on REIT returns in terms of their sensitivities towards the stock market and changes to interest rates from 1980 to 2013 and how these vary at different parts of an economic cycle. It is found that the impact of market returns is greater for internally managed REITs and those with more debt. REITs are only negatively affected by changes to short-term interest rates at the lowest 5% quantile of returns. Changes to long-term interest rates have an adverse effect on REITs only at the upper 75% and 95% quantiles. The possibilities that rental yields and inflationary expectations may offset the influences of financing costs are considered. Internal management appears to compound the effects of the stock market and interest rates on REIT returns. This has implications for investors looking to select REITs as substitutes for direct property investments.