The Capitol Spectator on the Fed’s campaign to raise short term interest rates. While noting some contradictory evidence, the Fed’s statements speak for themselves:

In fact, the bond market can take heart in the realization that the Fed yesterday effectively announced that it would keep raising interest rates until the economy slowed. And with Fed funds futures contract for next May currently priced at 4.725%, that’s a threat that some are taking seriously.

Due to these Fed rate hikes interest-sensitive sectors, like REITs, are becoming increasingly controversial investments. Nicholas Yuliko at RealMoney.com reports from the NAREIT convention that many attendees were downright bearish due in large part to higher long-term interest rates.

It’s the “most uncertain time for REITs in five years,” said Ken Rosen, chairman of real estate hedge fund Rosen Real Estate Securities, in a morning session Thursday. He said it is likely REIT stocks will decline 20% on average in 2006, hurt by rising long-term interest rates.

Rosen projects the yield on the 10-year Treasury could hit 5.5% or 6% by the end of next year. He recommends investors start hedging their real estate positions by either selling short or selling off some holdings. His hedge fund is currently 20% short residential mortgage REITs and homebuilders (which are not REITs) and 80% long apartment and office REITs.

Rosen admits he likes many REITs’ fundamentals, but he expects rising interest rates to significantly dampen the sector’s attractiveness as a yield investment. He also said that even though most REITs aren’t directly tied to the single-family housing industry, REITs across all property types will suffer if the national housing bubble deflates because of investors’ psychological association between REITs and anything that is tied to real estate.

There are very few market sectors more sensitive to interest rates. As noted there is little evidence yet that the Fed intends to either pause or end its campaign of higher rates. REIT investors should keep this in mind.

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