As a result of the Federal Reserve's unprecedented money-printing operation over the last couple years to alleviate the fallout from the financial crisis, U.S. interest rates have stayed close to zero. But rates will rise at some point, that much is clear.
Are low interest rates good or bad for businesses and the economy as a whole? Well, there are always two sides to the story. Low interest rates are certainly good for companies, giving them relief on the financing side of their businesses. If their debt capital becomes much cheaper, businesses have more money left to invest in operations and fund shareholder dividends and buybacks.
On the other hand, low interest rates signal an economy that is still not growing strongly. Interest rates usually rise when inflation increases, and inflation goes up when demand for workers and products goes up.
Rising interest rates indicate the economy is going the right way. This is usually a good sign for businesses, which can reasonably expect to increase their revenues and earnings in the foreseeable future.
Equities and real estate are particularly attractive investments in an economic expansion characterized by rising interest rates. Shares of publicly traded real estate investment trusts are also a promising way to play a recovery in the U.S. economy, which could see higher inflation and interest rates in the years ahead.
I think one investment in particular stands out for investors who expect rising interest rates in the coming years (I certainly do!), but want to bet on attractive upside potential nonetheless.
The case for American Realty Capital Properties
American Realty Capital Properties (NYSE:VER) is an interesting, diversified REIT with 4,429 properties in its real estate portfolio and has grown explosively over the last couple of years. ARCP's investment portfolio now encompasses a whopping 99.1 million square feet.
American Realty Capital Properties' real estate portfolio breaks down like this: 62%, retail and restaurant properties; 23%, office properties; and 15%, industrial properties. Its most recent portfolio occupancy rate stood at a fantastic 99.8%, and the REIT relies on long-term lease contracts with its tenants.
Long-term leases significantly reduce cash flow and vacancy risk, making American Realty Capital Properties a high-quality choice in the REIT sector.
American Realty Capital Properties has also embarked on an extensive acquisition spree since 2012, which has catapulted the company to the forefront of the REIT industry: ARCP now has a market capitalization of approximately $11 billion, which makes it even larger than the previous sector champion, Realty Income.
The company performs well when compared against other commercial REITs and has a competitive diversification profile: ARCP's 10 top tenants account for roughly 31.3% of the REIT's base rent compared to a ratio of 37.1% for Realty Income and an average ratio of 35.8% for the commercial REIT peer group consisting of ARCP, Realty Income, National Retail Properties and W.P. Carey.
The lower the top tenant ratio, the lower ARCP's dependence on its top tenants, which in turn significantly reduces the REIT's cash flow risk.
In addition to a solid value proposition in terms of property diversification, size, and portfolio metrics, American Realty Capital Properties convinces with competitive debt characteristics compared to its peers.
Slightly over 90% of ARCP's debt is fixed-rate, which insulates the company from rising interest rates for the foreseeable future. At the same time, ARCP continues to benefit from a comparatively low weighted average interest rate of 3.7%, giving the company a competitive advantage over its sector peers.
With a weighted average interest rate of 3.7%, ARCP fares much better than National Retail Properties and Realty Income, which both exhibit a rate of 4.8%, or W.P. Carey, whose weighted average interest rate stands at 4.6%.
American Realty Capital Properties makes an attractive value proposition all around: The company has transformed itself into an industry leader that should be able to capitalize on stronger growth and higher prospective demand for commercial real estate.
The company should also benefit from higher revenue from renting its properties and higher property valuations when the U.S. economy regains its momentum.
Moreover, ARCP's leverage profile puts it at a competitive advantage compared to its closest peers, which should allow for above-average earnings growth.
The Foolish takeaway
Rising interest rates are a characteristic of a growing economy. Real estate assets should benefit handsomely from broad-based economic growth, and an industry leader like American Realty Capital Properties should see significant appreciation potential in its underlying property portfolio.
Furthermore, if rental income and cash flow continue to increase in a cyclical upswing, this REIT should be able to reward shareholders with higher dividends. The company now offers investors an initial dividend yield of 8.4%.
Kingkarn Amjaroen owns shares of American Realty Capital Properties and Realty Income. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.