Utilities and REITs Decouple ⛓️

The usually high correlation between REITs and Utilities has broken down this year on both interest rate concerns as well the view that utilities, especially unregulated ones, will be a beneficiary of AI power demands.

One key factor driving the divergence is the differing impact of rising interest rates. REITs, which often rely on borrowing to finance property acquisitions and development, may see their borrowing costs increase and property values pressured as rates rise. This can weigh on REIT valuations. Utilities, while not immune to rate impacts, tend to have more predictable, regulated cash flows that can provide some insulation. As a result, if interest rates are expected to climb, investors may favor utilities over REITs.

Another potential reason for the breakdown in correlation is the growth outlook, particularly surrounding AI power demand. The rapid growth of AI and data centers is driving significant increases in electricity consumption. Unregulated utilities that can capitalize on this increased demand may see outsized growth and profitability improvements. REITs, while potentially benefiting from leasing to technology tenants, may not see as direct a benefit from AI power needs. This difference in the perceived AI-driven growth prospects could lead investors to assign higher valuation multiples to select utilities compared to REITs.

Additionally, sector-specific dynamics could be at play. Within the REIT space, the impact of remote work on office demand and changes in housing markets could reshape growth prospects for certain REIT subsectors. In the utility space, the mix of energy sources (e.g., renewable adoption), regulatory changes, and regional dynamics could create divergences among utility companies. These unique, sector-specific narratives may be driving investors to differentiate between REITs and utilities, breaking down the typical correlation in the process.