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For retirees searching for investment income and protection from inflation, one solution may be real estate investment trusts.
REITs, as they’re called, are companies that own and/or operate properties like office buildings, shopping malls, apartment complexes and warehouses. While they do come with more risk than some other income-producing investments — such as Treasury bonds — they pay dividends and can be strong performers in inflationary environments.
“Generally, REITs tend to do well in times of inflation, just because of their ability to increase rents and then pass that income on to [shareholders],” said certified financial planner Marco Rimassa, president of CFE Financial in Katy, Texas.
Inflation has become a central concern for investors, with the consumer price index — which measures the cost of a wide-ranging basket of goods and services — up 6.8% in November from a year earlier. This marks the fastest pace of inflation since 1982.
Roughly $1.6 trillion is invested in U.S. REITs, according to Morningstar Direct. Due to their legal structure, REITs are required to pay out 90% of their taxable income to shareholders in the form of dividends. Those payments typically are made quarterly or monthly, Rimassa said.
The average dividend yield on REITs is in the neighborhood of 3%, according to October data from industry group NAREIT. That compares to the 1.42% yield on the bellwether 10-year Treasury bond.
So far this year, the Morningstar U.S. REIT index has posted a 33.3% return. That compares to a 27.2% gain in the S&P 500 Index year to date (through Nov. 10).
However, not all REITs perform the same, regardless of what inflation is doing.
“It comes down to the underlying business,” said Kevin Brown, a Morningstar analyst. “There are a lot of different sectors and they operate on their own fundamentals.”
For example, what drives a hotel’s success is different from the factors for, say, a senior housing facility or warehouse space.
“You can’t think about a real estate company as being similar to every other one,” Brown said.
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Yet because rents and property values tend to increase when prices do, the REITs whose properties are able to capitalize on that can provide an inflation hedge.
For instance, hotels can boost room prices, or apartment buildings can push up rents more easily as tenants turn over. And higher REIT income generally means bigger dividend payments to shareholders.
REITs whose properties strike longer-term lease deals with tenants — for example, retailers at shopping malls — typically have annual increases built in that are based on the movement of the consumer price index. However, those rent hikes also tend to have a limit to how big of a jump can occur, which means inflation could outpace those increases.
Nevertheless, Rimassa said, “even if rent increases are not able to keep pace with inflation in the short term, the property values generally are still increasing.”
The easiest way to get exposure to many REITs at once is through a mutual fund or exchange traded fund that invests in those real estate companies. From a portfolio share standpoint, about 10% of your stock allocation could go to REITs, Rimassa said.
It’s worth noting that if you hold REITs outside of a tax-advantaged retirement account, their taxation can get tricky.
Generally, the dividends are subject to ordinary income tax rates, although you may be able to take a 20% pass-through deduction on some of the income. Because it can be complicated, it would be wise to get guidance from a tax advisor.