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By Dave S. Gilreath, CFP
Investors worried that rising inflation might hurt their stock portfolios probably should consider real estate investment trusts (REITs), because some types of this investment tend to do well in this environment.
REITs are a way to get exposure to various types of real estate without the hassle of actually owning property. Unlike actual real estate, REIT shares are highly liquid because they are traded on major exchanges. As alternative investments, REITS can add diversification to portfolios of traditional investments — stocks and bonds.
These are landlord companies that own and lease out commercial, industrial and residential properties. Nervous investors who feel that owning regular stocks is like betting the farm might think of REITs as owning the farm.
Their dividends are substantial because of a special tax status requiring them to pay out at least 90% of their income. This dividend income is almost bondlike in its reliability but much higher than bond yields — often 4% to 6% and sometimes more.
Although dividends alone are a great reason to own REITs, these investments should nonetheless be evaluated like stocks, assessing factors that could push share prices up or down. Just because you are getting regular produce from the farm does not mean you should not consider selling it for a profit someday.
The stock market is worried that rising inflation will prompt the Federal Reserve to reduce the economic stimulus that has been fueling the market since spring 2020. However, REITs are not directly correlated with the stock market and they tend to do well amid rising inflation because these companies can raise rents to avoid loss of real revenue.
In addition, they have a good record of performance during periods of rising interest rates. So if the Fed raises rates, an increased allocation to REITs can bring protection. Currently, REITs are generally undervalued, as indicated by a wide spread between REIT yields and Treasury bill rates.
Although some types of industrial REITs soared through the pandemic, others — commercial, residential, office and hospitality properties — suffered. REIT revenues are increasing as the economy reopens, but many in this category remain a good buy because they suffered when consumers were not going to retail stores, patients were postponing elective medical procedures and routine doctor visits, tenants had trouble paying apartment rents, companies needed less office space and the hospitality industry ground to a virtual halt. These scenarios have resulted in ample room for growth now that things have reopened. Increasing demand for these spaces is likely to drive up REIT revenues and share prices.
Here are the outlooks for some categories of REITs that suffered from quarantining and are starting to recover:
Retail: Online shopping had hit brick-and-mortar stores hard before the COVID-19 pandemic, but malls’ death at the hand of Jeff Bezos is greatly exaggerated, especially now that they are open again and filled with shoppers. Increasing demand for this space will increase rents. Examples: Realty Income Corp., which owns a wide range of retail properties, from drugstores to movie theaters, and Simon Property Group, owner of most shopping malls you have ever visited.
Medical: Because leases of medical facilities, nursing homes and surgical centers tend to be long term, the pandemic did not push down these rents much. But investors’ presumption that this would happen punished share prices, nonetheless. Some of these REITs are still bargains. Now that elective surgeries are happening again and patients are no longer paranoid about their providers, already-committed space is once again undergoing brisk use and expansions are no longer unthinkable. Examples: Physicians Realty Trust, Omega Healthcare Investors and Healthpeak Properties.
Apartments: During the pandemic, these REITs suffered the double whammy of unpaid rents from laid-off tenants and moratoriums on eviction. But with these issues mostly behind them, these companies can resume reaping benefits from the national shortage that benefitted them before the pandemic. The nation needs about 2 million new homes a year, apartments among them, and few were built during the pandemic. Demand pressure is also coming from young adults seeking liberation from their parents’ basements now that they can get public-facing jobs again. The steeply rising cost of single-family homes, from general demand and a spike in the price of lumber, will mean staying in apartments longer to save for down payments. Examples: Vornado Realty Trust (one of the biggest) and AvalonBay Communities.
Offices: Demand for office space naturally went off a cliff in spring 2020 when many offices issued a work-from-home edict. Although vaccinations are rising rapidly, many companies have not fully reopened. Some believe that many workers will never return to the mother ship, choosing instead to stay home (if they have the choice) and teleconference, but many managers are extolling the benefits of face time: spontaneity, camaraderie, esprit-de-corps, one-on-one interactions and the insights and creativity they foster. To the extent that companies value this face time, current demand for office space will grow rapidly. Examples: Boston Properties, an owner of office buildings and campuses nationwide, and SL Green Realty Corp., a dominant company in New York City.
Hospitality: Occupancy rates at many hotels are rising due to increased personal travel. Although business travel remains slow, it is expected to increase in the coming months. In the meantime, prices of hotel REITs remain depressed, meaning some good deals for investors with faith that business travel will return. In casinos, gamblers are returning in droves.
Examples: Host Hotels & Resorts, which eliminated its dividend in June but is likely to reinstate it, and VICI Properties, which owns real estate for gaming and entertainment, including various casino properties in Las Vegas.
As business improves at indoor public places, landlords owning this property and their investors through shares of these REITs will ultimately benefit.
David S. Gilreath, a certified financial planner, is a 40-year veteran of the financial service industry. He is the chief investment officer of Sheaff Brock Investment Advisors LLC, which handles portfolios for individual investor clients, and Innovative Portfolios, an institutional money management firm. Based in Indianapolis, the firms manage over $1 billion in assets from clients nationwide.