View of an apartment building in the Chelsea area of Manhattan, New York.
Drew Angerer | Getty Images
Retirees who are worried about inflation driving down the cost of their income may want to check out real estate investment funds.
REITs are companies that own and / or operate real estate such as shopping malls, office buildings, warehouses, and apartment buildings. While they carry more risk than some other income-generating investments such as Treasury bonds, they also have built-in inflation protections, experts say.
“Generally, REITs tend to thrive in times of inflation just because of their ability to raise rents and then transfer that income to [shareholders]- said certified financial planner Marco Rimassa, president of CFE Financial in Cathy, Texas.
As the US continues to recover economic activity before the pandemic, investors are thinking about inflation. Key inflation indicator – price index for basic personal consumption expenditure – increased by 3.4% in May from a year earlier. Another sensor, consumer price index, also jumped 5% last month over the same period.
However, given the state of the economy a year ago – still in agony over the pandemic-triggered halts – Federal Reserve officials view the price spike as temporary.
However, retirees looking for a stable income that will be less affected by inflation may consider using a REIT. Approximately $ 1.5 trillion has been invested in the US REIT, according to Morningstar Direct.
Due to their legal structure, REITs are required to pay shareholders 90% of taxable profit in the form of dividends. These payments are usually made on a quarterly or monthly basis, Rimassa said.
However, not all REITs work the same way, regardless of what happens to inflation.
“It all comes down to the core business,” said Kevin Brown, an analyst at Morningstar. “There are many different sectors and they operate on their own principles.”
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For example, what drives the success of a hotel is different from factors for, say, a retirement home or warehouse.
“You can’t think of a real estate company like any other,” Brown said.
However, since rents and property values tend to rise as prices rise, REITs whose property can benefit from this can provide a hedge against inflation.
For example, hotels can raise room prices, and apartment buildings can more easily raise rents as tenants change. And a higher REIT income usually means a higher dividend payout to shareholders.
REITs whose real estate has long-term leases with tenants – for example, retailers in shopping malls – typically have an annual increase based on CPI movements. However, these rent increases tend to have a limit to how much the jump can occur, which means inflation can outpace the increase.
Nevertheless, according to Rimass, “even if the increase in rents cannot keep up with inflation in the short term, the value of real estate as a whole is still growing.”
The easiest way to access many REITs at the same time is through a mutual fund or exchange-traded fund that invests in these real estate companies. According to Rimass, in terms of portfolio share, about 10% of your shares could go to REIT.
It’s worth noting that if you hold REITs outside of a tax-exempt retirement account, taxing them can get tricky. Generally, dividends are subject to normal income tax rates, although you may receive a pass-through deduction of 20% for some of the income. As this can be difficult, it is worth consulting with a tax advisor.