REITs: The Income Seeker’s Inflation Antidote

Best in class real estate investment trusts offer investors compelling value in an uncertain environment.

“Buy land. They’re not making it anymore.”

That quote is commonly attributed to Mark Twain, the pen name of Samuel Clemens. And what he said more than a century ago is still pretty good investment advice today.

Despite the best efforts of central bankers around the world, inflation is still running stubbornly high. And as I pointed out in my Substack post a week ago, rising interest rates have strengthened its key long-term drivers: Nearly a decade of lagging investment in natural resources and the expensive ongoing shift in global supply chains.

Real estate investors win with elevated inflation because land values consistently rise faster than prices of other goods and services. The main question now is what to own and the best way to buy it.

One of the easier ways to own property is to buy real estate investment trusts or REITs. These are companies set up to own property under a corporate structure that provides extensive tax advantages. Those savings allow REITs to pay dividends at the top end of the investment spectrum, and regularly increase them.

In past decades, REITs focused solely on owning traditional properties such as retail shopping malls, apartments and office buildings. That’s still primarily the case for the 85 names currently in my REIT Sheet coverage universe.

But current recommendations also include owners of casino properties, data centers, telecom infrastructure and laboratories, as well as warehouses, farmland, self-storage centers and resorts/marinas. And there’s a growing cohort of business development companies organized as REITs, one of which is America’s fastest growing lender and investor in small-to-mid-size efficiency and renewable energy projects.

Each of these property types has its unique economics. But all of them also have one thing in common: The assets they specialize in are on track on gain considerable value over the next decade. And these REITs are structured for the purpose of paying dividends, so investors will share the wealth every step of the way.

REITs trade as common stocks, typically NYSE or Nasdaq. So unlike when you buy an actual property or a partnership, you can trade them as often as you like. There are also plenty of REIT-focused ETFs, though you’ll do better picking out a portfolio of individual companies, especially from a yield standpoint. The iShares U.S. Real Estate ETF (NYSE: IYR), for example, currently yields just 1.83 percent.

I advise a REIT investment strategy based on four cornerstones. First, stick to the best in class and avoid companies that weaken as businesses. Invest fresh money only when a REIT trades at a good entry point. Be willing to take profits when REITs trade at what have historically been unsustainable valuations. And never load up on any one company, no matter how attractive.

Following those guidelines is particularly important in a market environment like this, where there are wide divergences in REITs’ business and share price performance. The iShares ETF is up about 3 percent this year including dividends paid. But inside that number are office REITs down close to 50 percent, and on the other side data center owners pumped up by AI adoption hype.

I’ve advised avoiding the office sector since the pandemic, the only exceptions being REITs specializing in businesses where attendance is mandatory like laboratories. We’ve already seen several major crackups of former leaders, for example Vornado Realty’s (NYSE: VNO) elimination of its dividend this spring. And with businesses downsizing space to a new home/office work model, there’s more disruption ahead.

I also believe investors should steer clear of conventional seniors housing REITs. These appear to have sustained lasting reputational damage from the pandemic. And I’m increasingly wary of data center REITs as well, which to profit from artificial intelligence will need to be able to bill customers to finance extremely costly upgrades.

It’s hardly surprising that financial REITs are a frequent topic at our monthly Capitalist Times webchats—as some pay yields upwards of 10 percent. But investors should generally avoid this group as volatile interest rates and credit pressures put dividends at risk.

Fortunately, there’s plenty of value elsewhere. For example, there’s still very solid business momentum at shopping center REITs. This group has taken some hard hits during previous recessions. And though the US economy still hasn’t officially slipped into one, investors have punished their stocks over the past year and a half in anticipation of one.

I’ll be wary of a recession and a corresponding stock market selloff so long as the Federal Reserve keeps raising interest rates. But barely two years removed from a pandemic that forced retail malls to actually close their doors, the retail REIT sector is fairly defensive, particularly owners of grocery anchored centers Kimco Realty (NYSE: KIM).

Rents are still rising, occupancy is near full, collection rates are near 100 percent and balance sheets are strong. And at the same time, valuations are quite low, providing the best in class an opportunity to expand on the cheap with acquisitions.

Those same factors have also made this the best of times for industrial REITs as well. These companies today are enjoying a warehouse boom, spurred by booming global e-commerce. Yet, because investors remember past recessions, the highest quality players are actually ripe for purchase, and poised for big gains the next few years.