Op-ed: Real estate investment trusts may provide inflation protection for investors

After being hobbled by the pandemic recession, real estate investment trusts are rebounding rapidly, and the economic recovery isn’t the only thing driving growth this year.

Share prices are rising from demand rooted in investor concerns about inflation and the potential for rising interest rates. As a result, the S&P U.S. REIT Index is one of the best performing parts of the stock market this year, up 27.9% through July 27.

While some types of REITs weren’t even nicked by the pandemic — including cell towers, data centers and marijuana properties — those that rely on people congregating were crushed by quarantining: retail stores, medical space, apartments, hotels and office buildings.

But this year, these REITs have grown apace from highly beneficial market conditions.

Rising construction costs are limiting the growth of leased space, giving existing properties a competitive edge. And to keep up with inflation, these landlords are using their standard tool of so-called escalator clauses to raise rents automatically in long-term leases.

These conditions make REITs especially appealing for investors concerned that continued inflation may lead to rising interest rates, significantly lowering valuations of some stocks. Thus, REITs are an alternative investment useful for diversifying equity portfolios.

The performance of these companies this year gives them new allure as a option for share price growth, in addition to their longstanding appeal of substantial dividends  — a good reason in itself to own them. A special tax status requiring payouts of 90% of profits to shareholders results in dividends as high as 4% to 6% (and sometimes higher), making them an attractive alternative to bonds in this period of rock-bottom bond yields.

While share prices in most categories are up substantially this year — for example, retail and residential, by more than 33% — others, such as hotels and offices, are in earlier stages of rebounding. Yet, these and other categories still have room to grow.

Here are the current scenarios for these categories:

• Retail REITs are up 35.9% in the first half of this year. Though online retailing was hurting bricks-and-mortar stores well before the pandemic, declarations of shopping malls’ doom from Amazon seem overstated now that mall foot traffic is increasing from pent-up demand. And ironically, Amazon is now leasing some of the mall anchor stores it’s credited with killing off, using them for last-mile delivery hubs. Category examples: Simon Property Group, the largest mall group in the country, and Realty Income Corp., which owns a wide range of retail properties.

• Apartments are up 37.7%. With tenants going back to work and moratoriums on evictions over, these REITs are positioned to benefit from rising demand. The nation needs about 2 million new homes a year, apartments among them, and few apartments were built during the pandemic. Occupancy rates are currently high in many markets, and long-term demand is projected to grow to the point where the nation will need 4.6 million new apartments by 2030.

In the shorter term, the steeply rising cost of single-family homes will force many to stay in apartments longer to save money for down payments. Examples: Vornado Realty Trust and AvalonBay Communities.

• Health-care REITs are up 24.6%. The pandemic didn’t actually hurt this category much because of the structure of  long-term leases for doctors’ offices, surgery centers and nursing homes. Yet investors nevertheless pushed this category down.

Now these spaces are busy again, boosting demand. Examples: Physicians Realty Trust, Omega Healthcare Investors and Healthpeak Properties.

• Office buildings are up 16.9%. Many workers are still working remotely from home, but many will eventually return to the office, as predicted by CEOs who speak passionately about the intangible benefits of facetime. Examples: Boston Properties, an owner of office buildings and campuses nationwide, and SL Green Realty Corp., a dominant office building landlord in New York.

• Hotels and resorts REITs up 17%. Though business travel is still slow, it’s expected to pick up substantially by next year. Vacationers are gradually returning to resorts and gamblers, to casinos.

Examples: Host Hotels and Resorts, which, still priced below pre-pandemic levels in July, eliminated its dividend but is likely to reinstate it; and VICI Properties, which owns real estate for entertainment and gambling, including casino properties in Las Vegas.

REIT growth will probably be slowed a bit by economic impacts of the coronavirus delta variant. But if these impacts triggers a stock market pullback, pushing down REIT share prices, investors can buy on the dip. If REITs grow enough in the meantime, such a pullback could be the last opportunity to buy them at highly advantageous prices.

Source: cnbc.com