Another Way to Beat Inflation and Generate Gobs of Income
And we’re off with inflation.
This morning, the Consumer Price Index (CPI) showed the largest monthly jump for May since 2008.
The CPI increased by 5% year-over-year. That figure topped consensus expectations of 4.7%, according to Reuters.
We’re all feeling the pain of inflation in our wallets.
This “unexpected” inflationary jump is one of the reasons why we need to take active steps to protect our money.
Any cash sitting in a savings account is losing purchasing power.
You’re better off putting it to work in the market.
Yesterday, I outlined an exciting stock pick that has crushed the market and inflation over the last 20 years. Downstream energy giant Valero Corp. (VLO) has drastically overperformed when inflation tops 2% annually.
But some investors might be wary of the energy sector after last year’s massive plunge in oil prices. There’s a solution to help overcome those fears in our Cognitive Bias series [read Part One here].
If I can’t convince you to dive into downstream oil and gas, then let me try something more “alternative.”
Today, we’ll talk about an investment class that has outperformed the S&P 500 over the last 25 years, according to research company Nareit.
Why does this asset class tend to go ignored by retail investors?
Because – well – it’s a little boring to some people.
But boring is sometimes the best way to make money and reduce risk of inflation.
Why REITs Make Great Buy-and-Hold Investments
Today, I want to talk about becoming a landlord in real estate.
Stay with me here…
When people think about being a landlord, they think about taking on residential tenants.
You might conjure the fear of late-night phone requests to change a light bulb.
You might fear having to pay a few hundred dollars because a washing machine broke.
Or you might fear that tenants will miss rent for a few days (or in the case of COVID-19, a few months).
That’s not the landlord role that I’m talking about today.
Today I want to talk about an “alternative” investment called a Real Estate Investment Trust (REIT).
A REIT is a company that generates income through a range of different property sectors. These REITs pool together investor capital and purchase properties with the intention of generating income from future tenants in the form of rent.
The sectors these companies operate in can include retail centers like malls, hospitals, cell towers and data centers, hotels, and apartment or office buildings.
By owning units of a REIT, you are acting as a landlord.
Think of it this way. If you invest in a mall REIT, you’ll collect rents from companies like Gap Stores (GPS), Abercrombie & Fitch (ANF), and other retailers.
If you invest in cell tower REITs, you’ll collect rent (as a landlord) from wireless tech giants like AT&T (T) and Verizon Communications (VZ).
These are established companies that have weathered the storm of this recent crisis. When a REIT’s tenants are large companies with robust balance sheets, we don’t have to worry about rent.
Now, that’s just the first advantage. You don’t have to personally own and manage apartments or other real estate, collect rents, make improvements, or face any other hassle.
But here’s a second benefit. REITs trade on public exchanges, but provide different benefits to investors than traditional stocks.
The single largest benefit is that they operate under a different tax and dividend structure.
REITs must invest at least 75% of their assets into real estate, cash, or U.S. Treasury bonds. In addition, they must generate 75% of their gross income from mortgages, rents, interest, or the sale of retail estate assets.
These REITs must also pay at least 90% of their net income to their investors in the form of dividends. That’s a huge number, and a rich source of cash flow for income investors.
Because of these rules, the company is able to pass-through the bulk of its income to shareholders and avoid taxation at the corporate level. As a result, you will see that REITs pay much higher dividends than most stocks and bonds.
There are other benefits to REITs as well. These assets are liquid, meaning they trade regularly and at higher volumes on the stock market. You don’t need to take weeks to unload a house or other property like you would in traditional real estate. Instead, you can buy and sell your position in these assets quickly.
In fact, roughly 145 million Americans own REITs through their retirement accounts or other investment funds, according to Nareit. Many investors might own these assets and not know they are getting all of the associated benefits.
Nareit notes that REITs have outperformed the S&P 500 over the past 25 years and delivered higher returns than corporate bonds. The combination of appreciation upside and strong income make REITs an attractive asset class.
The Inflation Benefit
There is one more benefit that I want to share.
Given today’s CPI figure, investors are seeking a hedge against inflation. In times of rising inflation, property values tend to rise.
But also remember that property values have intrinsic value.
Even in the face of a difficult environment like COVID-19, the properties maintain their underlying value if a tenant goes bankrupt. The property itself offers a built-in downside protection even if the property generates no cash flow for a small period of time.
But the most practical way to focus on inflation is simply to look at the dividend offered by REITs. As Nareit notes, REIT dividend hikes have outpaced inflation in 17 of the last 20 years.
“Over the 20-year period, average annual growth for dividends per share [is] 9.4% (or 8.4% compounded) compared to only 2.1% (2.0% compounded) for consumer prices,” the company notes.
This is very promising. When the trend is your friend, ride it.
There are many different types of REITs that provide unique benefits to investors.
However, it’s important to note that different sectors are poised to perform differently in the months and years ahead after this COVID-19 shakeout. Some REITs might face marginal pressures if they are unable to increase rent, while others might operate in sectors that are still facing headwinds in this economy. Next week, I’ll take you through a few that are poised to succeed and others to avoid in the year ahead.