Fighting inflation with REITs

Key takeaways

• Real estate investment trusts (REITs) can offer investors a unique combination of inflation hedging, income potential, and capital appreciation.
• REITs invest in a wide variety of types of real estate. Among the potential winners are REITs that invest in hotels, casinos, and strip-malls.
• REITs also have unique tax and reporting complexities that other types of investments may not.
• Careful security selection by experienced managers can help find attractively priced opportunities in volatile markets and manage the risks of investing in REITs.

With high inflation and rising interest rates shaking up stock and bond markets, it may be a good time to look at investments that have historically performed well in inflationary times.

Historically, when inflation has risen, real estate has tended to fare relatively well. While past performance offers no guarantees about what may happen in the future, that track record may make this a good time to find out more about REITs, which are companies that own, operate, or finance income-generating real estate including offices, apartments, shopping centers, hotels, and more.

Most REITs are publicly traded and enable investors to earn dividends from real estate without having to buy individual properties. REITs offer the potential for capital appreciation of stocks (and potential exposure to stock market volatility), income in the form of dividends, and also the benefit of exposure to underlying real estate that has tended to gain in value during inflationary times.

Furthermore, despite the benefits they potentially offer investors in inflationary times, many REITs may be temporarily mis-priced amid market volatility. This is creating opportunities for experienced investment managers who specialize in REITs.

Why REITs?

Steve Buller manages the Fidelity^® Real Estate Investment Portfolio. He says that REITs have historically proven to be good inflation hedges because the rents on many long-term commercial real estate leases adjust upward when inflation rises.

REITs may also benefit from higher inflation because it tends to limit the ability of competitors to build new buildings. "The costs for new competitors to enter markets by building new competing properties have gone up tremendously with higher prices for land, materials, and labor. That’s why inflation is a good thing for real estate that’s already been built," says Buller.

Besides its historical role as an inflation hedge and a source of income, real estate can also provide diversification within the equity portion of an investor's portfolio. While it's difficult and expensive to get exposure to real estate by buying and managing a building or developing a piece of land, buying shares of REITs that purchase and bundle buildings or land offer a practical and relatively liquid means of doing so. Keep in mind, though, that diversification and asset allocation do not ensure a profit or guarantee against loss.

Potential winners and losers

While REITs overall may be attractive, though, would-be investors need to understand that not every REIT is equally attractive. REITs typically specialize in certain types of properties such as retail or apartment buildings, and COVID has accelerated trends that were transforming real estate markets, benefiting some types of properties and disfavoring others.

Buller says he's added exposure in his fund to what he calls "smart risk" sectors, such as hotels, casinos, and strip-malls where he sees significant pent-up demand. On the other hand, he expects a likely reduction in future demand for office space and is also watching to see how the shift toward remote work could influence demand for apartments, as telecommuters reconsider where they are able to live while still earning a living.

Value and income

Buller says that broad sell-offs of many types of investments have also hit REIT prices. However, because of the strong fundamentals and inflation-fighting characteristics of many REITs, he views volatility as an opportunity for professional managers to add attractive assets that may be temporarily mis-priced.

Managing the unique risks of REITs

Careful security selection by active managers can help manage the risks of investing in this distinctive and highly variegated asset class. One of the unique characteristics of REIT shares is that they are liquid assets that derive their value partly from the ownership of illiquid assets. That can pose operating challenges because economic downturns and changes in real estate values can have a significant negative effect on real estate owners. REITs also have unique tax and reporting complexities that other types of investments may not.

Experienced managers with deep knowledge of individual companies and real estate markets can help investors avoid some of the risks while gaining the benefits of diversification, income potential, and inflation hedging.

Finding ideas

Many investors may have some exposure to REITs through diversified mutual funds and ETFs. Those who want to further diversify their portfolios with REITs should determine their existing level of exposure, consider the risks and complexities, and research professionally managed mutual funds and ETFs. You can run screens using the Mutual Fund and ETF Evaluators on Fidelity.com. Below are the results of some illustrative mutual fund screens (these are not recommendations of Fidelity).

Mutual funds that invest in REITs Fidelity funds

• Fidelity^® Real Estate Investment Portfolio (FRESX)
• Fidelity^® International Real Estate Fund (FIREX)
• Fidelity^® Real Estate Income Fund (FRIFX)

Non-Fidelity funds

• MFS Global Real Estate Fund (MGLAX)
• American Century Global Real Estate Fund (ARYVX)
• Franklin Real Estate Securities Fund (FREEX)

Exchange-traded funds

• Fidelity^® Real Estate Investment ETF (FPRO)

The Fidelity screeners are research tools provided to help self-directed investors evaluate these types of securities. The criteria and inputs entered are at the sole discretion of the user, and all screens or strategies with preselected criteria (including expert ones) are solely for the convenience of the user. Expert screeners are provided by independent companies not affiliated with Fidelity. Information supplied or obtained from these screeners is for informational purposes only and should not be considered investment advice or guidance, an offer of or a solicitation of an offer to buy or sell securities, or a recommendation or endorsement by Fidelity of any security or investment strategy. Fidelity does not endorse or adopt any particular investment strategy or approach to screening or evaluating stocks, preferred securities, exchange ­traded products, or closed-end funds. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from its use. Determine which securities are right for you based on your investment objectives, risk tolerance, financial situation, and other individual factors, and reevaluate them on a periodic basis.