- In an inflationary environment, real estate investment trusts (REITs) offer investors a unique combination of potential for capital appreciation, inflation hedging, and income.
- REITs invest in a wide variety of types of real estate. Among the potential winners: REITs that invest in industrial real estate, data centers and communication-tower properties..
- REITs also have unique tax and reporting complexities that other types of investments may not.
- Careful security selection by active managers can help manage the risks of investing in REITs.
With inflation rising and interest rates still near historic lows, investments that have historically performed well in inflationary times are appealing and so are those that can deliver income despite low rates.
Historically, when inflation has risen, stocks and real estate have tended to fare relatively well compared with bonds. While past performance offers no guarantees about what may happen in the future, the track record of both stocks and real estate 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 the 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, after a year of COVID-related restrictions which emptied many commercial buildings of tenants and customers, many REITs are trading at modest valuations even as economic growth revives.
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.
"I find REITS to be quite attractive and we're adding them," says Adam Kramer, lead manager of the Fidelity® Multi-Asset Income fund and co-manager of the Fidelity® Strategic Dividend Income fund. "It's a really interesting time for real estate in so many ways, because we've had this huge retreat from offices, an acceleration of the retreat from brick and mortar shopping, and now at least some things are coming back."
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-19 has accelerated trends that are transforming real estate markets, benefiting some types of properties and disfavoring others.
Steve Buller, manager of Fidelity® Real Estate Investment ETF says 2 of the most significant trends he's watching are the ongoing decline of brick-and-mortar retail properties and the accompanying growth in demand for industrial real estate driven by the growth of e-commerce. He says that owners of data-center and communication-tower properties have also experienced rapid demand growth as telecommuting has gone mainstream over the past year.
That same trend toward telecommuting is also raising questions about the future of office real estate. Buller 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
Kramer says that many REITs still have a lot of this uncertainty priced into them and because so much bad news took place last year a lot of companies already cut their dividends. He feels more comfortable about dividends actually growing from the low single digits to the mid single digits next year. "When you consider dividend yield, dividend growth, and potential for multiple expansion, REITs look more attractive to me than other income-oriented asset classes," says Kramer. "So that's why we've been looking across the full spectrum, but not only in the US. I'm finding opportunities in Canada as well. Canada is way behind the US in terms of the vaccine rollout and there’s more uncertainty around the reopening and use of some of the properties that these REITs own."
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 changes in real estate values or economic downturns 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.
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
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.