With the broad market in rally mode for the last couple of years, it's been easy to ignore real estate investment trusts, or REITs.
After all, REITs have been sluggish performers in the context of the general surge higher in stock prices. While the big S&P 500 index is up 16.6% on a price basis over the last 12 months, the price of the Dow Jones REIT Index is down around 4% on that same time frame. That's a performance chasm that isn't easily filled.
But after lagging the rest of the market materially, REITs are showing some signs of life this March. And, for retirement-focused investors, REITs' unique set of characteristics make them an incredibly powerful part of a retirement portfolio.
First, there's REITs' income generation ability.
REITs are required to pass through the vast majority of their income to investors in the form of dividends. Doing that gives REITs the ability to avoid double-taxation -- investors only pay taxes directly on REIT distributions. This structure gives these firms the ability to pay out meaningfully higher yields than conventional firms.
Because of this income-centric status, REITs tend to have more annuity-like income streams than most. REITs are essentially publicly traded landlords; but because they typically lease property on a "triple net" basis, it's the commercial tenants who are on the hook for property taxes, maintenance and insurance costs, leaving the REIT with a predictable and consistent rental check.
As inflation fears begin to rear their head in this market, REITs come with some noteworthy advantages.
Generally, REITs' biggest asset is real estate, an asset class that has historically tended to fare well in the face of inflation. Likewise, commercial REITs often have inflation-linked rent agreements (or at least rents that come with pre-set payment escalators). This helps to dramatically offset the negative impacts that interest rate sensitive stocks like REITs see from rising inflation.
Right now, the Dow Jones REIT Index yields a whopping 4.4% -- that's substantial income generation capability in this market.
Between that deep yield and a potential price rebound in REITs, now could be an opportune time for dividend investors to pull the trigger on some core REIT holdings.
The Vanguard Real Estate ETF has the benefit of a broad array of REIT holdings -- approximately 185 at last count -- which greatly diversifies away the risk that you'll take a yield of price hit by owning a single REIT that doesn't execute well.
Likewise, VNQ is one of the cheapest REIT funds on the market today, with an expense ratio of 0.12%.
For retirement investors, adding a REIT ETF like VNQ to your portfolio makes a lot of sense, now more than ever.