Inflation Proof Your Retirement with - Real Estate

For investors willing to take on a little more risk, there is an alternative that can offer relatively high yields: equity Real Estate Investment Trusts (REITs), which are companies that own and/or develop property. As can be seen in the chart below, average REIT yields in three major global markets—the United States, Canada and Australia—now significantly exceed average yields for bank CDs and U.S. Treasuries. Whether investors are in or nearing retirement or looking to add income to their portfolio, REITs can be a valuable component of a diversified portfolio. (from Charles Schwab)

The averages shown in the “REIT Yields” chart may understate the income from individual REITs for two reasons:

1. REITs sometimes pay sizable special dividends. A special dividend might occur when a REIT sells a big asset. By law, a REIT has to return a set percentage of cash to its investors, so if a REIT realized extraordinary income (e.g., via the sale of a large property), it may distribute cash as a special dividend rather than increase its regular distribution or buy back stock. For example, Boston Properties, a leading investor in U.S. office buildings, paid a special distribution of $5.05 per share earlier this year. This type of dividend is not reflected in the chart averages.

2. Average yields are higher than market-cap-weighted averages, which are preferred by analysts and shown in the chart. Because many smaller companies pay higher distributions, the simple average U.S. REIT yield was actually 5.6%—a full 1.3 percentage points higher than the weighted average. (NAREIT)

The chart below shows the range of current yields for the 103 U.S. REITs included in a leading industry index. On April 28, 57 of those 103 REITs were currently yielding at least 5%.

The correlation of REITs to the broader markets has mostly run on five-year cycles. A past cycle began with REITs showing a relatively low correlation to the broader markets, and then correlation increases for three to four years, and then finally, moves down for one year.

In terms of REITs' relationship to the bond market, many investors believe that when interest rates rise, REIT prices will fall. That's not quite right: Rising rates slow down new real estate construction, thereby making existing properties more valuable. Small amounts of interest rate increases, especially as the economy is expanding, may actually enhance REIT returns. In fact, returns came on very strong after the Fed started raising interest rates in May of 2004.

Ultimately, if interest rates rise high enough, it will mean lower returns for REITs due to vacancies caused by an economic slowdown. The REITs themselves will then become less attractive, as the spread between their dividend yields and the 10-year Treasury yields will fall.