One of the most stressful parts of retirement is the need to project costs in the future. If retirement ends up costing more than you thought, you could be in a very difficult place financially and be forced to choose between spending less or running out of money. To protect against this, save and invest as much money as possible for retirement.
While investment portfolios typically consist of stocks and bonds, there is another option that you may want to consider: the real estate investment trust (REIT), which is a company that owns and operates properties. Often, individual REITs focus on a particular sector of the market, such as multifamily properties or warehouses. Many REITs trade publicly like stocks and are easy to invest in during retirement.
Why REITs Can Prove an Good Choice in Retirement
One of the major benefits of holding REITs in your portfolio is the fact that they generate ongoing income for you. Every REIT is legally obligated to pay at least 90 percent of taxable income to shareholders through dividends. Because of this, REITs tend to pay higher dividends than stocks.
Second, many REITs increase their dividends over time to which increases the amount of money you have access to over the course of your retirement. This provides a degree of inflation protection as you estimate how much you will need in the future.
Third, just as stocks generally increase in value over long periods of time, the same applies to REITs. Thus, not only do can the dividends you receive increase over time, but so can the actual value of the investment. Because of these factors, REITs are can often be a better retirement choice than stocks or bonds.
Another important point to consider is diversification. REITs often bring important diversification to your portfolio since most individual investors are unlikely to have other significant real estate assets.
Additionally, you can diversify within the real estate sector by investing in different types of REITs. This is important since real estate does not always follow the trends of the larger market. Even if the entire market is taking a dip, real estate often holds steady and can maintain its value, thereby possibly helping keep your portfolio in the black.
Finally, REITs protect you from much of the risk involved with traditional real estate investing. You do not own any actual property, which can be quite illiquid, not to mention the need to pay for maintenance and the real possibility of vacancies.
REITs Are Sometimes Used As a Protection against High Inflation
In today’s market—with inflation rates at an all-time high—many retirees are worried about how this will affect their retirement income and are looking for ways to protect themselves. REITs could be part of the answer. Typically, REITs perform well during periods of inflation. They are generally able to increase rents and then pass that additional income on to shareholders.
Since people still need places to live and work, the real estate industry usually does comparatively well during periods of inflation. However, benefiting from this as an individual can be difficult unless you have the capital to buy and sell properties quickly. REITs allow you to benefit from the performance of real estate markets with much less risk to help protect your assets, and cash flow.
As of this writing, the average dividend yield from REITs is around 3 percent, which is equivalent to the current yield from a 10-year Treasury bond. Many investors see bonds as the other major strategy for protecting themselves from inflation. However, the yield from these investments can often be much less than from REITs, and do not offer the upside potential that REITs do.
Of course, not all REITs will perform well during periods of inflation, so you need to consider the health of the underlying industry. For example, an REIT that invests in hotels may not do as well since people may choose not to travel during periods of high inflation. On the other hand, an REIT that invests in apartment buildings would likely perform better during periods of inflation. Consider this as you select particular REITs if you want inflation protection.
The Downsides of Investing in an REIT
While REITs may sound like a great investment for retirement, there are still some drawbacks and potential risks to consider. For example, REITs tend to be leveraged since they have little cash flow for new property acquisitions, and must use debt financing . If the credit markets collapse, that could mean that REITs cut their dividends.
REITs also have some interest rate risk. When interest rates rise, demand for REITs falls and their performance can suffer. If you plan to hold REITs for the long term, this risk is not that important since interest rates will eventually come back down, or the REIT will have adjusted to the higher rate environment. However, in retirement you could find yourself in a position of being forced to sell when prices are lower than you would like. Finally, the other major risk with REITs is choosing the wrong one. You need to consider the underlying assets to help predict performance and be sure that you trust the management team to handle its investments well. There are various low cost index funds that hold a wide variety of REITs, which can greatly reduce the risks of choosing the wrong one or two REITs for your portfolio.