Still a Good Time to Consider Real Estate as an Inflation Hedge

Inflation still resides at four-decade highs, but after more than a year of elevated consumer and producer prices, some investors are wondering if it’s too late to embrace asset classes known for inflation-fighting traits.

The real estate sector and real estate investment trusts are credible ideas for investors seeking inflation protection, and the Virtus Duff & Phelps Global Real Estate Securities (VGISX) is a pertinent idea for investors seeking that protection. Fortunately, some market observers believe it’s not too late for investors to consider real estate as an inflation buffer.

“Real estate investment trusts have historically fared reasonably well as inflation hedges,” noted Morningstar’s Christine Benz. “That’s because the owners of the apartment and office buildings, shopping malls, and hotels in REIT portfolios are often pushing through rent increases, which in turn enhances REIT payouts and security prices, at times when inflation is running up.”

However, this isn’t a traditional inflationary environment. Consumer prices are accelerating at an alarming pace, prompting the Federal Reserve to raise interest rates more rapidly than expected. That’s problematic for REITs because they are a rate-sensitive asset class.

“Rising interest rates explain much of the downward pressure on REIT prices: Not only do higher short-term rates cut into REITs’ profitability, but higher bond yields also diminish REITs’ desirability for income seekers,” added Benz.

Struggles encountered by real estate equities at the hands of rising rates underscore the advantages of VGISX being an actively managed fund. Without the constrains of an index, VGISX managers seek out REIT opportunities that are less rate-sensitive and potentially more positively correlated with inflation than what’s found on the rosters of passively managed rivals.

Those are important points to consider because, in recent years, real estate’s correlations to other sectors and the broader market is increasing, diminishing the attractiveness of the asset class as a portfolio diversifier. That’s a scenario many passive funds can’t adequately deal with, but as an active fund, VGISX can identify names that aren’t highly correlated to the market at large. That could signal that VGISX is better equipped to deliver diversification benefits than are passive rivals. As for inflation-fighting credentials, real estate and VGISX still have those.

“If investors still want to go ahead and add REITs for inflation protection, however, they appear to have a decent margin of safety to do so. The typical REIT in Morningstar’s equity analysts’ coverage universe was recently trading at a 10% discount to fair value,” concluded Benz.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.