REIT Income Opportunity for Aging Retirees
Advancements in healthcare are allowing retirees to be more active and live well into their late 80s or longer. That means retirement income is becoming increasingly important for aging retirees. While traditional income vehicles like CDs (aka Certificate of Deposit or conservative savings account with a high-interest rate and penalty for withdrawal) and bonds can help, financial advisors are looking for other sources of income to help bridge retirement income gaps.
One alternative that has been gaining the attention of advisors and investors alike is a real estate investment trust or REIT. According to Nareit, the National REIT Trade Group, the average daily dollar trading volume for REITs continues to increase over time:
- October 2013: $5.2 billion
- October 2018: $7.5 billion
- October 2023: $8.0 billion
It’s important to note that despite being a well-regarded option for investing in a down market, there are still risks associated with REITs. Examples are:
- Adverse effects of low real estate prices
- Lack of liquidity (Cannot always be sold on the public market, though some public REITs are available)
- If not publicly traded, difficulty determining the value of a single share of the overall investment and/or value of the overall investment
Other factors to consider are that dividends may be paid from offering proceeds and borrowings, which can reduce share value and limit the company’s future asset purchases. That use of external managers poses a risk for conflict of interest.
Still, many find that REIT income offers 6 distinctive advantages to those looking for a retirement income strategy that is likely to weather the ups and downs of both the stock market and changing life circ*mstances.
The 411 on REITs
Created by Congress in 1960, REITs give investors the opportunity to invest in income-producing real estate through pooled portfolios of securities modeled after mutual funds. In other words, you are investing in a professionally managed group of properties.
REITs can include actual land, as well as apartments, offices, or hotels that generate income through the collection of rent. They may also include mortgages or mortgage securities tied to the properties. REITs provide investors with access to diverse portfolios of income-producing assets they would not be able to afford on their own.
Listed REITs are prominent in today’s investment landscape. They are included in 225,000 401(k) plans, and more than 150 million individuals are invested in REITs through these and other investment plans. There are more than 200 mutual funds and ETFs dedicated to stock exchange-listed REITs sponsored by major investment management firms.
Additionally, REITs are in a majority of target-date funds, most pension funds, and endowment portfolios and are one of the fastest-growing retail investment default options. As of November 2022, a little less than half of Americans (a whopping 45%) are invested in REIT stocks.
6 REIT Advantages for Generating Retirement Income
For investors looking for a retirement income-producing asset as familiar as an investment “next door,” there are six good reasons to diversify your portfolio with REITs:
1. REITs Help Offset the Impact of Inflation
Even at low levels, the cumulative effects of inflation over long periods can erode the purchasing power of portfolio assets. The dilemma for retirees is that it can be hard to stay ahead of inflation with fixed income securities, while equities are trimmed back to reduce investment risk. According to Patrick W. McKeon JD, CFP®:
Across all generations, individuals tend to create their retirement nest egg during their prime earning years based on long-term growth and accumulation strategies. Then, they gradually switch toward more conservative, income-oriented approaches as retirement day draws closer.
NAREIT claims that REITs offer a form of inflation resistance because commercial real estate rents and values tend to increase when prices do. As a result, this supports equity REIT dividend growth, which can provide retirement investors with reliable income, even during inflationary periods.
A look at the long-term track record for REITs (as measured by the FTSE NAREIT All Equity REITs Index) shows how well this class of investments performed as a hedge against inflation. REITs have proven to be more inflation-resistant than the S&P 500 Index and Barclays Capital U.S. Aggregate Index for the six-month rolling periods from December 31, 1975 through December 31, 2018.
2. REITs are a Potent Source for Retirement Income
According to Nareit, July 2019 yields for equity REITs outperformed the S&P 500 index yield, 4.16% to 1.97%, respectively. As of October 2023, this still holds true at 4.59% and 1.61%.
Beyond yields, however, a major benefit of REITs is their requirement to distribute most of their taxable income — at least 90% — annually to their shareholders as dividends. On average, 70% of the annual dividends paid by REITs qualify as ordinary taxable income, 15% qualify as return of capital, and 16% qualify as long-term capital gains.
Most income distributed from REITs is taxed as ordinary income rather than as dividend income. Like mutual funds, REITs can deduct from their corporate tax liability the amount they pay out as dividends. Shareholders pay tax on the dividend income they receive, generally at ordinary income tax rates.
3. REITs Demonstrate an Attractive Record of Outperformance
For a 65-year-old married couple, the probability that at least one will reach 92 is 50%, per the Society of Actuaries (SOA). That means that in addition to income, an investment will need to deliver an attractive level of risk-adjusted return. According to recent performance numbers from JP Morgan, REITs outperformed gold, oil, the S&P 500, bonds, the EAFE index, and inflation for the 20 years ending December 31, 2018, on an annualized basis.
4. REITs Offer a Proven Way to Diversify a Portfolio
Portfolio diversification is arguably one of the most important ways investors can temper risk. In fact, REIT investors share an advantage with other real estate investors: the ability to hedge against national and even international market risks.
The long-term correlations of equity REITs with other asset classes range from a low of -0.28 to a high of 0.76. Negatively correlated to currency prices, REITs have only a 30% correlation to bond prices and a 71% correlation to domestic large-cap equities.
5. REITs Come With Tax Benefits
REITs can provide tax-deferred income due to the depreciation of a property or a portfolio of properties. The greater the amount of depreciation expense, the more likely it is that the taxable part of distributions made by the REIT will decrease.
To capitalize on this potential tax benefit, it is important to understand the two classifications of distributions:
- Ordinary Income is the portion of the shareholders’ distributions that are taxable on a DIV Form
- Represents the operating profits from the REIT’s investment in real estate
- Return of Capital is the portion of distributions that are not treated as taxable income to shareholders on a 1099-DIV Form
- Occurs when the REIT’s current distributions exceed its earnings
6. A Smart Tax-Deferred Choice for Self-Directed IRAs
With so many pre-retirees searching for new ways to diversify their income beyond traditional investments, a REIT may be the right complement to a portfolio.
According to Paul D. McConville, President of Quincy Capital Partners, LLC:
Self-directed IRAs in invested alternatives like REITs may also allow investors to diversify a portfolio beyond traditional equity, bond, and mutual fund choices.
In effect, with a self-directed IRA, investors and advisors may gain a wider scope of action for how, when, and where to invest retirement assets. When combined with a self-directed IRA, the tax advantages of a REIT can be dramatic. Through a self-directed IRA, a REIT can grow dividends and capital gains on a tax-deferred basis. Taxes are paid on proceeds once they are distributed to an investor.
When It Comes to REIT Investing, Due Diligence is Required
While listed equity REITs are an investment in real estate, they also are stocks, which means their prices may rise or fall. Additionally, commercial real estate is a cyclical business with cycles that differ from those of other equities. Changes in the values of the property portfolios owned by listed equity REITs affect the valuation of their shares. Like every other investment strategy, there is no substitute for closely examining a REIT’s underlying prospectus.
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This is an updated version of an article originally published on August 21, 2019 and updated on November 28, 2023.]
©2023. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
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