Investors everywhere, including of the real estate investment trusts (REITs) I analyze, are wondering about inflation. As prices of goods continue to soar, memories of the ‘70s have begun to flare up like an outdated pair of bellbottoms.
We expected some inflation following Covid-19, of course. However, the escalating prices have ballooned beyond what was anticipated. Kingswood Chief Investment Officer Rupert Thompson states in the wealth management company’s “Investment Outlook for Q3 2021”:
“A spike higher had been expected, both on the back of prices (particularly oil) rebounding from the lows touched a year earlier and supply bottlenecks as economies reopened. But the increase, especially in the U.S., has been considerably greater than expected. The headline inflation rate is now running as high as 5.4%, while the core rate is up to 3.5% versus 1.5%-2% prior to the pandemic.”
You don’t need aviator glasses to see there are some similarities between the inflationary economies of the 1970s and today.
Bartlett Naylor, in “REITs Make a Comeback After Scandal of the ‘70s,” describes that bygone economic flop.
When the real estate market slumped in 1973, heavily leveraged REITs crashed… Two-thirds went into bankruptcy or reorganization. The 69 left in 1976 mustered a meager $124 million in dividends that year.
In short, REITs in the 1970s were just barely stayin’ alive. And that’s just not the case today. Today, they’re in a much stronger position.
In fact, REITs offer investors some security from inflation.
Flashback Inflation: Similarities Between Today and the 1970s
For better or worse, Covid-19 escalated government spending. On top of that, easy monetary policy have increased demand while supplies have been limited.
Those same three actions applied to the 1970s too. Everyone knows that spiking oil prices and excessive financial moves by the federal government were to blame.
What they don’t know is that’s only part of the story.
In the early 1960s, inflation remained at an average of only 1.1% despite the government’s increased social programs. However, then came the Vietnam War in 1965, and rising demand for industrial goods caused prices to surge.
Consumers had more spending money while consumer price inflation was leaping to more than 5% by 1969.
So far, so similar.
The same goes for government attitudes between the two time periods. In fact, this might be the most significant comparison.
Kathy Jones elaborates on this in “Is 1970s Style Inflation Coming Back?” published at Charles Schwab:
As in the 1970s, the Fed is making the choice to let inflation rise today. After a lengthy review of its policies of the past few decades, it concluded that it had focused too much on inflation and consequently had limited the economy’s growth and held down job growth and incomes for many workers. That was before the Covid-19 crisis hit. Now, faced with the deflationary impact of the pandemic, the Fed believes it has room to err on the side of being too easy for too long.
Now, we’re not reliving history completely though. History doesn’t ever repeat itself word for word, as I’ll show down below.
Differences Between Today and the 1970s
As Scott Horsley points out in “Think Inflation Is Bad Now? Let’s Take a Step Back to the 1970s” on NPR:
Treasury Secretary Janet Yellen and others in the administration argue that the current run-up in prices is a temporary phenomenon, sparked by supply shocks tied to the pandemic and pent-up demand from consumers.
That one is up for debate, and only time will tell.
But one critical and definite difference is the psychology of today’s America. In the 1970s, the American public believed inflation was inescapable. Yet not everyone is so pessimistic now.
Federal chairman Jerome Powell stated in an interview with Morning Edition:
If people believe that prices will be pretty stable, then they will be — because they won’t ask for very high wage increases. And people who sell things won’t be asking for high price increases. Once that psychology sets in, it tends to perpetuate itself.
Economist Alan Blinder, who served as the vice chairman of the Federal Reserve in the 1990s, agrees with this assessment:
If you’re a business and you expect the inflation rate to be 5%, you’re likely when it comes time to set the prices for the next year [to] go up 5%. On the other hand, if you think inflation is going to be 1%, you’re more likely to go up 1%.
Whether those predictions will play out accurately or turn out completely wrong will eventually be history itself. For now though, we do have ways to combat the present and even future situation, whatever it will be.
Investors naturally hope that the inflation we’re experiencing today isn’t a permanent issue. And maybe it will be.
Whether we experience a quick recovery or continuing inflation though, REITs remain a sound investment choice.
Although “inflation” may sound like a dirty word, a bit of it can be good for the economy. And even a lot doesn’t necessarily hurt certain businesses – especially REITs.
Real estate, after all, tends to increase in value along with consumer goods. This is something global fund manager Cohen & Steers outlines in “Three Strategies for Building Inflation-Resilient Portfolios”:
1. “Property values tend to rise with the overall price environment, as higher prices for labor, land, and materials used in construction can raise the economic threshold for new development. This, in turn, may constrain new supply, supporting higher occupancies and giving landlords greater power to raise rents.”
2. “Property types with shorter lease durations such as hotels, self-storage, apartments, senior housing, and billboards can take advantage of inflationary rents relatively quickly.”
3. “Many commercial leases have explicit inflation links, particularly outside the U.S., with rent escalators tied to a published inflation rate.”
Due to these factors, REIT dividends tend to grow faster than inflation, as summarized in the same piece:
Following pandemic-driven dividend cuts in 2020, we expect REITs may deliver above-average dividend growth over the next few years, just as we saw post-2009. Though the pandemic has accelerated changes in how certain real estate is utilized (some positively, others negatively), we believe the potential for REITs to grow rents faster than inflation remains unchanged.
At the risk of being repetitive, I really want to drive this home: Because real estate rental rates increase as the price of goods and services, REITs offer investors some security against inflation. As I said in a recent article, “The REIT Way to Think About Inflation”:
REITs overall are positioned to benefit from an inflationary environment while providing attractive current income streams – which should grow over time.
Whether inflation continues due to unexpected pandemic-related challenges or becomes more balanced… REITs provide investors with sound options for income streams. That’s why I’m sticking with them, and happily so.