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Stagflation. What is that? Sounds scary, doesn’t it? This is essentially a combination of stagnant economic growth and higher than expected inflation. Right now, that’s potentially on the horizon for Canadian and US investors.
While economic growth shows signs of slowing as the U.S. Federal Reserve scales back stimulus and raises interest rates, inflation remains consistently elevated and non-transitory thanks to a combination of supply chain disruptions , global economic sanctions and exorbitant energy costs.
A stagflationary environment wreaks havoc on most conventional investment portfolios, with stocks and bonds expected to offer low or negative returns under such conditions. Investors looking for yield in a stagflationary environment should consider alternatives such as commodities, precious metals or real estate.
Why invest in real estate?
For the last option, a good choice for your investment portfolio are real estate investment trusts (REITs). As a pool of exchange-traded real estate assets, REITs offer cash, monthly income, potential for capital growth, and exposure to real estate assets without the need to purchase property.
You can think of REITs as companies that act as a mutual fund for real estate. They pool capital from many investors, invest in real estate and pay out a distribution via the underlying rental/lease income generated. Think of it as being a landlord and collecting rent, but without the hassle.
REIT stocks trade on the stock exchange like any other stock, making it easy to buy and sell whenever you want. REITs can be held like any other qualified investment in a TFSA and RRSP, allowing for tax-free or tax-deferred distributions and capital gains. This makes it an excellent diversifier for most portfolios.
Which REITs are best for stagflation?
REITs can invest in different types of real estate, such as residential, industrial, office and retail. Different sectors have different levels of return and distribution risk, so you can choose according to your needs.
Good choices for a stagflationary environment would be industrial and residential REITs. These provide a hedge against inflation by passing on higher costs to their tenants through rent increases. Rising real estate prices (especially in Canada) are also outpacing inflation significantly, increasing the value of REITs.
For a residential choice, consider Canadian Apartment Properties REIT (TSX:CAR.UN). CAR.UN has over 57,000 suites, including townhouses and manufactured home sites, in Canada. CAR.UN pays a payout yield of 2.67% ($1.45 per share) and has a sustainable payout ratio of 17.54%.
For an industrial choice, consider Granite REIT (TSX:GRT.UN). It owns more than 108 logistics, warehouse and industrial properties in North America and Europe, representing approximately 45.3 million square feet of leasable area. GRT.UN pays a payout yield of $3.27 ($3.1 per share) and has a sustainable payout rate of 15.09%.
The insane takeaway
REITs are particularly well placed to potentially benefit from an inflationary environment. If inflation becomes stagflation, their income potential offers investors a source of returns in an otherwise unpredictable market. A small allocation to REITs in your portfolio can therefore provide great diversification benefits.