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Are REITs Right for Your Retirement Portfolio?

Rebecca Lake

Real estate is often viewed as an effective way to hedge against market volatility. In a 2016 Bankrate survey, 25 percent of U.S. investors chose real estate over stocks as their preferred long-term investment target.

While owning real estate can be lucrative, it's not necessarily the most feasible option for every investor. Acting as a landlord, for instance, can be both costly and time-consuming. A real estate investment trust, by comparison, offers many of the same benefits associated with direct property ownership without the hands-on management responsibilities.

REITs are designed to generate income for investors and they also offer an opportunity for long-term growth. As you're planning your retirement investment strategy for 2017 and beyond, it's important to ask yourself whether a real estate investment trust belongs in your portfolio.

Check the diversification of your investments. Diversification is an insurance policy of sorts for investors, creating a degree of insulation against the possibility of a market decline. This becomes more important as you get closer to retirement and begin to transition your portfolio from saving to spending.

[See: The 10 Best REIT ETFs on the Market.]

Scott Crowe, chief investment strategist at CenterSquare Investment Management in Plymouth Meeting, Pennsylvania, says investors who desire greater diversification should look to real estate.

"REITs offer significant advantages to investors who are seeking access to real estate relative to direct property ownership, including much lower asset management costs, improved liquidity in terms of geographic and property sector exposure and greater transparency," Crowe says.

For individual investors, one of the primary challenges associated with investing in specific properties is limited choice. When you have a finite amount of money to invest, it becomes more difficult to diversify across different property types. REITs remove those barriers.

"REITs are diversified across many different property types and geographies across the country," says John Snowden, portfolio manager at Resource Real Estate Diversified Income Fund in New York.

Snowden says the primary benefit REITs offer to individual investors is access to real estate investments that would normally be the exclusive domain of institutional investors. That includes residential real estate, as well as large-scale commercial properties.

Evaluate your liquidity needs. Certain investments offer more liquidity than others, which becomes more important as you approach retirement. Vince Vitale, a portfolio manager and chartered financial analyst with Advance Capital Management in Southfield, Michigan, says REITs outstrip other real estate investing avenues in that sense.

"Publicly traded equity REITs offer the greatest liquidity and availability to turn your investment back into cash," Vitale says.

Vitale acknowledges that while direct ownership offers greater control over the property, it can be costly, slow and difficult to sell. Real estate crowdfunding can increase diversification but it doesn't offer the same liquidity as a REIT and the fees may be higher.

As you're looking at your larger retirement picture, it's important to think about how easily you're able to access your various assets. If you've invested heavily in bonds, for example, and liquidity within the bond market begins to shrink, REITs could help to create more balance.

"[A REIT] position can be liquidated very quickly, often in minutes if necessary; the only cost involved is the broker's commission," Snowden says.

[See: The 10 Best Ways to Buy Real Estate.]

That may be reassuring if you're concerned about having assets readily available once you reach retirement.

Calculate the dividend factor. REITs are required to pay out 90 percent of their earnings as dividends to investors. Leveraging these dividends can prove valuable to your retirement outlook, says Steve Hovland, director of research at Irvine, California-based HomeUnion.

"Dividends provide investors with an additional income stream to invest into another investment vehicle, or reinvest into REIT stock, while building their retirement portfolio," Hovland says.

Jay Hatfield, co-founder and president of New York-based InfraCap, says investors should focus almost exclusively on dividend and interest income when planning for retirement.

"The fundamental value of investments is the cash flow produced by the underlying assets," Hatfield says, since the income an investment generates allows an investor to make withdrawals from their accounts without making sales, reducing risk and increasing flexibility.

Hatfield says that older investors who are preparing to begin drawing down assets can focus on lower-growth, higher-income investments like REITs to minimize or eliminate the need to sell securities to fund their retirement.

John LaForge, head of real asset strategy for Wells Fargo Investment Institute in Sarasota, Florida, says investors should consider the tax implications of dividend investments if they're investing in them outside of a tax-advantaged account, such as a 401(k) or IRA.

"When REIT investors receive dividends, they're generally taxed as ordinary income," LaForge says, and unlike stocks, REIT dividends don't qualify for lower common stock dividend rates.

LaForge says that roughly two-thirds of total REIT returns over time come from the dividend component so investors should be aware of how those dividends could impact their tax liability. They also need to factor in capital gains triggered by the sale of REIT assets, as well as taxation of any return of capital.

Don't forget about inflation. According to a 2016 LIMRA study, rising inflation can rob retirees of more than $117,000 in spending power over a 20-year period. REITs may provide an effective shield against that threat.

"REITs offer an inflation hedge in that their cash flows and the dividends paid to investors are derived from economic rents and grow with inflation," Crowe says.

Since real estate rents and values tend to increase as prices do, REITs can create a natural protection against inflation. These investments can provide a reliable source of income even during periods of higher inflation.

With the potential for interest rates to rise along with inflation, REITs may be a more attractive option than bonds or equities for investors who have an eye on retirement. When the Federal Reserve initiated a series of rate hikes between 2004 and 2006, listed equity REITs yielded a cumulative total return of nearly 80 percent, outperforming the Standard & Poor's 500 index over that same period, according to the National Association of Real Estate Investment Trusts.

If history were to repeat itself and the Federal Reserve follows through on proposed plans to increase the federal funds rate in the future, REIT investors could reap the benefits. Snowden says investors should stay focused on the positive implications of an upward trend in prices and rates in the meantime.

[See: A 14-Point Checklist for Land Investing.]

"Modest increases in interest rates and inflation are often signs of economic growth," Snowden says. "REITs are able to participate in this growth by growing their rent rolls, as well as benefiting from appreciation of the underlying real estate values."



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