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Hedge Your Assets Against Inflation: Real Estate Income Trusts vs Stocks

Updated: Feb 13

real estate stocks rising up and inflation also rising up, with buildings and real estate in the background

In the wake of recent world events including the COVID-19 pandemic, the Russia-Ukraine war, Sri Lanka’s civil unrest, the collapse of Silicon Valley Bank in the US, and now the Israel-Hamas war, investors and individuals are seeking ways to protect their assets against inflation.


As the cost of living continues to rise, traditional investment strategies may not be enough to hedge against the looming economic threats.


Enter the real estate income trusts (REITs) and Stocks, two asset classes that have historically offered a hedge against inflation.


REITs are companies that own and operate income-producing real estate, such as apartment buildings, office space, and shopping malls. We’ve done a complete article on REITs. You can read it here.


Stocks represent ownership in a company and can provide exposure to a wide range of industries and sectors.


In this blog post, we delve into the world of REITs and stocks, exploring how these two investment options can help investors hedge against inflation and achieve their financial goals.


We will examine their performance during periods of inflation, compare their risk and return profiles, and provide guidance on selecting the right investment strategy for your individual needs.


Real Estate Income Trusts vs Stock Market


Real Estate Income Trusts vs Stock Market

Real Estate Investments and Stock Market Investments both have their own unique characteristics and can offer different benefits and drawbacks during tough economic times, particularly during periods of high inflation.


REITs and stock markets usually move in tandem with the overall stock market. This correlation is often positive, meaning that when the stock market rises, REIT prices also tend to rise, and vice versa.


Perhaps, it wouldn’t be wrong to say that they aren’t entirely independent of each other.


Income Potential as a Function of Economic Conditions


Real estate investments provide the potential for rental income, which can serve as a steady stream of cash flow during economic downturns. On the other hand, stock market investments have the potential to generate high returns over the long term.


When the overall economic conditions are uncertain, the stock markets and real estate income trusts often start dwindling and over time may also drop down.


For example, during economic downturns, businesses may cut back on spending, leading to a decline in the stock values and eventually a drop in the REITs' prices.


Liquidity, Diversification, and Investor Sentiments


Both real estate investment trusts and stock market investments are highly liquid, meaning they can be easily bought and sold on stock exchanges. This allows investors to access their funds quickly and adjust their portfolios as needed.


In addition, both of these investment instruments offer a wide range of investment options, including equity, debt, dividend funds, and more. This can help mitigate risk and reduce the impact of economic downturns.


Now, to a large extent, the liquidity and diversification of these instruments depend on investor sentiment as well, which can be swayed by broader market conditions.


If investors are optimistic about the economy and the stock market, they may be more likely to invest in REITs and other stocks, driving up their prices. Conversely, if investors are more cautious or risk-averse, they may shift their investments away, leading to a decline in their prices.


Understanding the correlation between Real Estate Investment Trusts and the broader stock market can help understand and make informed decisions about investment portfolios.


However, the decision of whether to invest in real estate income trusts or the stock market during tough economic times depends on individual circumstances, risk tolerance, and investment goals.


Hedge Against Inflation


Inflation is the general increase in prices and fall in the purchasing value of money. It erodes the purchasing power of money, making it difficult to afford goods and services.


Historically, real estate and broad market stocks have proven their mettle in hedging against inflation. Despite rough market conditions, both of these asset classes have witnessed relatively less brunt of the broad economic conditions, especially inflation.


However, real estate has historically been considered a better hedge against inflation due to its ability to retain value and potentially appreciate over time, which stocks lack.


There are several reasons why real estate acts as a better hedge against inflation:


Rent or Lease Payments


REITs and landlords can pass on the increases in their operating costs such as property taxes and maintenance expenses, to their tenants in the form of higher rents. This helps to protect REITs’ and landlords’ income from the erosion of inflation.


Dividend Growth


REITs are required to distribute at least 90% of their taxable income to their shareholders, as dividends. As inflation rises, REITs’ income tends to increase, which can lead to higher dividend payments.


Real Estate Appreciation


The value of real estate tends to increase during periods of inflation, as investors seek out assets that can hold their value against the loss of purchasing power. This can lead to capital appreciation for REITs and homeowners.


Tangible Asset


Real estate is a physical asset that holds inherent value to it. Unlike paper assets like stocks or bonds, real estate has intrinsic worth, which makes it less susceptible to fluctuations in market sentiment. This tangible nature provides a sense of stability and security during periods of economic uncertainty.


Unlike the stock market, real estate helps protect investors’ interests and has become an investor favourite over the centuries.


Additionally, the real estate income trusts have allowed even micro investors to participate in the real estate market, thus leading to a more robust real estate economy.


It is noteworthy that over the last century, the global economies have faced two major inflation periods. During these periods, the real estate assets have held their intrinsic values.


In other words, real estate assets have not lost their value to the point where they prove to be a depreciating asset.


Let’s explore some inflation eras in the past century to better understand how real estate assets, or real estate investment trusts prove to be better than stock market investments.


The Stagflation of 1970s - REITs vs Stock Market


The 1970s was a period of high inflation which lasted for almost a decade.


During this time, the Consumer Price Index (CPI), which measures the average change in prices paid by urban consumers for a basket of consumer goods and services, rose at an average annual rate of 7.9%.


This was significantly higher than the average inflation rate of 2.3% over the previous two decades.


The inflation rate, as measured by the CPI rose to as high as 14.8% in 1979.


Several factors contributed to the high inflation of the 1970s, including:


The End of the Bretton Woods System aka THE GOLD STANDARD


The Bretton Woods system was put in place after World War II until 1971. Under this system, the value of the US dollar was fixed to gold, and other currencies were pegged to the US dollar.


This system helped to keep inflation low by preventing countries from devaluing their currencies.


However, the Bretton Woods system was unsustainable in the long run, and it was discontinued in 1971 by President Nixon.


While the Bretton Woods system was a fixed exchange rate system, its abolishment led to a period of floating exchange rates, which made it easier for countries to inflate their currencies.


The Vietnam War


Another factor that contributed to the high inflation of the 1970s was the Vietnam War which was a strenuous affair for the US economy.


The government financed the war by printing money, which led to an increase in the money supply.


As a result, it became easier for people to buy goods, leading to an imbalance in the supply-demand correlation, and causing high inflation.


The Oil Crisis of 1973


In 1973, the Organization of the Arab Petroleum Exporting Countries (OPEC) imposed an oil embargo on the United States and other countries that supported Israel in the Yom Kippur war.


Following this oil embargo, in 1979, the Iranian revolution caused the oil prices to quadruple and hence contributed to inflation.


Wage-Price Spirals


This is a rather speculated factor that led to high inflation in the 1970s.


It is believed that the US government’s social programs led to a wage-price spiral causing a cyclic effect on inflation which was difficult to break.


Wage-price spiral is a phenomenon, where workers demand higher wages to keep up with inflation, and in response to this businesses raise prices to cover their increased labour costs.


High inflation had several negative consequences for both Real Estate Income Trusts and the Stock Market, in general.


For example, the prices soared as the purchasing power declined, there was more volatility noted in the charts, interest rates increased, and of course, the overall growth was very slow.


However, the real estate market, which is often said to be the best hedge against inflation, plunged a lot less, relative to the stock market.


For example, home prices continued to rise albeit at a slower pace than in the previous decades. The average home price in the US rose by an average of 4.8% per year from 1970 to 1979. This made real estate investments a profitable affair during this period.


The demand for rental properties remained strong, as housing affordability became a concern for many homebuyers. This helped real estate income trusts perform better than stock markets despite economic woes.


The S&P 500, which is a broad stock market index and a go-to indicator for the overall market performance in the US, lost 27% of its value between 1970 and 1979.


Overall, despite all the challenges, the real estate market did not experience any significant decline during the 70s inflation period.


The 2008 Financial Crisis - Housing Market Crash


The second major inflation period, which also came to be popularly known as the housing market crash hit the US in 2008.


In the early 2000s, there was a surge in subprime lending, as lenders loosened their underwriting standards and homeowners sought to take advantage of rising home prices.


However many subprime borrowers were unable to afford their mortgage payments when interest rates began to rise in 2006.


As subprime borrowers began to default on their mortgages, the value of mortgage-backed securities, which are financial instruments that pool together mortgage loans, plummeted. This led to a loss of confidence in the financial system and a severe credit crunch.


The financial crisis had a devastating impact on the housing market. Home prices in the US fell by an average of 30% from 2006 to 2012, and millions of homeowners lost their homes to foreclosure.


Several factors contributed to the housing market crash of 2008, including:


Excessive Subprime Lending


The surge in subprime lending in the early 2000s led to a large number of mortgages being issued to borrowers who were unable to afford them.


Securitization of Mortgages


The securitization of mortgages allowed lenders to package large numbers of mortgages together and sell them as financial instruments. This made it easier for lenders to originate more mortgages, but it also created a risk that the value of these securities could decline if there were widespread defaults on mortgages.


Predatory Lending


Some lenders engaged in predatory lending practices, such as charging high fees and interest rates to borrowers with poor credit. This made it even more difficult for borrowers to repay their mortgages.


Housing Bubble


The combination of easy credit and strong demand led to a housing bubble, with home prices rising unsustainably. This bubble burst in 2008, causing a sharp decline in home values and a wave of foreclosures.


All of these factors caused the housing market crash of 2008, and it not only had a significant impact on the US economy, but globally, contributing to the Great Recession.


The crash led to a loss of wealth for homeowners, a reduction in consumer spending, and a decrease in employment in the construction industry.


It had a ripple effect throughout the economy, contributing to the overall financial crisis, which led to job losses, business failures, and a decline in consumer spending, further exacerbating the economic downturn.


However, despite the housing market crash, real estate income trusts outperformed the overall stock market.


While the value of real estate income trusts did decline during this period, they fared better than the S&P 500 index, which fell by over 50% between October 2007 and March 2009.


Of course, there were several reasons why REITs performed relatively well during the 2008 housing market crash.


For example, they were able to pass on the increase in their operating costs, such as property taxes and maintenance expenses, to their tenants as higher rents. This helped protect REITs’ income from inflation.


Overall, the real estate income trusts once again proved to be a better hedge against inflation than the stock market.


The Current Market State - Uncertain Times


The current global inflation outlook is uncertain, and it is likely to remain elevated in the near future.


In recent years, Stock markets have witnessed increased volatility, the real estate market is stagnant across the US and other developed countries, and global inflation has crossed the red mark at 8%. Thanks to the rising mortgage rates, increased energy prices, higher rents, global geo-political shifting, and the growing left-wing communism.


These events have got many suspecting of an upcoming global financial crisis.


In fact, the International Monetary Fund (IMF) has already flagged 14 countries on the verge of economic collapse.


Read the IMF’s latest Global Financial Stability Report here.


For reference, here’s the current snapshot of the global inflation index across world economies:


Top countries with the highest inflation rates*

​Sr. No.

Country

Inflation Rate*

1

Turkey

83.4%

2

Argentina

62.1%

3

Venezuela

55.4%

4

Zimbabwe

52.5%

5

Lebanon

32.6%

6

Sudan

30.0%

7

Pakistan

26.9%

8

Ethiopia

24.9%

9

Ghana

23.6%

10

Egypt

19.9%


Top countries with the lowest inflation rates*

Sr. No.

Country

Inflation Rate*

1

Taiwan

2.0%

2

Switzerland

2.6%

3

Japan

2.9%

4

Singapore

3.3%

5

South Korea

3.8%

6

China

4.5%

7

Thailand

5.0%

8

India

5.3%

9

Indonesia

5.4%

10

United States

7.7%

*P.S. Inflation rates are constantly changing and these figures may not be up-to-date when you read this article. It is important to correlate the information provided in this article with the prevailing data from a reliable source.


Many experts are now suggesting holding on to your assets until the tides pass away.


Homebuyers are suggested to look for stable markets where prices have not yet fallen steeply. On the other hand, home sellers are suggested not to liquidate their assets in panic.


For new investors, retail and institutional, it is recommended to invest in offshore real estate markets, like India and Dubai, which are currently witnessing steady growth, although the growth is not astronomical.


At the moment, comparing real estate income trusts and investments in the stock market can be complex, as both offer unique advantages and disadvantages.


The decision of whether to invest in the stock market or REITs depends on individual circumstances, risk tolerance, and investment goals. Investors should carefully consider their financial situation, risk appetite, and investment horizon before making a decision.


A combination of direct stock market investments and REITs can help investors achieve a balanced portfolio that aligns with their risk tolerance and investment objectives.


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