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Take a page from the country's biggest pension plans and build some inflation protection in your investment portfolio using real estate.
The $51.5-billion Ontario Municipal Employees Retirement System is a good example. Plan members have their pensions adjusted annually to reflect increases in the cost of living, which means the OMERS investment portfolio must be able to surmount inflation. Real estate is part of the solution. "Well managed real estate generally appreciates in value over time in step with inflationů," OMERS says on its website.
The OMERS people have put together a substantial real estate portfolio that is managed by a subsidiary called Oxford Properties. Among the holdings are downtown office buildings in Montreal, Toronto, Calgary and Vancouver, plus hotels, malls and industrial properties. Few investors are in a position to buy real estate holdings like these directly, but that's not much of a problem. Using real estate investment trusts, or REITs, you can buy into some of the best commercial properties in the country.
REITs are a kind of income trust based mainly on real estate in the retail, office, industrial, hotel, apartment and retirement home categories. REITs make regular cash distributions to their unitholders, and they offer solid potential for long-term capital gains. With the threat of inflation on the rise because of rising energy and food costs, REITs have some appeal right now. But there's another argument for buying them now. Simply put, they're on sale.
While banks and investment dealers have been the main victims of the upheaval in financial markets since last summer, REITs have been hurt as well. Borrowing costs for business have risen and REITs, which do a lot of borrowing, have been affected. Also, concerns about a slowing economy are weighing on REITs. The net impact is that the S&P/TSX capped REIT index, the gauge of REIT performance in Canada, was down about 20 per cent for the 12 months to mid-May. Globally, the Dow Jones Wilshire Global Real Estate Securities Index was down about 22 per cent from its high point of the past 12 months.
The soft U.S. economy raises questions about how quickly REITs listed on U.S. exchanges will recover. Here in Canada, where the economy is stronger, there seems to be a more solid foundation for a REIT rebound. While you wait, you get to collect cash distributions that in mid-May yielded anywhere from 6 to 7 per cent for big, established REITs like RioCan, H&R, CAP and Calloway.
If you're reluctant to choose individual REITs, a good alternative is to buy the diversified exposure to the sector through an exchange-traded fund, or ETF, called the iShares CDN REIT Sector Index Fund (XRE-TSX). It tracks the S&P/TSX REIT index, which itself comprises 12 established names in the REIT sector. There are a growing number of REIT-based ETFs listed on U.S. exchanges, some of them focusing on the U.S. market and others on global REITs. Also, more and more mutual fund companies are introducing global real estate funds that primarily hold REITs.
Returns from these funds have been in line with the REIT indexes in the past 12 months, which is to say they're down substantially. But recent results are looking up. Example: Fidelity Global Real Estate was up 4.8 per cent for the 30 days through May 15. More trouble in financial markets or worsening economic conditions could hurt REITs in Canada and abroad. But right now, they're an attractive buy in their own right, not to mention as a hedge against inflation.
Rob Carrick has been writing about personal finance, business and economics for more than 12 years.