Inflation is eating away at the buying power of your hard-earned dollars, which is a very big problem. However, just how big a problem it is may depend on what type of investments you own. But don't get caught up in what Wall Street thinks; do your own homework.
When you take a deeper dive into the numbers, you'll likely find that the downbeat view of real estate investment trusts (REITs) like W. P. Carey (WPC -0.85%) and Realty Income (O 0.24%) is a bit overdone. Let's find out why a $500 investment in either of these two stocks would be a genius move right now.
Many of the benefits that a bond has, only better
The big benefit of a bond is that you get a reliable stream of income from the interest payments and your cash back when the bond matures. They are, generally speaking, among the safest investment choices (leaving aside the high-yield niche). However, there is one very big problem with most bonds: The dollars involved are static, so they don't keep up with inflation. If you generate $1,000 in income from a 30-year bond, that yearly income stream just won't buy as much as the years roll by. And the value of the initial investment won't be quite as valuable when the bond matures.
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Net lease REITs are often looked at as bond alternatives. This is because they are fairly low risk, with large portfolios of assets for which the tenant has to pay most of the operating costs. And most properties come with long lease terms, which makes the income streams generated by net lease REITs fairly reliable. Leases often include built-in rent increases, but there's a broad range of mechanisms for this, from no increases at all to inflation-linked hikes. Often, however, the increases are simply set at a few percentage points a year. So, when inflation is on the rise, investors are justifiably worried that net lease REITs won't be able to keep up.
It's one of the big reasons why W. P. Carey and Realty Income saw their stock prices drop by mid-teens percentages from recent peaks in 2022.
Two ways around the problem
But instead of seeing these drops as a reason to be worried, you should probably view them as a reason to be excited. In fact, adding some cash to these investments may pay big dividends over the long term.
Roughly 40% of W. P. Carey's rents are tied to fixed rent increases, but a larger 55% is linked to inflation. That means that its rent roll will increase at a more rapid clip as inflation heats up. To put a number on that, adjusted base rent growth increased every quarter in 2022 and is now twice what it was in the fourth quarter of 2021. This trend is going to continue into the future, as well, so there's no risk of missing out on the inflation protection benefit here.
Realty Income has a different way to deal with inflation, and that's simple business growth. Realty Income has a massive market cap of just around $40 billion. Its portfolio is huge, with over 11,700 properties. It has an investment-grade-rated balance sheet and its shares are generally afforded a premium to its peers, which leads to lower capital costs. When you put all of these factors together, Realty Income has the ability to keep doing deals even when market conditions are tough. And as it expands, it can continue to support higher dividends. A key differentiating factor is that it can also handle larger deals that smaller peers couldn't even consider, which gives it more avenues for growth over the long term.
The success here is visible from the dividends. W. P. Carey increased its dividend annually since its initial public offering in 1998. Realty Income's increase streak is up to 27 years, making it a Dividend Aristocrat. To be fair, dividend growth isn't always large and doesn't always keep up with inflation over the short term. But, over the long term, both of these REITs have what it takes to deal with this often insidious scourge because the solution is pretty much built into their business models.
Now is the time to take a chance on these REITs
When Wall Street gets fearful it is usually time to get interested. In the case of W. P. Carey and Realty Income, adding to these positions today will allow you to lock in 5.4% and 4.7% dividend yields, respectively. Those are attractive numbers when the broader market is still only offering a sub-2% yield even after a bear market. And while inflation won't be an easy issue to deal with, W. P. Carey and Realty Income have well-tested ways to handle the headwind. The price drops here are more likely an opportunity than a threat.
