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September 01, 2004 at 04:00 AM
In these days of rising interest rates, it’s a good idea for retirement plan sponsors to consider adding a REIT mutual fund to their 401(k) plans because, contrary to popular belief, the value of REITs and REIT mutual funds don’t plummet when interest rates rise, according to Richard Imperiale, manager of the Forward Uniplan Real Estate Fund in Milwaukee.
Far too few plan sponsors offer a REIT fund option today, says Chuck DiRocco, VP of research and investor education at the National Association of Real Estate Investment Trusts (NAREIT) in Washington. That’s a shame because funds that invest in real estate also increase returns and decrease risk “because they’re not volatile investments,” he says. When equities take a nosedive, REIT funds stay steady because there’s little correlation between the two. REITs also have a low correlation to bonds. “When you add a REIT fund to your portfolio, you will see increased returns and reduced risk, and that’s with an asset allocation anywhere from 5% to 15%,” DiRocco says. “REIT funds add diversification [to a portfolio], which is what a defined benefit or defined contribution plan should be about.”
Imperiale recently authored a white paper called “Ending the Myth of REITs and Interest Rates,” which examined the long-term correlation of REITs to various fixed-income assets. What he discovered, he says, should help debunk the popular notion that because REITs have high dividend yields, their prices fall in a rising interest rate environment.
Using the NAREIT Equity Index, Imperiale studied the correlation between interest rates using 5-year and 10-year U.S. government bonds. The result: “When you look at REITs relative to bond indexes, there is a very low correlation over most time periods,” he says.
REIT funds are also a “good inflation hedge because REITs have to pay out 90% of their taxable income in the form of dividends to their shareholders,” DiRocco says. “The income return is really what keeps the REIT security above pace with inflation.” As further support for this argument, DiRocco cites Merrill Lynch, which recently screened 1,600 stocks to find the best equities for inflation protection. Of those 1,600 stocks, 59 companies made the cut, DiRocco notes, and 34 of those were REITs.
Jay Hyde, a VP at NAREIT, notes that “although the majority of REIT dividends continue to be taxed as ordinary income,” and not at the newly lowered 15% capital gains rate for corporate dividends, REITs “do qualify for a lower rate in a number of instances.” In reviewing REITs’ 2003 distributions, NAREIT found that about one-third of REIT dividends qualified for the lower 15% rate, “which is a significant number, and may come as a surprise to most planners,” he says. REITs paid out approximately $11 billion in dividends in 2003.
