REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do, due in part to the fact that many leases are tied to inflation. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.
A practical way of measuring the inflation protection provided by REITs is to directly compare REIT dividend growth per share with inflation. In all but two of the last 20 years, REITs' dividend increases have outpaced inflation as measured by the Consumer Price Index. Chart 1 shows the history of dividend growth per share compared to the annual inflation rate. In 2002, dividend growth failed to edge out inflation by just half a percentage point. The only other time in recent history dividend growth fell below inflation was just after the financial in 2009, when dividends dropped for the only time this period. Over the twenty-year period, average annual growth for dividends per share 9.6% (or 8.9% compounded) compared to only 2.1% (2.2% compounded) for consumer prices.
One of the difficulties in assessing REITs’ performance during periods of high inflation is that there haven’t been any such periods since the 1980s, before the modern REIT era. The U.S. had periods of high inflation in the 1970s and 80s when it was as high as 13% annually, but since 1990, the inflation rate has rarely gone much over 3%. Looking at the historical inflation rate since REITs’ inception in 1972, as shown in Chart 2, the U.S. has had two periods of high inflation, and several periods of moderate or low inflation. High inflation is defined as greater than one standard deviation from the time period’s average of 4.0%, greater than 7.1%. Moderate inflation is between 7.1% and 2.5% (based on the Federal Reserve target), and low inflation is below 2.5%.
Chart 3 compares the performance of equity REITs and the S&P 500 in these three periods as demonstrated in Chart 2. In the high inflation periods, falling REIT prices were made up for by a strong income return. In periods of low and moderate inflation, although the S&P has stronger price returns in these periods, REIT dividends also lead REITs to outperform the S&P 500.