4%+ inflation is on the way. What to do?

In early July, I wrote about the differing views of departing Bank of England chief economist Andy Haldane and his soon-to-be erstwhile boss at the Bank, governor Andrew Bailey.
Back then, the Bank of England’s ‘official’ view was that it expected inflation to rise to nearly 3% by the end of 2021: talk of higher numbers was mere speculation, and to be discouraged.
But Haldane — whom I’ve always held in high regard — reckoned that inflation would be closer to 4%. In other words, about double its July level.

Haldane: 1, Bank of England: 0

It’s not difficult to see why the Bank might take such a stance. As we saw in the 1970s, consumers’ — and businesses’ — future expectations regarding inflation have a nasty habit of getting ‘baked into’ wage negotiations and price-setting.
But turn the clock forward to late-September, and things changed.
At its latest regular meeting to set Bank Rate, on 23rd September, the Bank’s monetary policy committee now acknowledged that inflation was now likely to peak above 4%, and stay at that level into the second quarter of 2022.
I was sceptical regarding the Bank’s inflation forecasts back in July, and I’m just as sceptical now. (Don’t forget, the Bank’s economists were also the people whose ‘fan-tail’ forecasts of GDP growth in mid-2007 famously saw no prospect at all of an imminent recession, in any of the hundred or so possible scenarios that they had laboriously modelled.)
Why my scepticism about the Bank’s forecasts now? Because look at what we’ve seen since the 23rd of September: rocketing gas, electricity, and petrol prices, widespread labour shortages — affecting even white-collar professions — talk of empty supermarket shelves and food shortages by Christmas, and a government seemingly in a state of denial.
In other words, inflation could well sail past 4% by a considerable margin.

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Purchasing power erosion

For consumers — and ordinary savers — inflation can be a devastating destroyer of wealth and standards of living.
At 4% inflation, for instance, after 10 years the purchasing power of a sum of money will have shrunk by almost a third, halving in 18 years.
Inflation is particularly pernicious for savers. Assuming inflation reaches 4% in the months — or even weeks — ahead, what savings accounts pay more than that? Negative real returns beckon, and not just by a few fractions of a percentage point.
But as investors, we have a little more control over our returns. As consumers, we still suffer from rising prices and eroded purchasing power — but our investment income can at least be positioned for inflationary times. And in several ways.

Introducing REITs

Real Estate Investment Trusts (REITs) are one option, for instance. In my experience, many investors are under-exposed to REITs, with many not really understanding what they are, and being put off by the unusual terminology.
Companies, they know about. But REITs? What are they?

Simple: they’re companies that build or acquire commercial property, and then rent it out.
Right now, of course, the gloss has gone off shops and shopping centres as investment propositions. REITs specialising in these were already suffering pre-Covid, and Covid’s lockdowns haven’t exactly helped. Big city centre office blocks? Everyone’s working from home, these days.
But plenty of other options remain — with some REITs even specialising in property with rents that are explicitly linked to inflation.

REITs to think about

Looking at my own portfolio, for instance, I see Primary Health Properties, which owns doctors’ surgeries that it lets out to medical practices — effectively, the NHS is its tenant. And while I don’t hold it, Assura is a very similar business.
I also hold Tritax Big Box, which lets giant warehouses to businesses such as Amazon, which is its largest tenant. Warehouse REIT, which I also hold, operates smaller warehouses, close to cities and urban conurbations. Empiric Student Properties, which lets modern, well-furnished student accommodation to students, is yet another REIT to consider.
I don’t see inflation especially troubling any of these businesses, or sapping their earning potential and harming their profits.

And even less so with REITs such as LXi REIT, which aims to offer investors resilient, inflation-linked income, thanks to a high proportion of its properties being let on rents that are linked to inflation.

Some icing on the cake

Intrigued? I’m not surprised. Even better, REIT status also confers some extra advantages for investors.
Two in particular stand out.
First, dividends are paid out free of prior corporation tax, meaning that investors get a bigger slice of the profit pie. And second, REITs are legally obliged to pay out at least 90% of profits as dividends, providing additional income resilience.
To my mind, both of these are very handy.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Malcolm owns shares in Primary Health Properties, Tritax Big Box, and Warehouse REIT. The Motley Fool UK has recommended Primary Health Properties, Tritax Big Box REIT, and Warehouse REIT. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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