Advisors juggle a two-bladed sword when it comes to helping retirees who need low-risk options just as much as yield. Post-financial crisis, real estate investment trusts (REITs) have offered consistent returns and dividends as a refuge. But, the fear alone of an inevitable interest-rate rise is affecting the market. Some advisors are already taking action to protect portfolios.
REITs have had a long, happy run, thanks to the Fed's reticence to raise interest rates. They've benefited also from a shift to renting rather than owning, the growth in assisted living facilities, and the public's preference for urban habitats. What could also help REITs is that on September 16 real estate assets moved from the financial sector to their own sector in the Global Industry Classification Standard, making real estate an eleventh sector and the only sector addition in GIC's 17-year history.

Even with declining gains, the sector offers a dividend yield of about 3.2 percent and a current yield of around 3.5 percent -- twice that of the 10-year T-bond -- and it remains a must for retirees' portfolios, say advisors. “I think retirees should have a full allocation to the real estate sector,” says  Don E. Olmstead, CFP, and managing director of Novare Capital Management. “In this low interest-rate environment, many families are looking for dividends and yield.”

“As a separate asset class, real estate has a lower correlation [to the market] than a financial stock would,” says Paul J. Nikolai, director and principal at wealth management firm Aspiriant. Stocks, which he finds “stretched,” and bonds are looking expensive to Nikolai, who wants “lots of asset classes in portfolios to spread my risk around.” About 85 percent of Nikolai's clients are retired or living off their respective portfolios.

Contrary to a vanilla “balanced” portfolio of 60 percent S&P 500 Index and 40 percent Barclays Aggregate Bond Index, Nikolai's version of balance looks like this:

• 40 percent global equity (U.S. large cap, U.S. small cap, international large and small cap, and emerging markets)
• 5 percent real assets (U.S. REITs, international REITs, and master limited partnerships)
• 15 percent defensive strategies, including Liquid alternatives such as emerging debt, TIPS (Treasury Inflation-Protection Securities), managed futures, and puts and calls on the S&P 500.
• 40 percent fixed income (core bonds and high-yield bonds)
The 5 percent weighting represents a gradual drop in Nikolai's allocation of formerly 4 to 8 percent. He relies on specialist real estate managers, Cohen & Steers, investing domestically in its Instl Realty Shares (CSRIX) fund, a “bellwether REIT,” and the SPDR DJI RelEst ETF (RWX) for international exposure.       

Olmstead, however, has dropped his real estate weighting, to 1.5 percent, which is under the S&P 500's weighting of 3 percent. Olmstead says he reduced his REIT exposure after reviewing funds from operations (FFO), an important measure of the cash a REIT generates, and finding price-to-FFO had crept above long-term averages. Olmstead added that he also suspects interest rates may rise and that multifamily and possibly office markets may be overbuilt. “I don't want to put that portion of a client's portfolio at risk unnecessarily,”says Olmstead. “Especially with retirement income, you have to be very careful.”

None of the advisors interviewed intend to drop the real estate sector while rates are still low and earnings and dividends are attractive. Says Daniel Milan, managing director of Cornerstone Financial Services: “When clients are retired they're looking for yield.” But, he adds, “[REIT] values are not great from a share price basis. It's really a value-, a risk/reward- and a yield play.” Milan has cut back REIT weightings over the past six to nine months to 4 percent.

These advisors are using shorter-term alternative investments, also known as “liquid alts," to boost yields. Milan likes floating-rate senior credit and he's scoping out yields in the energy master limited partnership market -- mindful of default risk caused by the oil-price drop. But he expects oil prices to rise again. Meanwhile retirees' non-401(k) and non-IRA accounts are in a position to benefit from the tax advantages of MLPs.

Nikolai is passing on commodities for now. “Nothing too daring,” he says, “mutual funds that you can get out of when you want versus a hedge fund or small mutual fund.”