Although the economy is still in expansion mode, many investors are keeping a wary eye on prospects for 2020, particularly when the treasury market is signaling a slowdown. If a recession is in the works for next year, what’s an investor to do? Shifting to cash offers little yield and risks getting left behind when the economy starts to grow. Utilities are a traditional safe haven, but how about moving some of that allocation to REITs?
In the REIT market, there are several defensive property segments where companies should be able to power through a slowdown and (hopefully) keep the dividends growing. The following table outlines our REIT Recession Portfolio and related top picks in each category. Key characteristics include:
- Holding occupancy and rental rates. REITs with exposure to rental housing and food (and other necessity-driven items) should outperform in a downturn.
- Low financial leverage. Recessions are not the time to fix a balance sheet. Conversely, growth opportunities await for companies that are under-levered now.
- Portfolio size and market diversity are key attributes for survival. We focus on companies with $10+ billion market caps and avoid small-cap names where concentration risk can be fatal.
|Model REIT Recession Portfolio|
|American Homes 4 Rent||AMH||Single-Family||$12.3||0.8%|
|Camden Property Trust||CPT||Apartments||$13.0||3.1%|
|Equity Lifestyle Properties||ELS||Mfd. Housing||$14.0||2.0%|
|Regency Centers||REG||Shopping Ctr.||$14.9||3.5%|
|Sun Communities||SUI||Mfd. Housing||$15.3||2.3%|
|Source: REIT/BASE website and company supplemental documents. Market capitalization and dividend yield as of June 30, 2019.|
In apartments, our top picks are Camden Property Trust (CPT) and Mid-America Apartment Communities (MAA). Average monthly rental rates for MAA ($1,242) and CPT ($1,781) are solidly in the ‘affordable’ category for most U.S. households, and both companies sport investment-grade balance sheets from the rating agencies. Median Debt/EBITDA for the apartment group is running low-5x, with MAA at 5.0x currently and CPT at 4.3x. Dividend payout ratios from AFFO are similarly low (mid-70% area for both), suggesting that dividend growth can be sustained in all but the most dire scenarios.
Grocery-anchored shopping centers have performed well for decades, but with retail in transition our focus is only on the top locations. Regency Centers (REG) is our choice here for its concentration in upmarket centers ($22.30/sf average portfolio rents vs. $16.68 for KIM), strong tenant diversity (largest is Publix at 3.3% of total revenues), and solid 5x debt leverage. Ongoing reinvestment through renovation projects ($473 million pipeline) should keep REG's portfolio competitive and well-leased as weaker centers lose ground.
Manufactured Housing is the second way to play the middle-market housing theme, and both Equity Lifestyle (ELS) and Sun Communities (SUI) have been around for decades and demonstrated strong equity performance.
The net-lease category provides a number of good names, but category leader Realty Income (O) gets the nod here for a slightly more defensive tenant industry list than National Retail (NNN), due to the latter's 11% allocation to full-service restaurants.
Single-family homes. American Homes 4 Rent (AMH) is our selection in the single-family rental category due to its strong income diversity (52,600 homes in 22 states) and solid balance sheet (5.1x debt leverage, Baa3/BBB- ratings). The company's average monthly rent of $1,626 suggests 'affordable' to us, and is a third way to play the middle-market housing theme. AMH has a very low AFFO dividend payout ratio (21% for 2Q'19) resulting in a substantial dividend safety net and leaving plenty of upside for growth.
Our top pick in self-storage is Public Storage (PSA) due to the company's ultra-low financial leverage (12% for PSA including preferreds vs. REIT industry median of 31%) that gives it significant firepower for growth. While all of the storage REITs provide good defensive characteristics on the business side, PSA's balance sheet stands out as offering the best upside potential and significant opportunity for cost savings as we have written about here.
The following chart shows trailing twelve-month (LTM) returns for the model group through June 30, 2019.
As shown above, the model portfolio group has already begun to outperform the broader REIT sector, led by stellar LTM returns from the manufactured housing REITs and Realty Income. But if a recession's in your base case scenario, there's still time to leg into positions now that may provide good outperformance along the way.
Disclosure: I am/we are long AMH, ELS, MAA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.