Stocks are relatively risky investments by nature, but they aren't all in the same boat. While some types of real estate stocks -- like hotel operators, for example -- are rather sensitive to recessions and tough economic conditions, others are not.
With that in mind, here's a look at what makes certain real estate investment trusts (REITs) and other real estate stocks less susceptible to recessions than others as well as three examples of excellent REITs that should be just fine no matter what the economy or stock market are doing.
What makes a real estate stock recession-resistant?
There's no set formula that makes a stock recession-resistant. And it's also worth noting before we go any further that every recession is different, with unique causes, economic impacts, and other factors. For example, the recession caused by the COVID-19 pandemic is affecting the economy and the stock market far differently than the Great Recession of 2007-2009.
That said, there are some common characteristics to look for in REITs and other real estate stocks that can help you find companies that should survive recessions relatively unscathed.
This is typically the number one determinant of whether a REIT (or any other stock, for that matter) is recession-prone. In simple terms, cyclicality refers to how economically sensitive a business is. Healthcare real estate would be an example of a non-cyclical property, as people need to utilize healthcare services no matter what the economy is doing. On the other hand, hotel real estate is very cyclical, as travel demand tends to plummet during recessions.
Commercial real estate leases range in length from a day (hotels) to decades (retail, offices, and warehouses, for example). A longer lease structure can help offset cyclicality to some degree -- for example, retail is a cyclical business, but if a REIT's retail tenants are locked into 15-year leases, it helps stabilize the income even in tough times.
Generally speaking, I like to look for REITs whose debt loads make up less than half of their total capital structure. In other words, if a REIT's equity market cap is $1 billion, its debt load should be $1 billion or less. Lower is better, and a manageable debt load can provide financial flexibility and a much-needed cushion during tough times.
Don't confuse recession-resistant with recession-proof
One important thing for every investor to know is that there's no such thing as a bulletproof stock. While businesses that meet the criteria discussed in the previous section tend to hold up better during recessions and turbulent times than businesses that don't, it's important to emphasize that no business is completely recession-proof.
Even the least cyclical businesses are somewhat vulnerable to things like spiking unemployment, high inflation, and poor economic growth. And things like low debt and long lease lengths can certainly help to cushion the blow of a deep recession but likely won't eliminate the effects entirely.
In a nutshell, keep in mind that while this discussion is about recession-resistant stocks, it's important to remember that they are stocks and by nature carry a certain level of risk.
Recession-resistant real estate stocks
It's important to note that nothing is truly recession-proof. There are always vulnerabilities and risks in any investment, and each economic downturn brings new challenges.
While no recession is identical to the last, there are certain sectors of real estate that are more resilient during a recession. Real estate investments that serve people's basic needs, such as housing and agriculture, or provide essential services for economic activity, such as data processing, wireless communications, industrial processing and storage, or medical facilities, are better suited to survive challenging economic times.
Investors can own and manage properties in any of the asset classes; however, many choose to participate by purchasing shares in a real estate investment trust (REIT). REITs can be a much more cost-effective and attainable way for investors to get started in real estate while gaining access to institutional-quality investments in a diversified portfolio.
We live in a technological era driven by data. Nearly everything we do requires some sort of data storage or processing, and the demand for data centers will only increase as more technological or data-driven devices are introduced in the coming decades. Recessions typically leave more people at home doing things like watching TV, using their computers or smartphones, or, in the case of the recent coronavirus crisis, working from home, which means increased reliance on data centers. Currently there are five data center REITs to choose from, with all five up 33.73% year to date, according to the National Association of Real Estate Investment Trusts (NAREIT).
Self-storage is commonly viewed as a recession-resistant asset class. As budgets are tightened, some families downsize, moving in with each other to save on costs, or relocate to new areas to improve their quality of life or pursue a new job opportunity. This means there is an increased demand for storage.
The COVID-19 pandemic, however, has impacted the storage sector in unexpected ways. While occupancy has remained high, eviction moratoriums and increased expenses for cleaning and safety protocols decreased revenues across the board. Currently self-storage REITs are down 3.51% year to date, according to NAREIT. However, it's likely this sector will bounce back quickly, especially companies like Public Storage (NYSE: PSA), the largest publicly traded self-storage REIT, who boast a top-notch credit rating and high-quality portfolio.
Warehouse and distribution
E-commerce changed how our economy functions. With more people than ever shopping from home, demand for quality warehouse and distribution centers has skyrocketed. Oversupply of industrial space, particularly warehouse and distribution space, is a risk, as this sector has been growing steadily for the past decade; however, it's already proven to be the most resilient asset class of all commercial real estate as a result of COVID-19, making it a great pick for a recession-resistant investment. Prologis (NYSE: PLD), one of the largest warehouse and logistics REITS, and Americold Realty Trust (NYSE: COLD), a REIT that specializes in cold storage facilities, have both proven to be very resilient in the current economic climate with room for growth.
People will always need a place to live. Residential housing, which can range from single-family homes to high-rise apartments or retirement communities, serves a basic need that even during times of economic hardship is essential. Rents may stagnate and evictions or foreclosures can increase during recessions, but in general, residential rentals are a fairly safe and consistent income stream during economic recessions. American Homes 4 Rent (NYSE: AMH), who specializes in single-family rental housing, and Equity Residential (NYSE: EQR), who specializes in urban high-rises in high-density areas, are two of the biggest players in residential housing -- both of which have maintained high occupancy and collection rates despite COVID-19 challenges.
Beyond housing, agriculture and food production are the other essential services that our country and world depend on. Our current food system relies heavily on industrial agriculture, but more and more independent and regenerative agriculture projects are popping up, allowing for more diversification in crops, increased production, and lowered risk for economic or environmental impacts.
Wireless communication has become a behemoth industry, with the two largest REITs in the world, American Tower (NYSE: AMT) and Crown Castle International (NYSE: CCI), falling under this category. Cell tower REITs offering telecommunication services are an essential part of our world today, and while growth opportunities can be challenging, super strong track records and increasing demand make this a great real estate investment that is sure to survive a recession.
Healthcare services, including medical facilities, senior housing, hospitals, urgent care, and surgery centers, provide an essential service that will always be in demand even through economic recessions.
Before you jump ship when you see this category, let me start by saying that retail is not dead -- at least not all types of retail. Retail centers that provide essential services and products, like grocery stores, will continue to be in demand and have proven to do fairly well during this past pandemic. The challenge here is retail REITs to invest in with enough focus on the essential service sector that other sectors like tourism, restaurants, or general shopping and goods don't put the company or investment at risk overall.
The bottom line
Just because they fall into a certain category doesn't mean they're built to last. What really makes an investment built to survive a recession is the quality of investment or company. This includes asset type, the market the properties are located in, type and quality of tenants, how much debt the company or asset carries and the cost of that debt, the supply and demand for the asset class in the given market, and the general cash flow and financial health of the portfolio or property. All of these factors combined will ultimately tell you how well an investment will fare and whether they are built to survive. Make sure you evaluate each investment, your current portfolio, and where a company stands today before investing.