Investors take on risk by investing in an income-focused stock instead of a Treasury security. So they expect a higher yield on their investment. When rates rise on Treasuries, the same tends to happen with REITs. Since price and yield have an inverse relationship, higher REIT yields mean lower stock prices.
We’ll discuss the effects of recessions on retail REITs in the next section. In short, certain forms of retail are recession-prone while others are recession-resistant. Most retail businesses have some degree of economic risk, but it varies quite a bit.
This is a big risk factor for retail REIT investors. The surge in e-commerce over the past decade has wreaked havoc on many types of retail businesses. People can get many products more cheaply online, and the emergence of free and fast shipping means there’s little convenience advantage in going to the store.
Just as with recession vulnerability, there’s a range of e-commerce risk levels in retail. For instance, retailers who sell full-price discretionary goods are at a high risk of e-commerce disruption. On the other hand, retailers who have service-based businesses or who sell essential products have a much lower risk.
How do retail REITs hold up during recessions and tough economies?
There’s a variety of risk level involved with retail REITs because there are so many different kinds of retail properties. The three main things to consider when evaluating a particular retail REIT's risk profile are
- the typical lease structure its tenants sign,
- the cyclicality (economic sensitivity) of its tenants, and
- the e-commerce vulnerability of its tenants.
As far as lease structure goes, most retail tenants sign long-term leases with annual rent increases built right in. However, tenants of freestanding properties typically sign triple net leases. These make the tenant responsible for property taxes, maintenance, and insurance expenses. Landlords' income is more consistent under a triple net lease than a gross lease, under which a tenant simply pays rent.
When it comes to recessions, businesses that sell products people need tend to hold up relatively well. Businesses that sell products people want can struggle. Similarly, businesses that sell products at a discount (think warehouse clubs and dollar stores) tend to hold up better than businesses that sell products at full price.
Finally, there are three types of businesses that are well-insulated from e-commerce disruption:
- businesses that sell things people need quickly (like drug stores),
- businesses that sell things at a better discount than can be found online, and
- businesses that primarily sell a service (like an automotive repair shop).
If a retail business doesn’t fit into one of these categories, expect some headwinds as it adapts to the new retail environment.
3 examples of retail REITs
To give you a better idea of the types of retail REITs in the market, here are three very different examples.