Investing in REITs in a Recession

Real estate investment trusts, known as REITs, are known to be stable securities despite the bear market setback.

The REIT industry has undoubtedly been impacted as a result of the pandemic, with U.S. REIT earnings declining 9% in the first quarter of 2020 compared to the prior quarter, according to a Nareit Total REIT Industry Tracker Series report.

“Many REIT sectors are not demonstrating the same level of defensiveness today given the underlying fundamentals of how different this downturn is compared to other downturns in the past,” says Uma Pattarkine, investment strategy analyst at CenterSquare Investment Management in Philadelphia.

In the first quarter, REITs endured the consequences far better than the S&P 500. Earnings growth for the S&P 500 fell 13.8% in the first quarter before the index started to recover in April, according to a report by FactSet, a financial data and software company.

Certain REIT sectors are proving more resilient than others. In fact, some are poised for sustained improvement in this low-growth environment, presenting opportunities for investors in search of yield.

Here’s what to look for in the real estate investment trust industry through the rest of 2020:

— Upsides to REIT investing.

— REIT sector performance.

— Residential vs. commercial REITs.

[READ: Investing for Kids: How to Invest for Them.]

Upsides to REIT Investing

REITs provide the investor with a more diverse investment portfolio and reduced risk since you can purchase a variety of shares in buildings, shopping centers, hotels, warehouses and mortgages, to name a few. These assets are traded in a liquid market, which means they can be bought and sold easily, like stocks. Market liquidity is important because if you prefer to get rid of a position or purchase a company of interest, you can do so easily.

A characteristic unique to REITs is that they have high-yield dividend growth. REITs are required to pay out 90% of their income to shareholders that typically pay higher cash dividends that common equities, so investors searching for yield to replace fixed income may be looking at REITs favorably as income-generating assets.

“REITs as long-term investments typically carry an average dividend yield of 4 to 5%, giving investors an immediate return and hopefully there’s upside from real estate appreciation,” says Barry Oxford, managing director at D.A. Davidson & Co., an investment banking firm in New York City.

Since we been experiencing market uncertainty, there may be REITs that have gone on discount.

“Demand for certain things is likely to wane so you can sometimes make purchases at a discount, which is not available when the economy is running full speed,” says Kelly Crane, president and chief investment officer at Napa Valley Wealth Management in St. Helena, California.

But Crane recommends investors to take care when considering low-priced REITs because certain types of real estate may see decreased demand that could last for 10 to 15 years, as real estate cycles tend to be relatively long, posing a greater risk for the investor.

[See: Retail Stocks Trying to Survive the Pandemic]

REIT Sector Performance

No sector is safe from the pandemic, but some have fared well while others are slowly falling apart.

Experts say hotel and hospitality REITs are experiencing the hardest losses as the pandemic has brought travel to a standstill. It is predicted that this industry will continue to endure significant losses well after the pandemic passes.

The retail sector is an area that is “permanently impaired” in terms of real estate, Pattarkine notes. “There may be about 25% of the most troubled retail square footage that may soon shutter,” she says.

Well-known American retailers such as JCPenney, Pier1 Imports and Modell’s Sporting Goods, among others, have filed for bankruptcy and are planning to close some locations if they haven’t already done so. These closures will be a massive blow to retail REITs since large retailers like these are likely anchor stores in their respective shopping centers.

Office space is another property experiencing negative trends. Companies are seeing their employees work from home efficiently and may not be renewing their leases in the future, so there may be an abundance of office space that may last for years to come.

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The work-from-home environment has been supporting the growth of digital technologies, bringing data storage and cell tower REITs to the forefront.

“REITs that have outperformed have largely been driven by secular tailwinds and are not necessarily cyclical in nature,” Pattarkine says.

Technology is among this wave in driving the economy so real estate that supports this movement is also doing well, experts say.

Industrials are pulling strong weight in the REIT market, proving to be a stable sector. In particular, REITs with warehouse holdings are well-positioned for growth since space for inventory from online purchases may increase demand for storage in the future.

“The industrial sector is a beneficiary of the e-commerce trend and is in its best time right now,” Oxford says.

“FedEx (ticker: FDX) and Amazon ( AMZN) are expanding because they have to put their products somewhere as more people order online,” he continues.

Oxford offers his recommendations on a couple of industrial REITs, including Terreno Realty Corporation ( TRNO), a public San Francisco-based industrial REIT in major U.S. coastal markets like Southern California and Northern New Jersey, to name a couple. Oxford focuses on this REIT due to its attractive infill locations that are close to a dense population of consumers.

Another industrial REIT he recommends is Monmouth Real Estate Investment Corp. ( MNR). He recognizes its good credit and large holding in FedEx, a positive upside for this REIT.

[See: 7 Top S&P 500 Stocks That Insiders Are Buying.]

Residential vs. Commercial REITs

The multifamily apartment sector is holding up for the time being. “(The percentage of) rent collections have been in the high 90s where landlords are not under distress since rent is one of the top bills paid first,” Oxford says.

But this may not last.

Pattarkine notices dynamic demographic movement happening where millennials are moving from multifamily to single-family residences since urban centers surrounded by amenities are now closed due to the pandemic.

“We’re seeing a shift of millennials going out towards the suburbs looking for more space and to settle down, which provides a great tailwind for single-family homes,” Pattarkine explains.

People are tied to their homes, and as a large segment of the U.S. population is working remotely and finding that urban areas have not been accommodating, their interest is moving toward suburban, single-family homes.

Families may be well-positioned to make this move now that interest rates are low. It could even be the case that they pay equal or less on a mortgage than rent all while building equity and having more living space.

“It’s difficult to see how much of this is a permanent shift versus a timing issue,” Pattarkine observes. “Are we going to see urbanization come back? I’m not sure, but in terms of the older millennial cohort, we anticipate that their shifts would be longer-term would largely make that shift more permanent,” she says.

Many market changes have resulted from new living arrangements and consumer behavior, creating new trends for businesses and industries.

REITs have been a part of this transformation, and to best position their investments for growth, investors must evaluate how these trends impact the overall REIT industry.

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