RReal estate tends to be a cyclical industry. As the economy slows, demand for real estate generally cools, which weighs on property values and rental rates.
However, some segments of the real estate market are holding up better than others. For this reason, real estate investment trusts (REITs) focused on these types of properties could continue to thrive even if the economy enters a downturn this year. Three REITs that aren’t worried about a recession are Accept real estate (NYSE: ADC), Residential Equity (NYSE: EQR)and Prologis (NYSE: PLD).
Agree Realty grows portfolio and performance with a who’s who of strong commercial tenants
Mark Report (Accept real estate): Agree Realty is a retail REIT, a sector that has been hit hard by the pandemic and is still struggling to recover overall as inflation rages and recession fears loom. But this is no ordinary REIT. Building on a record long-term outperformance, Agree’s stock has continued to rise and is now up around 8.5% year-to-date as a benchmark. Dow Jones US Retail REITs Index fell about 15.5% over the same period.
And while recession warnings have sounded throughout 2022, this REIT continues to build its war chest, adding 205 cash-generating properties in the first six months to bring its portfolio to 1,607 buildings and land leases across 48 states.
These properties are leased to tenants in 25 retail sectors and represent a total acquisition volume of approximately $828 million. By the end of the year, Agree says it expects the total to be $1.5 billion to $1.7 billion in portfolio expansion.
Agree’s long list of tenants is dominated by blue chip companies, including the top five in order: walmart, tractor supply, General dollar, best buyand TJX Companies.
Long-term leases from a diversified portfolio of generally recession-proof general merchandise, auto parts and service, home improvement and consumer electronics retailers indicate rising revenue and dividend growth.
Agree has been public since 1994 and has since more than doubled the total return of the S&P500, and it just increased its dividend again, this time by almost 8% to $0.234 per share per month. Add a payout ratio of just over 70% based on funds from operations (FFO) and all that growing revenue makes Agree a standout option among the 33 retail REITs tracked by trade group Nareit and on the stock market in general.
Equity Residential is well protected from a recession
Brent Nyitray: (Equity Residential): Equity Residential is an apartment REIT that focuses on affluent tenants in prime urban areas. The Company has properties in Southern California, the Bay Area, Seattle, New York and Washington, D.C. The Company selects its markets based on a number of factors, including high prices for single-family homes, the rapid growth in employment and wages and the limited supply of housing.
Highly skilled knowledge workers are the typical tenant at Equity Residential and competition for these workers is fierce. During the second quarter earnings conference call, CEO Mark Parrell mentioned, “The average earnings of our residents who sign[ed] new leases with us in the past 12 months is 13% higher than the group that signed with us in the 12 months ending June 2021.” This 13% increase is not directly comparable to the 5.2% increase in average hourly earnings reported in last Friday’s report. jobs report, but that’s a pretty decent benchmark.
Parrell also mentioned that these workers pay less than 20% of their income in rent. This means that they are not subject to rent constraints, which have always been considered to represent more than 30% of income.
In addition to rising earnings, most Equity Residential markets have seen rapid appreciation in home prices. And when house prices rise, rent increases usually follow. While growing affordability issues have caused demand to plummet, home prices are still appreciating in double digits.
Equity Residential has a high occupancy rate of 96.7% and prices are up 10% year-to-date. Note that much of this falls directly on the bottom line since the lion’s share of its borrowing costs is in fixed rate debt. Between its tenants and rising house prices, Equity Residential appears to be in a good position.
No signs of slowing down
Matt DiLallo (Prologue): Shares of Industrial REITs have fallen this year on fears that demand for storage space will cool as the economy slows. Industry leader Prologis lost a quarter of its value due to these demand issues.
However, the industrial REIT does not see a drop in demand. Far from there. The company noted on its second quarter earnings call that occupancy and rental continued to grow, driven by demand from a wide range of users. Demand is so robust these days that Prologis has raised its rental growth forecast this year. He sees warehouse rental rates rising 23% globally (and 25% in the United States), up from his initial estimate that global rent growth would reach 20% this year.
Even in the event of a recession, this would have little impact on Prologis’ growth prospects, thanks to the long-term nature of its leases. The rates for these leases are currently 56% below current market rents. For this reason, Prologis estimates that its net operating profit will increase at an annual rate of more than 8% until 2025 as its long-term leases expire and it captures current market rents even if they are do not increase further.
In addition to this, Prologis has several other growth drivers. The REIT has an extensive portfolio of development projects which will help increase its rental income as they come online in the years to come. It also recently agreed to acquire another industrial REIT Duke Real Estate in a $26 billion deal. This acquisition will immediately increase Prologis’ base funds from operations per share while improving its long-term growth prospects.
While recessions typically impact demand for industrial real estate, the backlog from the pandemic is so massive that it will drive industry growth for years to come. Add that to Prologis’ other growth engines, and this REIT isn’t worried about a recession slowing it down.
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Brent Nyitray, CFA has no position in any of the stocks mentioned. Marc Rapport holds positions at Agree Realty and Prologis. Matthew DiLallo holds positions at Prologis. The Motley Fool holds positions and endorses Best Buy, Prologis and Walmart Inc. The Motley Fool endorses The TJX Companies and Tractor Supply. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.