VNQ - 3 Best REITs To Buy For A Recession

Summary

• Economic storm clouds are gathering.
• Three reliable indicators are pointing to a coming recession this year.
• We suggest three defensive and recession-resistant REITs to buy in order to weather the storm.

Storm clouds appear to be gathering on the horizon.

More and more signs are appearing that point to a recession in 2023. At this point, a recession is highly anticipated by many investors. It would not exactly come as a shock if one occurred this year. And yet, perhaps in anticipation of lower interest rates, stocks ( SPY ) and REITs ( VNQ ) have been rebounding so far this year:

At this point, we find it not only plausible but probable that this year will see both economic weakness and falling interest rates. Though REITs generally benefit from lower interest rates, many will also suffer to some degree from economic weakness.

That is why we recommend looking at recession-resistant REITs. In this article, we discuss three of them.

Three Recession Indicators

Leading Economic Indicators In The Red

The latest reading of The Conference Board's Leading Economic Index for December 2022 shows an accelerated weakening of indicators that normally turn negative in advance of a recession.

The LEI has an excellent track record of turning negative a few months in advance of a recession.

Here's Ataman Ozyildirim, Senior Director of Economics at The Conference Board with some commentary:

There was widespread weakness among leading indicators in December, indicating deteriorating conditions for labor markets, manufacturing, housing construction, and financial markets in the months ahead.

...Overall economic activity is likely to turn negative in the coming quarters before picking up again in the final quarter of 2023.

The depth of a probable oncoming recession is difficult to assess from the LEI alone, but there is no question that the index is pointing to a 2023 recession.

Inverted Yield Curve

For those unfamiliar with the Treasury yield curve, it can seem a bit wonky.

All else being equal, investors demand higher yields in exchange for locking up their money for longer periods of time, resulting in an upward "yield curve" from the shortest-term Treasury bills to the longest-term Treasury bonds. But sometimes, the market comes to believe that economic weakness (i.e. a recession) is going to cause interest rates to fall. So, while the Federal Reserve exerts control over the short end of the yield curve, the market prices the long end of the yield curve lower (higher bond prices) in anticipation of the Fed eventually pushing short-term interest rates down in response to the recession.

The yield curve isn't really an economic metric in itself, just a measurement of the market's collective belief about the near future. Nevertheless, an inversion of the yield curve, wherein long-term rates are lower than short-term rates, is a reliable forward indicator of recession.

Today, the 10-year / 2-year yield curve is more inverted than at any time in the last 40 years:

Meanwhile, the 10-year / 3-month yield curve, which some consider a more reliable and timely indicator, is at its second most inverted level in the last 60 years - behind only 1980.

Unless the yield curve is just broken because of a decade of low interest rates, the inverted yield curve is flashing red: "Pain ahead!"

Fizzling Consumer Buying Power

This is not a traditional indicator of an oncoming recession, but we would argue that it is in this case.

It is actually a combination of two metrics looked at together: the personal savings rate and the total level of credit card debt.

While the personal savings rate has collapsed to an ultra-low level, credit card debt has quickly soared back to around its all-time high.

While the consumer is still spending, we think this indicates that the buying power of the American consumer is dwindling. There simply is not as much room to continue expanding personal consumption today as there was a year or two ago.

Since personal consumption accounts for about 2/3rds of US GDP, we view this as a sign of an oncoming recession, fueled in part by a decrease (however slight) in consumer spending.

Putting these three indicators together, we think the evidence is pretty strong that the US economy will dip into recession (or perhaps is already in a recession) this year. Of course, we don't have a crystal ball, but we believe it would be foolish to ignore these signs.

With that said, here are three recession-resistant REITs to buy today ahead of a potential 2023 recession.

1. Agree Realty ( ADC )

ADC is one of the most conservative and defensive net lease REITs by multiple measurements.

First, it boasts a highly defensive portfolio of essential retail properties, wherein over 2/3rds of tenants are investment grade-rated and most of its tenant industries are necessity-based retail sectors like grocery stores, auto services, and dollar stores.

Having Walmart ( WMT ) as its largest tenant at ~7% of base rent signifies ADC's peer-leading bent towards a strong tenant base with very little risk of defaults during a recession. In fact, Walmart is even a little bit countercyclical , as consumers tend to "trade down" to cheaper options like Walmart during economic downturns.

Second, ADC enjoys peer-leading balance sheet strength, with net debt to EBITDA of 4.0x, interest coverage of 5.0x, and very little debt maturing until 2028.

ADC's nearly 4%-yielding dividend has been raised by over 6% per year over the last 10 years, and given ADC's strong cost of capital and proven ability to ramp up acquisitions, that dividend growth streak should continue for many more years.

2. Crown Castle ( CCI )

CCI is one of the largest REITs by market cap and operates an extensive portfolio of telecommunications infrastructure, including over 40,000 cell towers, 115,000 small cell nodes, and 80,000 route miles of fiber.

Telecommunications infrastructure is highly recession-resistant because the vast majority of cellular subscribers will continue to pay their phone bills through a recession. Cell phones have become both the primary method of communication and an essential daily part of life for most people.

And even if a small minority of users fall behind on their bills, the revenue hit will be felt by the telecom service providers like AT&T ( T ) and Verizon ( VZ ) rather than CCI, because the REIT operates with multi-year lease terms. Besides, service providers would not want to give up their infrastructure over temporary economic weakness.

Consider how CCI's core tower business performed through the Great Recession of 2008-2009:

As you can see, neither revenue nor operating income fell during the Great Recession years, and CCI's yield-on-cost only expanded.

CCI also maintains a strong balance sheet with a weighted average maturity of 8.5 years at a low average interest rate of 3.3%. CCI does have some debt maturing this year, but nothing that the telecom infrastructure giant can't easily handle.

CCI does face some headwinds over the next few years as the Sprint and T-Mobile ( TMUS ) merger has led to some cancellations of Sprint tower leases, but this has nothing to do with a potential 2023 recession and has already been priced into the stock.

Given management's recent reiteration of a long-term average dividend growth rate of 7-8% per year, buying CCI today at a 4.3% yield looks like a smart move.

3. Camden Property Trust ( CPT )

CPT is a Sunbelt multifamily REIT that has enjoyed double-digit rent growth from the influx of people and jobs into its markets in recent years, and yet its stock price has fallen almost all the way back to its pre-pandemic level. The market seems to fear a surge of new apartments coming online in the following years destroying CPT's ability to raise rents, but migration into the Sunbelt is set to continue for the foreseeable future. That should allow new apartment supply to be absorbed without too fierce a competition for renters.

CPT's high-quality and diversified portfolio is mostly Class B, suburban, garden-style apartment communities that provide affordable rent for middle-income workers and families.

Given the general affordability of CPT's rent rates compared to urban Class A apartments and single-family rentals, it's unlikely that its occupancy would dip substantially lower during a recession. Some renters may have to trade down to a Class C apartment, but other renters from Class A units may trade down to CPT's Class B apartments.

And, of course, CPT's A-/A3 credit rating and strong balance sheet give it ample financial flexibility to withstand some pressures from a recession.

CPT has enough liquidity to pay off its next five years of debt maturities if it so chose, and maturities of $250 million this year pose no threat.

The multifamily REIT's 3.2% dividend yield remains well-protected and likely to grow in the coming years.

Bottom Line

While we cannot be sure a recession will manifest this year, we also cannot ignore the increasing signs that one will . Thus, we think it is a good idea to prepare for a recession by owning high-quality, defensive REITs with strong balance sheets, attractive assets, and good records of cash flow growth.

ADC, CCI, and CPT are three REITs that perfectly fit that bill.

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