RTLPP - Will REITs Stand Up To A Recession? Brad Thomas With Kirk Spano

2023-07-02 11:30:00 ET

Summary

• Real estate expert Brad Thomas discusses the potential of a recession and how real estate investment trusts (REITs) can be used as insulation and income generation during such a period. He advises avoiding the hotel sector and limiting exposure to retail, while recommending investment in net lease, industrial, cell towers, and data centers.
• Thomas also discusses the risks and opportunities of investing in Florida, considering the state's aging population, climate resilience, and high insurance rates. He suggests investing in sectors such as manufactured housing and healthcare due to the high demand from retirees.
• Despite the risks, Thomas believes Florida offers diversification and solid returns due to its consumer demand and population growth. He also mentions the Carolinas, Georgia, and Alabama as attractive opportunities due to their lower prices.

Listen below or on the go on Apple Podcasts and Spotify .

Brad Thomas joins Kirk Spano to discuss using REITs as insulation and income generation during a potential recession (0:50), and concerns around the sun belt region, primarily Florida (6:55). This is an abridged conversation from Seeking Alpha's Investing Experts podcast .

Free trials for Kirk Spano's Margin of Safety Investing and Brad Thomas' iREIT on Alpha .

Transcript

Kirk Spano: Hello, everybody. Kirk Spano with Seeking Alpha’s Investing Experts. And today, we will be interviewing Brad Thomas , who is a real estate expert that I've been following for, boy, quite a long time. His service on Seeking Alpha is iREIT on Alpha .

One of the topics that's been in a couple of your articles recently has been the idea that we may have a recession coming. And how do we use REITs as a bit of insulation and income generation during a potential recession? What are we looking for as far as characteristics go with those types of REITs? What are your thoughts on REITs that should stand up to a recession? Do you even think that we need to worry about that just from your experience with cycles?

BT: I wish I knew – if we were going into a recession or not, some argue we're in a recession. And so I'm of the belief now that maybe we may avoid a recession, but I'm preparing our readers and our base for a recession because having lived through the Great One myself, I really think there's so much an investor can utilize from looking at how real estate and REITs and specifically these property sectors have managed through these various recessions. And now, I've lived through quite a few.

So I'm preparing, and I'm preparing our team for recession. And so some of the sectors that we're really avoiding completely are, of course, the hotel sector. The hotel sector typically does not do very well in recessions at all. And again, we can rely on history now to look at all the lodging REITs and how they've underperformed in those recessions.

If there's one subsector of lodging that probably, I would say, I would not necessarily recommend it, but I'd probably say is probably the most defensive sector is the limited service sector. But overall, I mean, we're staying clear of lodging right now.

Retail, I think, is just going to be fine, especially some of the categories that we really like more, like the Necessity ( RTL ) grocery chains, grocery anchored shopping centers would be kind of one category. But retail has actually held up pretty well. And so – but I would say limiting your exposure to retail as we potentially enter a recession is something I would definitely maintain a more moderate exposure to.

In terms of sectors that I think are more defensive, net lease has always been for me a more attractive property sector. Obviously, the long-term long duration leases certainly provide that predictable revenue. We look harder though at the companies that support that revenue or generate that revenue.

So right now, I like those investment-grade backed tenants like Realty Income and Agree. Realty ticker (NYSE: O ), and ticker (NYSE: ADC ). They both have a large number of investment-grade rated tenants. We think those are going to be extremely defensive in this cycle.

And, of course, if we go back to 2008, 2009, all three of these larger net lease REITs Realty Income and W. P. Carey (NYSE: WPC ) and National Retail Properties (NYSE: NNN ), all did very well before, during and after the recession. They both and all the – all three of those increased dividends on 2008, 2009.

Of course, Agree had some struggles. And I think it really, it's more of a lessons learned for Agree. I know the CEO really, Joey, really well. And I'm glad to see Joey interacting on Seeking Alpha. He's one of the few CEOs, but he does get into the chatroom, which is great.

And so – but Agree did have to make some necessary changes to their business model. They had a lot of borders exposure and Kmart exposure. And coming out of The Great Recession, they've really done a great job of recycling that entire portfolio, and it's much more defensive. And it is definitely in line with a Realty Income business model today.

So I like those defensive spaces. Industrial has held up extremely well. And I think they will even in this potential recession. So we like those areas.

We talk about the technology trifecta. Meaning these sectors that are all correlated with their various technology. So, for example, we have industrial, we have cell towers, and we have data centers, all three of those are combined and kind of create that three leg to the stool type of business. And what's interesting is you look at those companies and the growth profile of all three of those sectors and they've all – they all have and will continue to generate above average growth, earnings growth and dividend growth.

So technology really is a great place to invest through real estate. We're seeing all of this AI craze right now. And the automated vehicles and all of that – all the technology that we're seeing today is really if it weren't for the data centers, none of this would even occur. I mean, the whole infrastructure that supports AI or – is the data center business.

So we think that we're extremely bullish with data centers right now. And, of course, there's some really good, really attractive pricing right now in that sector. Same goes for the cell tower space. We think there's some really good attractive names there. And, of course, the industrial sector as well, which is large – largely supported by e-commerce.

So those are areas that I think we're really looking hard at. And again, this is a great opportunity to be buying REITs right now. Obviously, we're still kind of in the middle of this rate increase. But I think at some point in the not near future, we will see a permanent pause, and I think that that will be the time where you're going to start to see share prices really starting to revert towards the mean. So it's a great time to be owning REITs today, but we're very selective looking at and at quality focusing on the underlying earnings.

KS: I really like to look for cheap because cheap builds in a margin of safety that you don't get when you're paying full price for something, right? I'm sure we agree on that. My concern with the Sun belt is this, in particular, Florida. We look at things through the viewpoint of not only private equity, but also migration patterns, rents, and climate resiliency.

We are desperately afraid of Florida because we know that they have billions and billions of dollars of infrastructure that they're going to have to repair and fortify over the next 20 years. Insurance rates are sky high. Rents have flattened in the last couple of quarters, which I think is a signal that growth is slowing there, and you really have an aging population.

So you have the combination of an aging population in Florida, it's not a very climate resilient place. Insurance rates show that rents are flattening. You have the boom going in on the financial industry down around Ken Griffin in Citadel in Miami .

I think that probably is a supportive thing for that area, and that will help them build the 30-foot walls that are a football field thick along the ocean that they're going to need. If you've been to New Orleans, you've seen that they had to do that along the Mississippi. And these are tremendously expensive projects.

So we don't really invest in Florida anymore. We did years ago, especially in 2020. But all the way back, I'd say, 20 years ago, we were picking out spots down there. Where do you really want your dollars to go?

BT: Oh, that's a great question. And I kind of agree, Florida is definitely an outlier. But kind of drilling down to Florida, again, I've got a place in Florida and an office in Florida, and I'm down there quite a bit in a car, a car down there. So I'm not a resident yet, but maybe the car is a resident.

But, look, I think you're right. I mean, in certain sectors, I would avoid in Florida. It's definitely, I would stay away from multifamily. That – what I really like about Florida is the aging population. You just can't deny the demographics of Florida, so much demand from people coming down to retire in Florida.

And so the sectors that I would really invest in would be manufactured housing, number one, which by the way also includes Marinas, one of the companies we – that I'm invested in, Sun Communities (NYSE: SUI ). They also own a very large Marinas – a number of large Marinas, but one in particular is called Safe Harbor, which is in Fort Lauderdale, one of the largest in the U.S.

So I like manufactured housing. I like – as a result of the aging population, I like the healthcare business down there. There are a number of really high-quality medical office buildings down in Florida owned by Healthcare REIT (NYSE: HR ) and Physicians Realty (NYSE: DOC ). So healthcare certainly is correlated to that aging population.

And then I think certain retail, I like – in Florida, again, all of this – all of the consumer demand and all the people moving to Florida, but there are certain categories I agree that are getting frothy. And frankly, if I were in the – because we're actually investing in private equity as well, if I were looking at private money, I would not – I would avoid Florida.

The only reason I own any real estate in Florida is through my REITs. And obviously, with their cost of capital advantage and their scale advantage, they're able to generate really solid returns. So I like Florida for diversification.

I do worry there are certainly risks that you know, with the weather, hurricanes, I haven't gone through a hurricane in Florida, I have in South Carolina, but I think you – I think definitely there are certainly risks there. But again, I think it's all part of an asset allocation strategy. And I like the fact I do have exposure to Florida.

But I will say, I mean, the Carolinas again going back to kind of my home here, home state. It's some very attractive opportunities here and just not as pricey. So you can get a lot more for your money, going back to the margin of safety here in the Carolinas and in Georgia and Alabama, some of those markets. So for sure.

So – but that's a great question. And I think Florida is definitely going to be interesting. I'm glad we didn't talk politics, Kirk, because I really didn't want to, but obviously that's another risk if you want to throw that in for Florida.

For further details see: