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Worried About a Recession? These 3 REITs Aren't.

Motley Fool - Sat Aug 13, 10:05AM CDT

Real estate tends to be a cyclical sector. As the economy slows, demand for real estate typically cools off, weighing on property values and rental rates.

However, some segments of the real estate market are more resilient than others. Because of that, real estate investment trusts (REITs) focused on these property types could continue thriving even if the economy enters a downturn in this year. Three REITs that aren't worried about a recession are Agree Realty(NYSE: ADC), Equity Residential(NYSE: EQR), and Prologis(NYSE: PLD).

Agree Realty grows its portfolio and its performance with a who's who of strong retail tenants

Marc Rapport (Agree Realty): Agree Realty is a retail REIT, a sector that was hit hard by the pandemic and is still struggling to recover as a whole as inflation rages and recession concerns loom. But this is no ordinary REIT. Building on a long-term record of outperformance, Agree's stock has kept on rising, and is now up about 8.5% year to date as the benchmark Dow Jones US Retail REITs Index has fallen about 15.5% over the same time.

And while recession warnings have been ringing throughout 2022, this REIT keeps building its war chest, adding 205 cash-producing properties during the first six months to grow its portfolio to 1,607 buildings and ground leases spread across 48 states.

Those properties are leased to tenants in 25 retail sectors and represent total acquisition volume of about $828 million. By year-end, Agree says it expects the total to be $1.5 billion to $1.7 billion in portfolio expansion.

Agree's lengthy tenant list is dominated by investment-grade companies, including these top five in order: Walmart, Tractor Supply, Dollar General, Best Buy, and TJX Companies.

Long-term leases to a diverse portfolio of such generally recession-proof general merchandise, auto parts and service, home improvement, and consumer electronics retailers point to more income and more dividend growth.

Agree has been public since 1994 and since then has more than doubled the total return of the S&P 500, and it just raised its dividend again, this time by nearly 8% to $0.234 per share per month. Add a payout ratio of just over 70% based on funds from operations (FFO) and all this growing income makes Agree a standout option among the 33 retail REITs tracked by the Nareit trade group and in the stock market overall.

Equity Residential is well insulated from a recession

Brent Nyitray: (Equity Residential): Equity Residential is an apartment REIT that concentrates on affluent renters in highly desirable urban areas. The company has properties in Southern California, the Bay Area, Seattle, New York City, and Washington, D.C. The company selects its markets based on a number of factors including high prices for single-family homes, fast job and wage growth, and limited supply of housing.

Highly skilled knowledge workers are the typical tenant for Equity Residential and the competition for workers like that is fierce. On the earnings conference call for second-quarter earnings, CEO Mark Parrell mentioned, "the average incomes for our residents who sign[ed] new leases with us in the last 12 months is 13% higher than the group who signed with us in the 12 months ended June 2021." This 13% increase is not directly comparable with the 5.2% increase in average hourly earnings reported in last Friday's jobs report, but it is a pretty decent point of reference.

Parrell also mentioned that these workers are paying under 20% of their income in rent. This means they are not rent-stressed, which has historically been considered to be over 30% of income.

Aside from increasing incomes, most of Equity Residential's markets have seen rapid home price appreciation. And when home prices rise, rent increases usually follow. While rising affordability issues have caused demand to fall, home prices are still appreciating by double digits.

Equity Residential has a high occupancy rate of 96.7%, and pricing has grown 10% since the beginning of the year. Note that much of this falls straight to the bottom line since the lion's share of its borrowing costs is in fixed-rate debt. Between its tenants and rising home prices, Equity Residential seems to be in a good position.

No signs of a slowdown

Matt DiLallo (Prologis): Shares of industrial REITs have tumbled this year on fears that demand for warehouse space will cool off as the economy slows down. Industry leader Prologis has lost a quarter of its value on those demand concerns.

However, the industrial REIT isn't seeing any downturn in demand. Far from it. The company noted on its second-quarter earnings call that occupancy and leasing have continued to grow, driven by demand from a broad set of users. Demand is so robust these days that Prologis increased its forecast for rent growth this year. It sees warehouse rental rates rising 23% globally (and 25% in the U.S.), up from its initial estimate that worldwide rent growth would hit 20% this year.

Even if there were a recession, it wouldn't have much impact on Prologis' growth prospects, thanks to the long-term nature of its rental contracts. Rates on those leases are currently 56% below current market rents. Because of that, Prologis estimates that its net operating income will grow at a more than 8% annual rate through 2025 as its long-term leases expire and it captures current market rents even if they don't increase further.

On top of that, Prologis has several other growth drivers. The REIT has a large pipeline of development projects that will help boost its rental income as they come online in the coming years. It also recently agreed to acquire fellow industrial REIT Duke Realty in a $26 billion deal. That acquisition will immediately boost Prologis' core funds from operations per share while enhancing its long-term growth prospects.

While recessions typically impact demand for industrial real estate, there's such a massive backlog from the pandemic that it will drive the sector's growth for years to come. Add that to Prologis' other growth drivers, 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 has positions in Agree Realty and Prologis. Matthew DiLallo has positions in Prologis. The Motley Fool has positions in and recommends Best Buy, Prologis, and Walmart Inc. The Motley Fool recommends The TJX Companies and Tractor Supply. The Motley Fool has a disclosure policy.

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