The 4 Most Recession-Resistant Commercial Real Estate Asset Types
Real estate is a well-known asset class that has been used to build wealth for centuries, defend against inflation and is sometimes referred to as recession-resistant. Commercial real estate investments can show more resilience than other investments during a recession, but not all asset classes of real estate investments will be able to weather the storm. The properties likely to best perform in a recessionary environment will have four characteristics: good location, strong fundamentals and functionality, sufficient cash flow and modest capital needs.
So, what are some examples of recession-resistant real estate? This article will explore the following four types of commercial real estate assets:
- Self-Storage Facilities
- Medical Office Buildings (MOBs)
- Mobile Home Parks
- Suburban Multi-Tenant Office
At a time when hotels, travel, retail and restaurants are hemorrhaging, it makes sense that self-storage facilities will continue to see demand as consumers and businesses are more likely to downsize during a downturn. The four Ds — downsizing, divorce, dislocation and death- are aspects of real life. Recessions tend to exacerbate these life events, leading to increased rental activity in the self-storage space. As companies and consumers downsize, storage will continue to see demand.
In fact, self-storage REITs were the only real estate asset type that was positive in 2008. That certainly doesn’t guarantee this will repeat in this cycle, but there are reasons to believe this will happen again in this seemingly perfect storm of crisis we find ourselves in during 2020.
Pros of Investing in Self-Storage
- Steady Rent Prices: Tenants not particularly price-sensitive
- Long Term Tenants: High switching costs & perceived vs. Actual length of stay
- High Fragmentation: About 75% independent operators (top 3 <15%)
- Large Industry: Similar to number of Subway, McDonald’s, & Starbucks combined
- Low Management: Easy to manage a mediocre facility—hard to manage a great one
- Powerful Business Plan: Mom-and-pop seller—institutional buyer
- Ability to Meet Demand: Simplicity of unit reconfiguration
- Ancillary Income: Significant opportunities
- Staffing: Low staffing cost, highly trained and franchise supported staff
- Low Competition: Prohibitive cost of land for new competitors
- Affordable Value-Adds: Low-cost opportunities
- Adaptability: Flexible lease terms & easy eviction process
Medical Office Buildings
10,000 baby boomers enter retirement every day with very little savings. This indicates the demand for healthcare services outside a traditional hospital setting is not going away. In fact, it is set to increase as Baby Boomers – those born between 1946 and 1964 – enter their golden years. This demographic is 75 million people strong and will only see its need for medical attention increase in the coming years. Seniors spend five times more on medical services than those in a younger generation. Because of the influx of patient needs, there is now a need for more medical offices, outpatient clinics, and surgery centers.
Medical office buildings (MOB) should provide investors with long-term rent upside even in the event of a downturn, according to industry experts. According to John Chang, Marcus & Millichap Research Services Senior Vice President and National Director, “Medical office is another property type that will be supported by a strong demographic outlook”. Additionally, medical office building tenants tend to have strong credit, though every tenant is unique and should be evaluated on an individual basis. Medical office buildings that possess anchor high-credit, long-term tenants can potentially attract even more of the same, as healthcare providers generally prefer to be situated near complementary services. The chart below is from CBRE’s 2019 report on medical office which shows the clear trend toward outpatient care centers (accessible here).
Additionally, alternative medicine is growing in popularity, with specialties such as chiropractic, massage therapy and acupuncturists needing office space. These treatments are increasingly covered by insurers, and are coverable under HSA’s making them more accessible and popular than ever. The number of chiropractors and massage therapists in the US has increased by 73% in the past 10 years.
Location, tenant roster and the physical real estate will generally be paramount when examining a commercial real estate investment. An aging population combined with an increasing emphasis on wellness and preventative care outside a hospital setting could potentially foster an ever-growing demand for quality healthcare providers outside a hospital setting.
Pros of Investing in MOBs
- Increased Demand: The aging baby boomer population will increase ths need for more MOBs
- Strong Tenants: MOB tenants typically maintain strong credit
- Diverse Tenants: primary doctors, plastic surgeons, dentists, women’s wellness centers, urgent care facilities, etc.
- Always Needed: Medical workers are considered an essential workforce, keeping them resilient against potential work-from-home trends
- Low Turnover Rates: Historically long term occupancy rates
- Beneficial Tax-Treatment: Increase in accelerated depreciation that comes from direct MOB investment
- Market Cycle Resistants: Historically stable during economic downturns
Mobile Home Parks
Mobile home parks have been called “the darling of all commercial real estate.” That’s a pretty big label considering investors looked down their nose at this asset class a few years ago.
From a CrowdSteet Webinar on the Effects of Coronavirus on CRE, “Arguably right now [manufactured housing] is the darling of the commercial real estate industry. You know, if there is one thing that you can look at in terms of wanting to see the leading edge of where we are, go look at the public CRE markets, right? You’ve got hospitality REITs that are getting wacked 40 to 50 percent… [manufactured housing] are positive because there has been no supply. It’s the most affordable form of housing in the United States and the NIMBY-ism (not-in-my-backyardism) basically makes this stuff difficult to obtain.”
Pros of Investing in Mobile Home Parks
- Recession Resistant: Steady in all cycles
- Limited Supply: Unique asset class
- Affordable Housing Crisis: Equates to increased demand
- High Switching Costs: Equates to low tenant turnover
- Fragmentation: Mom-and-pop owners
- Low Operating Costs: Low maintenance & capital expenses
- Less Competition: Stigma of mobile homes
Multi-Tenant Office Properties in Suburban Growth Markets
Though not in line with historical trends, we’d like to introduce the idea that multi-tenant offices – specifically located in suburban growth markets – deserve a place at the table. The belief being that secondary and suburban markets will continue to see increased population and job growth post-pandemic. Generally speaking, cash flow is always king in real estate investing. But during a recession, cash flow is exceedingly valuable. The more income you have, the better positioned you are to cover expenses and debt service even if a significant portion of the income your investments earn is suspended for a period of time. Income-oriented, multi-tenant office, especially when anchored with credit-quality, long-term tenants (WALT 5+ years) has the makings of a resilient asset in the midst of a recession. Landlords benefit from long term leases and banks look favorably upon them.
No doubt, the big question in office is how to quantify the long-term prospects of the space as this work-from-home (WFH) experience has proven viable – if recency bias is allowed to play into it – a concept few of us were thinking about six months ago. There is definitely a growing chorus of companies thinking through a percentage of their labor pool working-from-home post-pandemic. And to state it starkly, these same companies are likely thinking through how much of their labor pool they intend to retain post-pandemic.
Investors need to assess the impact of a slowdown in demand caused by industries that intend to lean into WFH (some people home permanently, others a day or two a week) versus the likely reverse of a long-term densification trend packing more employees into less space.
Perhaps the value is unlocked by following millennial migratory patterns into secondary markets. According to a recent Marcus & Millichap report on the office sector, suburban properties may be the biggest winner of evolving millennial lifestyles. Many millennials are beginning to form families after delaying marriage, and are (like their parents) realizing the appeal of suburban neighborhoods as more affordable housing costs and proximity to quality schools becomes increasingly important. Suburban housing demand will be bolstered in the coming years amid this lifestyle shift, the report noted, putting further pressure on urban apartment vacancy rates, but also encouraging corporations to set up campuses in suburban employment hubs — thus priming the pump for more demand of suburban office, even in the face of any slowdown in the economy.
Pros of Multi-Tenant Office Investing in Suburban Markets
- Increased Population & Job Growth: Many Tier2 and suburban growth markets experiencing increased population and job growth coming from densely populated gateway metros
- Better Commute Efficiency: People do not need to rely on public transportation to get to work, but can live closer to work and drive shorter distances, making for easier commutes
- Improved Tax Benefits: Tax-treatment that comes from direct real estate investment and repayment of capital
- Deep discount to replacement costs
- Stable Income Generation: Longer term leases generate instant and ongoing cash flow
- Ideal Tenants: Access to credit quality companies as tenants
In a time when the US economy is turned on its head, it’s important to find security in certain investments that can help bolster your portfolio and help you weather the storm. While the asset classes listed above can perform well during economic downturns for different reasons, the overarching theme is that they all provide a service whose demand is either unaffected by the economy or is increased during recessions. What’s even more interesting is that these asset classes provide a lucrative ROI for investors without much of the pain that accompanies typical real estate investments. When identified tactically, you can target assets very few large institutions focus on, making the market substantially less competitive.
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