Last week was a roller-coaster week in the stock market as the S&P 500 ETF (SPY) finished the week lower by 9.4% while the Dow Jones Industrial Average (DIA) dipped 2,600 points. The week saw 1000-point swings that was capped off on Friday by the single largest point gain in history.

The ongoing coronavirus crisis continues to spread fear across the globe, with many countries taking drastic measures to enhance social distancing. Last week U.S. President Donald Trump announced a 30-day travel ban on citizens from 26 European countries.

In a research report Cohen & Steers explains:

anticipation of significant disruptions to travel, trade, manufacturing and confidence resulting from the COVID-19 outbreak are leading to assumptions of a potential global recession, causing markets to reprice asset values across the board.

This week’s declines put essentially every global stock index firmly into “bear-market-territory” with the ironic exception of China, which has rallied in recent weeks as the pandemic subsides at the epicenter of the outbreak. Hoya Capital Real Estate explains:

“Encouraging indications emerged from South Korea, Singapore, and Japan as well, which have seen a dramatic decline in new CV-19 cases and a gradual return to normalcy within weeks of the outbreak’s peak”.

However, Hoya warned:

Western Europe has seen a concerning intensification of the outbreak, particularly in Italy which was forced to institute an unprecedented nationwide quarantine in an attempt to slow the outbreak.

As Cohen & Steers continues, “The impact of the virus will depend on the extent to which containment efforts and shocks to supply and demand disrupt economic activity.”

As the spread has expanded, overall risks to growth have increased and Cohen & Steers provides three potential scenarios. But, says the global asset manager, “even in a worst-case scenario, which might trigger a global recession,” the firm “expects the recovery to be swift once normal activity resumes.” The economic impact of the virus will depend on:

• success of prevention efforts in limiting the spread, and
• the extent to which containment measures and shocks to supply and demand disrupt activity.

Due to the significant uncertainty in these measures, Cohen & Steers outlined these three potential scenarios:

Scenario A: Containment by the end of March. New global cases begin to fall by the end of March. Global growth takes a modest hit but recovers quickly.

Scenario B: Escalation into the second quarter. New cases continue to rise until May, disrupting activity both on the supply and demand side for several months before rebounding in the third quarter. Central banks respond with emergency interest-rate cuts and fiscal authorities begin easing measures. In the short term, the impact on growth could come close to the dot-com recession in 2000 but should not be as bad as the 2008–09 financial crisis, with a near-term impact on job growth and consumer confidence.

Scenario C: Global escalation and demand destruction. The virus continues to escalate into the third quarter across all major economies. Profits contract for a sustained period, the global unemployment rate rises, consumer confidence falls sharply and retail sales contract. Central banks coordinate monetary easing and provide liquidity to keep lending channels flowing. This could lead to a global recession (two quarters of negative growth) before rebounding in the fourth quarter.

Cohen & Steers believes “Scenario B is the most likely outcome, with the potential for Scenario C.” The silver lining is that financial balances are generally strong, monetary policy is loose, inflation is under control and there are no major inventory overhangs. This should all help boost the economy in the recovery phase.

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This Time It’s Different…

As a young investor I can remember Black Monday, the name commonly attached to what is now the second largest stock market crash in history. That was Oct. 19, 1987 when the DJIA (DJI) fell 508 points (22.6%).

I was still in college then, and I didn’t have much money in the market, so I was not as tuned into market dynamics in 1987.

However, I was extremely tuned into the Great Recession. That was the catalyst for me to become a writer on Seeking Alpha.

From 1988 through 2008 I was deeply involved in direct real estate investing, where I was on the front lines of the financial crisis in which most every REIT was forced to cut their dividend (note: only 13 REITs increased their dividend in 2009).

Source: Yahoo Finance

As I reflect on my 30 years of experience (in both the public and private markets), I am reminded of the many lessons that I have learned over the years, and the one that’s most meaningful is the last recession, in which the $6 trillion U.S. commercial real estate market was pummeled. As the economy began to improve, REITs began to claw back market share and deliver healthy total returns.

Source: Yahoo Finance

As viewed below, the coronavirus effects have been wide-reaching across the stock market, and REITs (as per VNQ) have seen shares slide by 21% year-to-date (and 21% in the last 30 days). Last week, the VNQ dipped nearly 12% with six of the 18 REIT sectors lower by more than 20%.

Source: Yahoo Finance

As a result of the latest events, we have reduced expectations for most every REIT property sectors as we expect to see general activity slow. Under the above-referenced (Cohen & Steers) “scenario B” (not as bad as the 2008–09 financial crisis, with a near-term impact on job growth and consumer confidence) we believe that many REITs could see modest to major impact to leasing and investment activity (in volume and pricing).

In this report, we will take a closer look at each property sector to identify the strengths, weaknesses, opportunities, and threats (S.W.O.T.) in order to provide our newly established price target cuts for each sector.

While our markdowns may lean conservative, we believe it’s in the best interest of our readers to be over-prepared as no one knows whether the coronavirus events will turn into “scenario C.”

Keep in mind that historic crashes are precisely the best time to put money to work (similar to 2009), and we believe that now is not the time to begin to scoop up cheap REIT shares for the sake of being the first mover on these beaten-down shares.

On the contrary, we believe that investors should become more tactical and look to accumulate shares in the most defensive REITs, recognizing that it’s highly possible that we are now in a recession. Jeff Miller explains:

Recession odds. The average person I speak with believes we are already in a recession or that it is inevitable later this year. By contrast the economic forecasters are more in the 50-50 range, where I have been for some months. This is important because stocks are already pricing in a recession which may or may not occur.

As you will discover when you read our property sector S.W.O.T. analysis (below), I have become much more conservative, recognizing that I have learned the lessons of the past. While it’s tempting to be like a kid in a candy shop and scoop up all of the sweet REITs, I am cognizant of the past and I have become much more conservative in my plan to “retire Rich with REITs.”

I remain optimistic that the coronavirus will get under control in Q2-19, yet the sustained rally will likely require (1) containment (which seems to be working), (2) clarity of the economic event (big unknown now), and (3) speed in which global policy works in concert.

Finally, I want to point out that it’s not smart to put 50% of your eggs in one basket, and although I have a passion for REITs, I would never recommend the policy of holding more than 20% in REITs. Although the asset class is defensive, it’s not immune from volatility and it’s important for readers to consider the risks related to each property sector or subsector. We all know the importance of the words “cash is king.”

Healthcare REITs

Strength: Defensive, and the highest-strength subsectors are medical office buildings and life science. We like Physicians Realty (DOC) and Healthcare Trust of America (HTA) in the MOB sector.

Weakness: Highest-risk sectors are skilled nursing and senior housing. We like Ventas (VTR), Omega Healthcare (OHI), and LTC Properties (LTC). We plan to write a detailed article this week on healthcare REITs with an emphasis on skilled nursing and senior housing.

Opportunity: VTR has moved into deep value range, dividend yield is now 9.6% (payout ratio is 88%). Balance sheet is strong (BBB+) and we consider DOC, HTA, VTR, OHI, and LTC to be solid long-term picks.

Threat: Under “Scenario C” the healthcare REITs could see guidance reductions (especially in senior housing and skilled nursing). We are downgrading FV targets for all healthcare REITs (except HTA, HR, DOC, and ARE) by 10%.

Lodging REITs

Strength: Deep value and high recession risk. We have a Hold now on all lodging REITs and consider them speculative as we enter elevated recession risk.

Weakness: Based on the 50% decline in leisure bookings and erosion in earnings and occupancy, we are now moving all lodging REITs to a Hold (we are already speculative and underweight).

Opportunity: Conference cancellations are mounting, and given the social distancing objectives, we see high risk to the business model as travel becomes highly restrictive.

Threats: Dividend coverage at high risk of being cut (includes RHP, PK, RLJ, HT, PEB and others). We are reducing FV targets for all Lodging REITs by 15%.

Gaming REITs

Strength: 30% Deep value and high recession risk. Similar to Lodging, the sector has elevated risk due to “social distancing.”

Weakness: 30% declines in room pricing in Las Vegas and events being cancelled. I was planning to attend the ReCon conference in May (in Las Vegas) and it has been cancelled. This is the first time in 30 years that I have missed this event.

Opportunity: Conference cancellations are mounting and given the social distancing objectives, we see high risk to the business model as travel becomes restrictive.

Threat: Under “Scenario C” gaming REITs could come under higher pressure. Material declines could spark dividend cuts. We are lowering our FV for all gaming REITs by 15%. We move the category to speculative and have out Holds on all names: VICI (OTC:VICI), MGM Growth (MGP), and Gaming and Leisure (GLPI).

Net Lease REITs

Strengths: Among the most defensive sectors in equity market. Long-term leases provide clarity and predictability.

Weakness: Cost of capital elevated, could result in missed acquisition targets (unless share prices move higher).

Opportunity: Selecting high-quality REITs like Realty Income (O), National Retail (NNN), and W.P. Carey (WPC). We also like Store Capital (STOR) after the pullback, but investors should also consider the fact that STOR’s tenant base is middle market and subject to higher credit risk. Also, STOR has casual dining exposure that could impact earnings under “Scenario C” (and possibly under “Scenario B”).

Threat: EPR (EPR) is a Sell after it announced a $1 billion gaming deal and pulled as a result of recent events. Also, EPR has high exposure with AMC (NYSE:AMC), which will be impacted given “social distancing” efforts. Under “Scenario C” EPR’s dividend is in jeopardy (they cut in 2008). Also, Four Corners (FCPT) is a Sell given its concentration with casual dining operator, Darden Restaurants (DRI). We are lowering our FV for all net lease REITs by 5% and to EPR and FCPT by 10%.

Office REITs

Strengths: More defensive play on valuation although social distancing is a risk factor.

Weaknesses: While co-working (and social distancing) are higher risk, longer-duration leases help mitigate risks.

Opportunity: We like Empire State Realty Trust (ESRT), which owns the Empire State Building. Although tourism has hit the shares hard, we believe there’s upside assuming “Scenario B” unfolds (Q2 recovery). According to the company’s CEO, “the Chinese market accounted for approximately 3% of revenue in Q1 2019… I think that if we have a more broad spread of this, we could have a more broad impact.” Shares are now sub $10 and yielding 4.4%. We also like Vornado (VNO.PK) and SL Green (SLG), given the pullback.

Threats: Office REITs screen opportunistic but it’s important to consider the balance sheet strength for each company. We are lowering our FV target for all office REITs by 10% across the board.

Shopping Center REITs

Strengths: We like the grocery-anchored REITs due to their more recession resilient platforms. Also, longer-term leases support the defensive attributes and predictability of earnings.

Weakness: Social distancing will hurt certain retailers and restaurants, especially under “Scenario C.” Lauren Thomas (my daughter) just wrote that Nike (NYSE:NKE) is closing all of its US stores. If and when we see a trend of more retailers closing stores down, it could impact the mom-and-pop and local retailers. So, shopping centers are not immune, but grocery stores and home improvement chains are more resilient. Also, higher cost of capital could impact acquisition guidance in 2020.

Opportunity: We see opportunity in the higher-quality names like Federal Realty (FRT), Kimco (KIM), Regency Centers (REG), and Retail Opportunity (ROIC).

Threats: Avoid names like Whitestone (WSR) with mom-and-pop tenants and high payout ratio (dividend cut possible) and Wheeler (WHLR). We are lowering our FV target for all shopping center REITs by 10% across the board.

Industrial REITs

Strengths: Highly defensive and we like improved valuation (but still few bargains).

Weakness: Lease rollover risk, especially under “Scenario C.” Also, eroding fundamentals due to port slowdowns that could impact absorption. Small tenants are likely to slow, and cost of capital could impact acquisitions.

Opportunity: We like Stag Industrial (STAG), which now yields 6.0%. Duke Realty (DRE) (best defense) and Americold (COLD) are more attractive, but not yet near our FV target.

Threat: Balance sheets could get stretched and we recommend owning high-quality names. We are lowering our FV target for all industrial REITs by 10% across the board.

Apartment REITs

Strengths: Shelter is a strength during this “social distancing” phase (the cornerstone of the White House policy).

Weakness: Under “Scenario B” there could be disruption that could put pressure on renters.

Opportunity: We like Equity Residential (EQR) and Mid-America (MAA), but shares are still above our revised FV range. American Campus (ACC) is interesting, but we’re not sure of the impact as college kids (like my daughter) are back at home (due to social distancing) and not utilizing dorm space.

Threat: We are lowering our FV target for all apartment and manufacturing REITs by 10%. Still avoiding UMH Properties (UMH) given the tight payout ratio.

Mall REITs

Strengths: Higher risk profile and deep value.

Weakness: Social distancing will impact retail and restaurants (with “experiential” elements). Some retailers could file bankruptcy as a result of “Scenario C” and that will likely put added pressure on the dividend of Macerich (MAC) and Pennsylvania REIT (PEI).

Opportunity: We maintain Strong Buy with Simon Property (SPG), now yielding 9.6%. Key issue is going to be the prolonged impact of “social distancing” and the health of the tenant base.

Threat: We downgrade Tanger (SKT) to speculative given the new reality as it relates to impacts related to the pandemic. Although the balance sheet remains strong, the “black swan” event puts added pressure on the business model and under “Scenario C” could reduce occupancy below 90%. We are lowering our FV target for all Mall REITs by 15%.

Self Storage REITs

Strengths: Defensive sector with minimal human interaction. Also, performs well during recessionary markets.

Weakness: Higher cost of capital, but manageable.

Opportunity: We like Extra Space (EXR) (the best) and Public Storage (PSA). EXR’s 2020 growth is estimated at 4%-5% and we believe there’s brand equity to the platform.

Threat: We are lowering our FV target for all self-storage REITs by 5%.

Data Center REITs

Strengths: Highly defensive given the sector’s leverage and development profile. Digital Realty (DLR.PK) closed on its announced combination with InterXion (INXN).

Weakness: Risk of a shortfall in server shipments and higher lease rollover exposure.

Opportunity: Pullback has created opportunity. We like Digital Realty and CyrusOne (CONE), but we would wait on a pullback with regard to DLR. We see M&A with CONE as very likely in Q2-20.

Threat: Under “Scenario C” global risk could impact earnings growth. We are lowering our FV target for all data center REITs by 5%.

Cell Tower REITs

Strengths: Highly defensive sector and social distancing creates higher demand.

Weakness: Higher cost of capital but moderate impact.

Opportunity: We like Crown Castle (CCI) (only US assets) but valuation is still stretched. Landmark Infrastructure (LMRK) is a higher-risk option (structured as an MLP) that now yields 13.8% (and considered speculative). We just wrote an article on LMRK for the marketplace.

Threat: Under “Scenario C” there would be elevated global risk. We are lowering our FV target for all cell tower REITs by 5%.

Recalibrating REITs

Most obviously, equity capital markets are not favorable, and the risk is elevated for most all REITs. Although market risk has clearly spiked, we think that it’s a good time to consider utilizing dry powder favoring the highest quality REITs.

Additionally, yields are more attractive than they have been for a long time, and we think the steady income that REITs generate will eventually bring investors back. Keep in mind that REITs own real estate and there remains structural demand for most property sectors, which is a solid underpinning for fundamentals.

As you recalibrate the latest news, consider the following property sectors that we find most attractive: cell towers, data centers, self-storage, apartments, industrial, net lease, and (certain) healthcare sectors like MOB and life science.

We believe the shock to the market provides real value (wider margin of safety) and if you are a long-term real estate investor, you should be secure in knowing that the impacts will be temporary. Be careful not to get caught up in the motion of the market.

You must have a long-term goal and you should maintain responsible diversification. If you don’t have the time or the stomach to be a do-it-yourself investor (or DIY), I suggest purchasing an ETF (we’re working on a REIT ETF article this week on iREIT).

Finally, now is not the time to be too cute. While the coronavirus is having widespread impact across almost every asset class, we believe REITs provide a valuable place setting given their highly predictable income attributes. Always remember that “this too will pass” and you must always play the “long game” when it comes to protecting your hard-earned retirement savings.

Adversity is bitter, but its uses may be sweet. Our loss was great, but in the end we could count great compensations.

Benjamin Graham

My thoughts and prayers go out to all of those impacted.

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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