…We are living in a highly globalized world…[with] U.S. large cap companies generating a high percentage of their profits from abroad, and, [as such,]…their exposure…to a trade war has never been higher…Should tensions continue to rise, we believe that we are set for a disaster to happen. [Therefore, it begs the question:] “Where should one invest to “trade war proof” one’s portfolio?”
…We believe the best sectors to “trade war proof” your portfolio are those that generate steady “infrastructure-like” cash flow from domestic sources and REITs are a great example…
- they are a “local man’s game”,
- they enjoy strong protections from long term leases, and finally,
- they enjoy greater margin of safety and more reasonable valuations.
With that said, not all REITs will do. Some are more cyclical than others; and most importantly, some are more exposed to the potential consequences of a trade war. #munKNEE/Money!
Below we outline 3 REIT sectors that will allow you to generate high income, diversify your portfolio, and “trade war proof” your portfolio…
1. Manufactured Housing
Our favorite sub-segment of the rental market is manufactured housing which has greatly outperformed most other property sectors over the past decades. We expect further out-performance in the long run due to the numerous qualities that make it a superior investment in the long run, namely:
- Limited Capex: The property owner only owns the land and associated infrastructure and therefore, the capital expenditure requirements are minimal compared to other property types. The tenants rent the site, but own and maintain their manufactured homes.
- Minimal Tenant Turnover: Tenant turnover is very much reduced compared to apartments because of high cost and effort to move a house from one site to another.
- Unlikely Defaults: The risk of a tenant defaulting on your rent is greatly reduced because this is the most affordable option for housing. Moreover, landlords may also be able to foreclose on your home if you miss on payments. The landlord gets paid regardless.
- Recession-Resilient: There will always be demand for affordable housing; regardless of whether the economy is booming or if we go through a sharp recession. Cities generally do not want more manufactured housing (MH) communities and therefore, the existing park owners enjoy a strong moat with little new competing supply.
- Rapid Growth: Rents are growing faster than most other property types…because, despite increasing rents, tenants are unlikely to find a more affordable option. Moreover, due to the high cost and difficulty of moving their home elsewhere, tenants are often just pressured to stay and accept the newly increased rent.
- Elevated Cap Rates: Finally, MH communities sell for high cap rates relative to their lower risk and higher growth profile. This is because there is often a “stigma” associated with investing in MH properties.
Manufactured Housing and other affordable housing solutions offer high and resilient income to investors. This income is insulated from trade wars and deserves a place in a diversified portfolio. There exists three manufactured housing REITs today, namely: Sun Communities (SUI), Equity Lifestyle (ELS) and UMH Properties (UMH).
2. Hospital Investments
Hospitals provide services that are insulated from the trade war and economic cycle. Property owners can rent these facilities to private operators and earn steady cash flow that is backed by strong rent coverage ratios.
There are many reasons to like hospitals as real estate investments:
- High Cash Flow: Unlike most mainstream property types such as office, industrial, retail and apartments which have experienced cap rate compression, hospitals continue to sell at 7-10% cap rate due to the lack (relatively speaking) of demand. Hospitals are big ticket investments and require specialized expertise that is not widely available.
- Defensive and Durable: Hospitals are absolutely essential infrastructure to our society that we cannot substitute or live without for even one day. A trade war is certainly not going to stop people from going to the hospital. Regardless of economic turmoil, this is a vital necessity, and therefore such assets are perfectly insensitive to the economy. The same cannot be said about most other property sectors which may experience greater cash flow volatility in recessions.
- Strong Operators: One of the main risks of healthcare assets today is that changing regulation and market landscape is putting great stress on operators which struggle to remain profitable. This has in the recent years been an issue for skilled-nursing home landlords…[that] operate on very tight rent coverage ratios. In comparison, hospital operators are much healthier and able to maintain stronger rent coverage.
- Demographic Tailwind: With the rapidly aging population, the demand is expected to surpass the supply growth of hospitals in the long run…This creates additional demand and hospital owners are posed to profit in the long run.
There are only a few REITs today that own hospitals…[They include] Medical Properties Trust (MPW) which is the only pure-play on hospitals and other diversified Healthcare REITs such as Ventas (VTR).
3. Freestanding Net Lease Properties
…Most property investments are rented with a “gross lease,” which generally comes with greater cash flow volatility. The “net lease” (freestanding retail property investments such as Dollar General (DG) convenience stores, CVS (CVS) pharmacies, or even Chevron (CVX) gas station) mitigates the risks by modifying the lease terms more in favor of the landlord and, [as such,] they are some of our favorite properties. They have historically generated some of the highest returns, and yet they have done so while being less risky and paying higher income.
[Consider the following benefits:]
- Very Long Lease Terms: Tenants will commonly sign an extraordinarily long lease of 10-20 years with multiple five-year extension possibilities.
- No Landlord Responsibilities: During the lease term, the tenant takes care of all property expenses and must maintain the building.
- Defensive Sectors: The businesses that occupy net lease buildings commonly operate in defensive sectors such as convenience stores, pharmacies, gas stations and quick service restaurants.
- Strong Profitability: The rent coverage ratios are generally in the 2-4x range – making it very unlikely that tenants default on their leases. In most cases, tenants would need to see 50%-plus drops in unit profits before they would struggle to cover their rent payments.
- Protection Against Inflation: Net leases are generally tied to an inflation index or include fixed and automatic rent increases of 2% per year or 10% every five years. Since property expenses are borne by the tenant, but the rent keeps on rising, the landlord is protected against inflation. Therefore, the cash flow is “bond-like” and net leases are often referred to as the safest income properties for real estate investors.
You have probably already heard about the two largest and most popular net lease REITs, Realty Income (O) and National Retail Properties (NNN)…[which] are both famous for having been exceptionally strong performers with market-beating total returns of up to 15% per year on average and consistently growing dividend payments over many decades. Not even the great financial crisis could take them down as both REITs increased their dividends in 2008 and 2009.
It’s by targeting this type of defensive, yet undervalued sectors that we aim to outperform in today’s volatile and uncertain environment…Compared to traditional equities, our “trade war proof” portfolio has much lower exposure to deteriorating economic conditions and also enjoys much greater margin of safety in its valuation metrics…
With the trade war only getting worse and worse, we believe that the above three sectors will provide an attractive refuge for consistent income and lower volatility.
Editor’s Note: The above excerpts are from the original article by Jussi Askola, and have been re-formatted, color highlighted, edited ([ ])* and abridged (…) by Lorimer Wilson, editor of munKNEE.com – Your KEY To Making Money! – for the sake of clarity, and brevity to provide a fast and easy read.
*(The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.)