Growth with Downside Protection - 3 "All Weather" Niches to Invest In
Whether you are in the camp that this economic expansion has long legs or starting to get concerned about how to protect your assets in a downturn or minimize damage, I wanted to share 3 niches that I invest in. These 3 commercial real estate niches self-storage, manufactured home parks and value add apartments, have been some of the top performers for decades. I believe one of the reasons they have performed so well for so long is that they handle downturns much better than other asset classes or real estate niches, thus recover faster with less damage to your returns while performing admirably during good times.
When thinking about your portfolio holistically, there are not a lot of places to hide with stocks when the storms come, and bonds certainly are not in a place to grow your wealth while it does a respectable job of protecting the downside. Many investors I talk to are in search of “all weather” opportunities now - niches that have a long-term track record of growth (the sunny days) but don't get tossed around frantically nor capsize when the storms arrive. Let’s simply start with historical returns data.
Return Performance (last 25 years)
According to the National Association of REIT (Real Estate Investment Trusts), Self - Storage was the top performing sector in annual returns from 1994-2017. I put in the S&P 500 stock index for a comparison. The three commercial real estate classes beat stocks by a whopping 6 - 10 % over 25 years, and this does not include the tremendous tax benefits of owning real estate. On an after tax basis, it would be even more impressive.
Apartments: 13.32 %
Manufactured Homes 13.27%
S&P 500: 7.54% (https://dqydj.com/sp-500-return-calculator/)
I would encourage you to review the data from NAREIT.
Recession Resistance (2007 - 2009)
According to the NAREIT, Manufactured Homes and Self-Storage were the two strongest performers of all commercial real estate during the 2007 – 2009 downturn.
Manufactured Homes .47%
S&P 500: -22.03% (https://dqydj.com/sp-500-return-calculator/ )
Apartment returns data includes new and value add, but research would indicate value add holds up much better during a correction. Additionally, during the 2009 market crash, mortgage delinquency for MF apartments was less than 1% versus 4.5% for single family homes nationwide - that’s significant!
Why these 3 Assets are “All Weather” Performers
Why was self-storage able to outperform almost every REIT sector during the most recent recession? When the economy is good and disposable income is on the rise people buy more “stuff” and need a place to store it, which makes sense. Why is this sector somewhat insulated to the impact the recession had on other market sectors? During the recession homeowners were losing their homes to foreclosure or downsizing to apartments and where did they put their stuff? Self-storage units! At the heart of this issue is the fact that Americans have a culture of buying too many things and we can’t seem to get rid of most of it. The demand curve for self-storage seems to be inelastic which helps pull the sector through any major downturns. Estimates are that one-third of storage space is filled with items that have been there for over three years.
Manufactured Homes Parks (MHPs)
The increasing affordability crisis keeps buying a home for many challenging. Over 10,000 baby boomers retire every day with little savings and living primarily off social security. Couple that with little or no supply of new MHPs nationwide being built and you have a very favorable scenario of strong demand and lack of supply. Supply is constrained since towns and municipalities receive little tax revenue from building new parks and may have historical stigmas attached to them. Additionally, since its costly to relocate manufactured homes (for the individual owner) and the lot rent is more affordable, you have a more reliable income stream. Lastly, lot rents are at a relatively low base. Nationwide average is $275 / month. A 5% increase in lot rent annually is typically not going to make a meaningful impact to your unit owner's ability to pay.
Apartments (value add)
With apartments, it’s the most popular niche for folks needing a roof over their head outside of the single-family home. The affordability issue of saving for a down payment and paying the mortgage with the rise of more younger folks and retirees wanting more freedom to live, work and travel anywhere without the cost and burdens of taking care of a home makes this asset class a steady performer in all cycles. Value add investing in older apartments (1980 – 2005 vintage) with owners who are looking to improve the look (renovations) and operational performance of these assets help protect you somewhat from a downturn. Rent concessions can certainly happen in a severe downturn but unlike new construction, the concessions should be more reasonable as you are primarily housing the working-class service industry that is not as impacted as much as the higher wage earner who is more targeted in layoffs.
Wrapping up, adding one or some of these niches above can help improve your overall performance in not only down markets but also perform well in good times too. That’s why it’s a good idea to consider having some “all weather” assets as part of your overall portfolio. One of the best ways to get involved in these niches are through syndications. Syndications are run by experts that focus on one of these niches. They acquire, manage and distribute cash flow monthly or quarterly during the typical hold period (~ 5 years) and ultimately return your capital with profits at the end of the investment. You, as a limited partner (investor) get to participate by providing investor capital in exchange for returns without having to spend your time involved in day to day management. Do your homework, focus on one sector at a time and research good operators with solid track records. Here's an article on vetting an apartment sponsor that you may find helpful.