Housing properties and real estate-related assets are subject to the risks typically associated with real estate, including, but not limited to, natural disasters, acts of war or terrorism, environmental issues, changes in governmental laws and regulations, and adverse changes in national and local economic and real estate conditions.
The economic recovery is approaching its tenth year since the nadir of the Great Recession. Despite the long recovery, we still believe the fundamentals of real estate support current pricing. However, real estate is correlated to the overall health of the economy, in particular, to the job market and overall GDP. After all, United States commercial real estate prices have never decreased outside of a recession.1 But what happens if the economy begins to slow? How do investors attempt to protect their portfolios? We believe, the multitenant rental housing sector typically provides some downside defense versus other property types during broader economic downturns. Specifically, we outline apartments, student housing, and senior housing as possible asset classes that tend to perform better during and after a recession.
Historically, the apartment sector has been viewed as a lower-risk asset type of the real estate sector. This makes sense since housing is a necessity and financing for the asset class has historically been readily available from general real estate financing sources in addition to government-back agencies. As a result, historical capitalization rates and the risk premium or spread between the capitalization rates and U.S. Treasury rates (i.e., risk-free rate) tend to be lower than other asset classes. During the past 15 years (2003-2018), apartments, on average, had lower cap rates than other property types.2 Further, the risk premium of apartments, as measured by the spread between capitalization rates and U.S. Treasury rates, has consistently been lower than any other major property type, as seen in Figure 1.
Figure 1: Historic Yield Spread of Major Property Types
Over the past 15 years, the average risk premium of apartments has equaled 3.30% versus 4.01%, 4.18%, 4.39%, for retail, office, and industrial assets, respectively. So, does this translate to multi-tenant assets outperforming other asset classes during economic downturns? Maybe, but during the Great Recession the answer was, yes! To be clear, apartment prices did decline during the Great Recession; however, the peak-totrough price movement was less severe than other property types. The apartment sector experienced the smallest cap rate expansion during the Great Recession and was the first asset type to reach pre-recession capitalization rates coming out of the Great Recession.2 As a result, the Consumer Property Price Index for apartments not only outperformed other main property types (i.e., office, retail, and industrial/warehouse assets) during the Great Recession, but has had outsized performance in the past eight years relative to these other main asset classes, as outlined in Figure 2.
Figure 2: Consumer Property Price Index for Major Property Types
Student housing and senior housing also may provide some stability to a portfolio during economic downturns. According to Stanford News, in every recession since 1960, colleges have experienced an increase in enrollment. Figure 3 shows the last couple recessions and the increase of enrollment coming out of those economic cycles. Fundamentally, we believe this makes sense as the opportunity cost of going to college—the job opportunities a person misses out on while in college—drops during recessions. For instance, it may be difficult to find a job or to get a promotion during recessionary periods so expanding one’s education may look like an appealing alternative. Further, during recessionary periods, we believe, large private capital outlays to fund new housing projects on campuses will be more difficult to access since capital tends to pull back during economic downturns, which could put pressure on new supply to meet the potential demand.
Figure 3: Historical and Projected Enrollment Demand
In terms of senior housing, we believe the sector has typically been recession-resilient, and the current demographic trends driving demand are attractive today as the Baby Boomer Generation ages. Although average occupancy rates declined to just below 87.0% during the Great Recession, annual net absorption and rent growth was positive.3 Despite the overall condition of the economy, people still age, get sick, become injured, and require care for disabilities. Senior housing generated annualized total returns that outperformed the broader real estate market over the past ten years through March 31, 2018, a period that cycled through the downturn, and experienced the recovery after the economic downturn.4 As outlined in Figure 4, according to NCREIF, a quarterly index of private commercial real estate properties, senior housing generated annualized total returns of 10.52%, versus 6.09% for the broader NCREIF NPI during this ten-year period.
No one can predict the exact timing of the next recession or how a sector will perform; however, it is never too late to think ahead and prepare your portfolio for the market’s cycles.
Figure 4: Senior Housing Performance
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Any views expressed herein are for commentary purposes only and do not take into account any individual personal, financial, or tax considerations. There is no guarantee that the views and opinions expressed herein will come to pass. This material represents an assessment of the market environment at a specific point in time, is subject to change without notice, and should not be relied upon by the reader as research or investment advice. With regard to sources of information, certain of the economic and market information contained herein has been obtained from published sources and/or prepared by third parties. While such sources are believed to be reliable, they have not been independently verified and we do not assume any responsibility for the accuracy of such information.
Actual events are difficult to predict, are beyond our control and may differ from those assumed. There can be no assurance that forward-looking statements will materialize. All forward-looking statements included are based on information available on the date hereof, and we assume no duty to update any forward-looking statement. No representation or warranty of any kind, express or implied, is made as to the accuracy or completeness of the information contained in this article, and nothing contained in this article shall be relied upon as a promise or representation whether as to the past or future performance.
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