Did you read Saturday’s Wide Moat Daily? If you didn’t, you should. It’s a good one.

Guest written by Stansberry’s Credit Opportunities editor Mike DiBiase, it predicted a recession.

“Most economists and the mainstream financial media seem confident that we’ll achieve a ‘soft landing,'” he wrote. “This is the term used to describe when the Fed is able to lower inflation and interest rates without the economy crashing and going into a recession.”

It’s a very nice thought, of course, especially after all the economic issues we’ve had these past five years. However, as Mike added, “Soft landings are incredibly rare. The only time the Fed was able to do it was in 1994. Every other time it failed.”

He’s right, of course. So why in the world are all the “experts” convinced it’s different this time?

This morning’s inflation news certainly seems to indicate that it’s not. The Consumer Price Index rose 3% in January after increasing “just” 2.9% in December. And core inflation rose 0.4% compared to December’s 0.2% gain.

If you’re a regular Wide Moat Daily reader, you know I’ve been predicting a recession for several months. A recent mention of this topic was on January 16 in “My Five Recession Rules.”

One of my readers, Jim, must have missed that one. (Life gets busy. I get it.) But he did catch Saturday’s piece, and he took it seriously enough to send me this:

Suppose that Mike DiBiase is correct. What will be the impact of a recession on REITs [real estate investment trusts]? Will they drop in price because earnings are dropping? Or will they hold their value and maybe increase because – if there is inflation – land should increase in value?

I would appreciate some advice as to how I can use REITs as opposed to bonds to deal with the recession.

It’s a great question with some very interesting answers I’m more than happy to explore.

Bonds Are Not REITs, and REITs Are Not Bonds

I first need to thank Jim for writing in since I always love hearing from my readers. I might not be able to personally respond each time, but it’s great to see what you all are thinking regardless.

Jim, for his part, is clearly thinking ahead. He’s proactive, looking to protect his portfolio before danger strikes.

That’s the best time to protect it, of course. After all, you can’t take out an insurance policy while the car is crashing.

That’s why I’m going to start with his last statement instead of his first. Because it constitutes its own danger.

Jim is hardly alone in thinking of REITs as bond substitutes. This is a very common belief, and understandably so.

Both offer investment income with higher yields. Both tend to be safer assets to hold. And both are sensitive to interest-rate changes.

(REITs with strong balance sheets should be less sensitive than bonds. But market perceptions will be what they’ll be.)

Don’t let those similarities fool you though. They’re actually completely different vehicles, with bonds being debt instruments and REITs falling into the equity category.

In many cases, bonds offer a lot of yield and very little else – which can work ideally. The share price of REITs can appreciate significantly, especially when they’re paying dividends.

That combination can add up a lot more than you might imagine. In fact, I might have to write a whole entire article on the subject one of these days.

For now though, I’ll quote REIT lobbyist and advocate Nareit:

Because stocks, bonds, cash, and REITs generally do not react identically to the same economic or market stimuli, combining these assets may produce a more appealing risk-and-return trade-off. This makes REITs a potentially good candidate for investors looking to build a diversified portfolio.

In other words, you probably need both REITs and bonds in your portfolio.

I can’t give you personalized investment advice, of course. But for most people, it’s not an either-or question.

For REITs, I’d encourage subscribers to catch up on our coverage in The Wide Moat Letter. For bonds, Mike and his team would be a good resource. I’d also point subscribers to our own chief analyst, Stephen Hester, who has been finding attractively priced bonds in our High-Yield Advisor service.

How REITs Perform in a Recession

Now that we have that established, let’s discuss how REITs perform in a recession.

Nareit found in late 2022 that “public real estate posted positive cumulative total returns for four of the last six recessions.” Obviously, the last two were pretty hard on REITs. But that’s to be expected when the housing market crashes, and then commercial real estate is closed to the public for months on end.

I don’t expect either to happen again anytime soon.

Even so, not every sector is recession resistant. For instance, Nareit also reported that when you excluded mortgage REITs – which operate as real estate-specific financial institutions – REITs produced an annualized 15.9% return during recessions.

Those are very attractive findings. But they also demonstrate how you have to be selective. You can’t just grab anything that bears the REIT title.

Some sectors are more tied to economic swings than others, including the aforementioned mortgage REITs. And the same is true of hotels and billboards.

That’s why I prefer to hold mission-critical properties like data centers and healthcare during a recession. People need them and use them just as much (or very nearly so) in bad times as in good times.

Net-lease REITs are another solid consideration. They typically rent to top-notch national and international tenants with solid balance sheets and consistent earnings growth.

Take a playbook from them in this. If you want to boost your portfolio’s recession-proofing power, look for the best of the best, examining:

  • Their balance sheets,

  • Who they lease to,

  • Their dividend track records as far back as you can, and

  • Their management members and structure (I prefer internal versus external management).

And remember two things as you do, the first being that even if you find a REIT that checks every single box and then some…

If it’s not trading at fair value or below, it’s probably not worth buying. Put it on your wish list and wait for the recession to take its price tag down a few notches.

Last but not least, don’t kick your bonds out in the process. Because, as I already said, they’re in a category all to themselves.

Regards,

Brad Thomas
Editor, Wide Moat Daily

MAILBAG

What other questions do you have about a possible recession? Write us at [email protected].