DSTs And Recession

As our trade war with China deepens, U.S. stock markets haven’t made any real progress in 18 months and everywhere you look economic data is worse than it was last year at this time, real estate investors have to be asking themselves, what to do, what to do?

The fear out there is palpable and the yield curve inversion (three-month Treasury bill rate being demonstrably higher than 10-year yields) is just the most obvious manifestation of this.  A yield curve “inversion” like this has preceded every U.S. recession in the past 50 years.  FYI, that’s most of my life.

If anxious investors are bailing out of stocks and other risky assets, what then is the takeaway of all this for income producing commercial property investors?  First and foremost, don’t chase yield.

Commercial real estate is identical to the bond market from the standpoint that risk and return are commensurate.  Therefore, the higher the yield on any property type, the greater the risk to principal.  This is why retail and office properties in the DST space consistently provide cash on cash returns 50-100 basis points higher than other types.

To give you a better idea of how profound the changes to bricks and mortar retailing has been, in little more than 10 years some of the oldest and largest chains in North America (Sears, K-Mart, JC Penney, Toys R Us, J. Crew) have all disappeared into chapter 11 bankruptcy protection.

This happened so quickly and went so deep that even some of the biggest names on Wall Street:  Eddie Lampert – once lauded as the next Warren Buffett, Bill Ackman, Richard Perry, KKKR and Bain Capital were taken unawares.  They all underestimated or were too slow to react to changes wrought by the Internet.  All their investments ended with a great leaden thud.

Next, don’t assume what’s always worked before will continue doing so in the future.  Since collapse of the single-family home market in 2008, the asset class of choice in the DST space has been multifamily.  Following the crash, a whole generation of never should have been owners became renters again.  This was exacerbated by traumatized millennials postponing buying.  It took nearly 10 years for supply to catch up with this huge increase in demand.

However, for some time now we have been telling investors this party is over.  This is borne out by cap rates on apartment buildings in the nation’s top markets creeping higher.  Cap rates (property yields) only go up if prices are coming down.  Prudence then dictates you begin looking elsewhere.

The question of course is where?  In anticipation of a downturn, I believe one of the most recession proof property types available is self-storage.  The logic is simple.  The principal demand drivers for self-storage are:  death, divorce, dislocation and downsizing.  Unfortunately, all these go up when the economy goes down.

Even in a healthy economy, I believe the supply-demand fundamentals of this sector are attractive.  Unlike apartments there hasn’t been unremitting building.  It is a Janus-faced property type, steadily increasing demand from an increasingly peripatetic population accompanied by a NIMBY (not in my back yard) attitude.  This limits supply and keeps demand strong.  Furthermore, the less capital-intensive nature of construction allows DST investors to achieve greater diversification over a larger number of properties in different physical locations.  While not guaranteed, diversification may help against potential loss.

Finally, any asset with a meaningful healthcare “hook” should be given serious consideration.  In 2008 when the single-family home market collapsed and sent the global credit system into a tailspin, well sited healthcare properties held up exceptionally well then.

This is because Americans are growing older.  Baby boomers (between ages 55 and 73 in 2019) are having a profound affect on demand for healthcare goods and services.  Their outsized impact here is no different than their previous demands for housing and consumer goods.  It is akin to a snake swallowing an egg.  A big bulge in demand follows them wherever they go.  Obamacare supercharged this process by enfranchising 10 million more Americans with healthcare insurance.

To be sure, this was profoundly unsettling in terms of existing structure and relationships.  However, it has had the affect of heightening demand for delivery points of goods and services.

Aging is inexorable.  Therefore, the demand this places on healthcare assets is little impacted by economic cycles. 


This material and views are prepared solely by the author and does not necessarily represent the views of the its affiliates. Statements concerning financial market trends are based on current market trend, which will fluctuate. Projections are inherently limited and should not be relied upon as an indicator of future results. Historical figures and performance are not indicative of future results. This is for informational purposes only and does not constitute an offer to buy or sell any investment.

DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.

Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice.  


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