As the coronavirus pandemic ravages the global economy, investors are seeking safety in assets that will make it out unscathed. One type of investment I’ve heard recommended for this environment is REITs. People need somewhere to stay, even when times are tough, the argument goes, so the demand for rental space won’t go down. I’ve even heard it suggested that “shelter-in-place” rules will have people staying home more than ever, somehow resulting in better earnings for REITs.
The problem with this line of argument is that needing living space is not the same as being able to pay rent. As layoffs hit consumers in the pocketbooks, they may lose their ability to pay, and the political pressure on REITs to grant rent deferrals will mount. Further, not all REITs rent space to individuals. A great many of them rent to businesses, many of which could go bankrupt in the event of a prolonged recession. In that case, commercial and office REITs could see a permanent loss of tenants.
None of this is academic. We’re already seeing signs that COVID-19 is hitting many REITs hard. For ones that came into this with poor finances, the threat could be existential. The following are two big reasons why.
Big tenants can’t pay their rent
As the coronavirus hits companies in the pocketbooks, we’re beginning to hear reports of large corporations defaulting on their bills. Anecdotally, I’ve heard of companies telling big law firms that they won’t be able to pay invoices. More concretely, we had CNN reporting that Cheesecake Factory won’t pay its landlords in April. Neither of these are good signs for commercial REITs. And what’s true of billion-dollar corporations will be even more true of individuals.
The same could be true of individuals
If huge corporations are having a hard time paying rent, we can expect the same to be true of individuals. On Thursday, the U.S. reported its largest influx of jobless claims ever — approximately 3.3 million. There’s no doubt will see a similar increase in Canada. When people aren’t getting paid, they can’t pay rent. Doubly so if they’re living paycheque to paycheque. And while the Canadian government has prepared a generous aid package, it’s unlikely that most families will get enough money to pay typical Toronto rents.
One REIT that may buck the trend
If all of this sounds like doom and gloom for the REIT sector, remember that not all REITs are created equal. The silver lining is that some REITs have tenants that could actually do well in this economy.
One example of such a REIT is NorthWest Healthcare Properties REIT (TSX:NWH.UN). As a healthcare REIT, it rents primarily to healthcare providers. That’s one industry that’s certainly not going to lose revenue any time soon. With a portfolio of medical clinics and hospitals in Canada and Europe, it has tenants that will only get busier in this economy. This explains how it has been able to achieve a 97.3% occupancy rate domestically and a 98.3% occupancy rate internationally.
In its most recent quarter, NWH.UN delivered a 35% unitholder return and outperformed the TSX REIT index by 1,200 basis points. It also grew its revenue by 4.7% and AFFO by 3.7%. Based on the success of its European operations, NWH.UN embarked on an acquisition program, acquiring six private hospitals in the United Kingdom. These investments should pay off handsomely in the future. None of this is proof that NWH.UN will do well this quarter, but it’s better positioned than the average Canadian REIT.
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Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends NORTHWEST HEALTHCARE PPTYS REIT UNITS.