How will real estate investment trusts react if there’s a recession in the US? That’s the question posed by Goldman Sachs in a new research report out today that takes a look at the state of the REIT sector. The report, a copy of which has been reviewed by ValueWalk, tries to estimate the potential downside for select REITs if the US economy does indeed being to contract once again, as some economists are predicting.

Goldman’s economic research team puts the odds of a US recession at only 18% and 23% over the next one and two years respectively. But it never hurts to be prepared, and it’s quite interesting to assess the possible recession downside for the REIT sector – a sector that’s  considered to be relatively defensive.

REITs: 22% downside potential in a recession

The equity analysts in charge of Goldman’s REIT report assumed the following stresses for REITs during the next two years: (1) earnings shock, net operating income declines could be similar to 2009 levels, and (2) multiple shock, it is assumed that 2017 multiples fall to second-half 2009 levels.

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Using the above stress-test factors, Goldman estimates that the REIT sector as a whole (those REITs covered by Goldman’s research team) could fall a further 22% from present levels if a recession emerges. Interestingly, the bank’s analysis also shows that there’s not a strong correlation between recession valuation downside and leverage:

“…thus our analysis does not suggest investors should simply purchase low leverage stocks at the expense of high leverage stocks. We estimate there is below average-downside risk in certain high-leverage stocks (FCE-A, and B mall REITs as examples) while some low-leverage stocks have above-average downside risk (such as EQR, EXR, PSA, and O).”

And like all backtested research, there are some critical caveats to Goldman’s REIT analysis, namely, due to market changes that have taken place since 2009, past performance may not be indicative of future performance:

“We acknowledge the past may not be indicative of the future for REITs given the changes in industry fundamentals and balance sheets. For example, Healthcare REITs have a smaller relative balance sheet advantage than in 2009, while tenant coverage and senior housing conditions are less attractive on a relative basis. Meanwhile, other REITs (GGP as an example) have undergone balance sheet improvement versus 2009.”

Goldman’s REIT picks

Based on the above assumptions and analysis, the trusts with the most potential downside in a recession, assuming a return to 2008/09 multiples, are General Growth Properties (GGP, 80.5%), Terreno Realty Corp. (TRNO, 55.3%), Prologis Inc. (PLD, 45.8%), DDR Corp. (DDR, 45.6%) and Extra Space Storage Inc (EXT45.5%).

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On the flip side, the five REITs that are least likely to be affected by a recession are Care Capital Properties Inc. (CCP, 19.8%), HCP Inc. (HCP, 17.4%), Omega Healthcare Investors Inc. (OHI, 6.0%), Ventas Inc. (VTR, 2.4%) and Medical Properties Trust Inc (MPW, -1.5%).

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