“Recession-Resistant” vs. “Needs-Based” Real Estate

On last week’s podcast, Adam and I had a fun and engaging discussion with Dani Lynn Robison, a seasoned real estate entrepreneur (and former professional trumpet player).

The whole episode is worth a listen, but something that’s stuck in my head this past week is Dani’s primary investment thesis, what she calls “needs-based” real estate.

“Needs-based.” The more I’ve thought about it, the more I love it.

(As an aside…I played trumpet all through high school and college, so I may be biased, but I wasn’t one bit surprised that a trumpet player was the one with the sharp take. 🎺)

The usual label for an asset that holds up in a downturn is “recession-resistant.” But it gets attached to so many deals that it’s honestly lost most of its meaning. Not to mention that “recession-resistant” doesn’t mean “impossible to over-pay.”

“Needs-based” is a lot easier of a concept to grab onto – and you don’t need a degree in economics to understand why it works. I think it’s going to change the way I hear “recession-resistant” from here on out.

Will they still pay the bill?

When money gets tight (whether due to a recession or otherwise), people cut their spending in a rough order of priority…and the things they truly need are the last to get cut. Said another way, the bills that matter most are the first to get paid.

So the question I’d ask about any property, regardless of asset class, is simple: is this truly a need, the kind of bill someone in distress will make sure gets paid?

Dani focuses on workforce housing, senior housing, and self storage for exactly that reason. In her words, “people will prioritize healthcare, they’ll prioritize where they have to live.”

By way of example, hotels and luxury properties sit much higher on the list of things people cut. There’s nothing wrong with owning them, but their income depends on people choosing to spend money they could otherwise hold on to.

This question is what I think makes “needs-based” more useful than “recession-resistant” – it has a much more tangible answer. “Will this asset hold up in a recession?” is a lot more vague and mushy than “is this a bill someone in distress will make sure they pay?”

Even housing isn’t equally needs-based

Housing is about as clear a need as it gets. But that still doesn’t make every apartment building equally safe when the economy gets rough.

The typical tenant in a generic Class A building (newer buildings charging top-of-market rents) has a good income but isn’t truly wealthy. When things get tight, they’ll still pay rent, but they know they can pay less of it by moving somewhere cheaper.

That’s why generic Class A apartments tend to suffer in tougher times, while Class B and C properties usually hold up. They absorb the renters moving down from the tier above, as well as Class B renters moving down to Class C.

The exception is the very tippy top of the market. As Adam put it on the podcast, if you’re selling Gulfstreams, they’ll keep getting bought. A recession doesn’t squeeze those buyers’ budgets the way it squeezes most people’s. That’s why if you’re going to invest at the high end, it’s best to go all the way to the top, where the term “need” is mostly irrelevant.

So the risk sits in the middle – in the properties that are nice to have but ultimately optional for the people paying for them.

Start with who’s paying the rent

Sponsors aren’t going to stop calling their deals recession-resistant, and to be fair, plenty of the deals that get that label truly are. But thanks to Dani, when I hear it now, the first thing I’m going to think about is the people actually paying the rent.

So the next time you hear it in a pitch, ask the sponsor who the tenants are and where they’d go if they needed to spend less.

Because if they can easily cut that bill when times get tight, the income and equity growth you’re counting on gets cut with it.