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  • Martin Kollmorgen


Updated: Feb 16, 2023

** This newsletter was originally distributed to Serenity investors in November of 2020

POST RECESSION POWERHOUSE – REITs on average have returned 19.6% per year during five-year periods following recessions since 1972. INTEREST RATE BLISS– Low-interest rates are a boon for REITs, and usually translate into higher REIT multiples. Benchmark BAA rates suggest REIT values should be 33% higher. CASH FLOW CONFUSION – REIT cash flows, in general, have likely already bottomed, but investor uncertainty has kept valuations depressed. FINDING VALUE IN VALUE – Value strategies typically perform well following recessions, and many distressed REITs could double over the next 2-5 years. No quote this month, no obscure movie references seamlessly woven into meta investing commentary, no tricks, no treats, no gimmicks. This month we get straight to the point. This is the most compelling opportunity in REITs I have seen in my career. Period. End of sentence. I can’t allude to it in passing anymore; can’t dance around the question of timing, can’t worry about being cute and nailing the bottom, and can’t ignore the data. There may not be another opportunity like this for another 10+ years. The last one was in 2009. From 2010 to 2015 REITs returned 16.9% per year. But what about the coronavirus? What about the election? What about people never going back into office buildings? There are plenty of completely valid fears to have at this point in the economic cycle. But as Paul Atreides from the sci-fi epic Dune would say, “Fear is the mind-killer. Fear is the little-death that brings total obliteration. I will face my fear.” So much for skipping the obscure quotes. It’s time to face some fears. The fact remains REITs trade at historically attractive (in many cases distressed) valuations. Cash flow concerns are well known and improving, and uncertainty is extremely high. For those willing to banish their emotions the opportunity in REITs is obvious, the case to lean towards value is evident, and in many property types, the consensus is badly offsides. This fund was designed for this type of environment. With the ability to add leverage, concentrate our positions, and embrace strategies many REIT investors have abandoned, our outlook for the next five years is more positive than ever. So buckle up for a longer and more data-intensive newsletter than usual. Consider this a rare pound the table moment regarding REITs and a guide to our plan of attack. We don’t intend on leaving opportunities on the table over the next five years, and our clients will benefit from over 10 years of REIT experience and 5 years of dedicated research and development within our flagship fund. Will you be among them?


Serenity Alternatives Fund I returned -3.18% in October net of fees and expenses bringing our YTD returns to -0.8%. The FTSE NAREIT All Equity REIT (FNER) index returned -3.36% bringing 2020 returns to -15.2%. Since the beginning of 2019, our fund has returned +16.4% on an annualized basis versus the REIT index at +4.8%. Since inception, our fund has returned +4.7% with 73.8% average net exposure, versus the REIT index at +4.5%. The REIT market sold off with broader equities in October as coronavirus and election concerns percolated. For additional commentary on what drove our results this month please reach out separately. For this month’s newsletter, we need to preserve some space…lots of ground to cover!


In our last newsletter, we spent some time trying to dispel the myth of REITs as defensive investments. We presented the annualized returns of the REIT index over every five-year period following a recession since 1972. To the right, we have re-published the accompanying chart in an attempt to hammer this point home. REITs historically exhibit their most compelling returns over multi-year periods following economic downturns.

These are not just “pretty good” returns. At 19.6% returns per year, the REIT index is averaging a double every 3.6 years during periods following recessions. Contrast this with full-period REIT historical returns of 11.4% per year, which is a double every 6.3 years (still good, but less mouthwatering).

And the story does not end there. Below we present a more granular view of REIT returns during these periods. Remember these are returns for the five years following the end of each historical recession. What is notable in the chart below is that the BEST returns during these periods were captured in the first few years. Following the most recent two downturns (2001 and 2009), REIT returns decline almost monotonically by year, meaning that they were the highest in the first year and then gradually fell towards their longer-term average.

To summarize, this data makes a few things clear. 1) REITs tend to rocket out of recessions, on average doubling within a 4-year period. 2) Returns remain strong for up to five years following the end of recessions but… 3) There is a premium for acting early, with REIT returns at their best in the first two years of a new economic cycle.


Historical data so far tells a compelling story, namely that REITs tend to produce excellent returns in the years following recessions. Based on the fact that we are currently in the midst of such an economic downturn, prospective REIT returns should look pretty rosy. But what gives us confidence that the setup for REITs this time around is anything like that of previous downturns? To address this question, let’s examine a relationship which most investors will recognize; the interplay between bond yields and REIT multiples. Namely, as bond yields fall, REITs and their valuations tend to go up. This occurs for a few reasons. First of all, lower bond yields translate directly to better earnings for REITs. As levered entities, REITs are constantly refinancing their portfolios, and lower bond yields translate to lower interest expense. Lower interest expense leads to higher earnings and thus higher values. Bond yields also tend to be important because to some degree, corporate bonds compete with REITs for the attention of investors. Think of it this way, if you have the chance to buy a REIT yielding 5%, or a corporate bond yielding 2.5%, which will you pick? The answer will vary based on your risk tolerance, but if we slightly tweak the question, and assume the bond is now yielding 1.5%, the REIT all of the sudden starts to look more attractive. Basically, as bond yields fall, investors will prefer REITs on the margin for their higher yield, driving investors into REITs, and driving REIT multiples higher (all things equal).

This relationship can be seen in the chart above, which displays BAA Corporate Yields (as tracked by Moody’s) and REIT AFFO (cash flow) multiples. There is a fairly clear linear trend relationship between BAA yields and REIT multiples. As BAA rates go lower, REIT multiples tend to go higher. There is also a clear break from this relationship in the cluster of points at the bottom left of the chart. These represent instances in which REIT multiples and BAA yields have broken their historical relationship (recessions). The current data point for this series is captured within the red circle.

If we run a simple linear regression against this data, what we find is our current data point within the red circle should be much further to the right; i.e. REIT multiples should be much higher based on the current yield of BAA rated bonds. To be more precise, REITs have a current median AFFO multiple of 13.7x. Based on our regression results and the current level of BAA yields, this value should be closer to 18.3x, almost 35% higher than it is currently.

This suggests that REIT valuations are over 30% too low based on the current level of bond yields. For the more visually inclined, below is a slide from our newest investor presentation that illustrates the same point. Bond yields are at all-time lows, but REIT values are NOT at all-time highs.

The take-away here is that REITs have the potential to re-rate higher based on valuation alone by a significant amount. Said another way, REITs are cheap relative to bonds historically. Now you may say “but of course they are cheap, their cash flows are cratering!” Not so fast.


The direction of REIT cash flows is the second key variable in the REIT equation (the first being valuation) and the more difficult to untangle. It may sound overly simplistic and obvious, but when REIT cash flows go down, REITs tend to go down as well. It would then hold that in order for REITs to start moving higher, REIT cash flows have to be moving in the right direction. This is where we come to a conundrum. Based on the draconian measures put in place to slow the spread of the pandemic in March and April, REIT cash flows essentially went into free fall in Q2 of this year. According to NAREIT, Same Store NOI for REITs fell 7.5% in Q2, the worst reading in NAREITs history (yes worse than the 08-09 recession). Based on this fact, and the fact that the economy is now at least partially open, REIT cash flows have steadily improved since the depths of Q2. There is basically no way for them to go much lower absent another full-scale lockdown. This leaves investors in a challenging scenario. Long term investors can take solace in the fact that the economy will eventually heal, and REIT cash flows will eventually recover. Most professional investors, however, have quarterly performance numbers to consider, nervous clients to placate, or monthly newsletters to write. This forces these investors to consider changes in cash flow direction on a shorter-term basis. This brings us to today, where REIT cash flows have somewhat recovered from their March and April lows, but their near-term direction is much less certain. Investors at this juncture are faced with a myriad of difficult questions. When are lodging REITs going to be able to attract business travelers again? Will office REITs see permanent cash flow impairment due to the pandemic or will it end up as just a temporary pause in leasing? What levels of rent can retail landlords sustainably recover? These fog of war questions keep investors on the sidelines and keep the value of many REITs depressed. Add in the fact that REITs are currently highly correlated with value stocks, and the lack of momentum in the sector makes a lot of sense. But what if we re-frame this scenario and ask a higher-level question. Does the ability to NAIL the timing of cash flows really even matter? Well if you have ever read our newsletters, you likely know that we do, in fact, believe that timing matters. It matters a lot. But in this instance, I’m not convinced that it’s the timing of cash flows that matters as much as it is the timing of sentiment. Now the cynics in the audience are probably thinking “Nice, way to completely dodge your own question.” Which is a fair point. That being said it is impossible to argue that sentiment changes do not have a massive impact on stocks in this day and age. In an era of 24/7 news cycles, alternative data sources, and monthly rent collection updates, sentiment tends to move much faster than reported cash flow data. Said another way, the REIT market is likely to move in anticipation of a bottoming in cash flows. This anticipation could be precipitated by a vaccine, a stimulus package, or a realization that incredibly expensive tech stocks have little upside and huge downside. *Note: This paragraph was written prior to Monday’s vaccine-induced rally…which basically proves the point. Essentially, nobody knows when REIT cash flows are going to start moving higher fast enough to sustain a multi-year rally. This will eventually happen, however, and the REIT market will move before it is readily apparent in the data. For this reason, we believe having some cyclical exposure in the portfolio is prudent. Every day we get closer to solving the global health crisis brings us closer to a sustained rally in beaten-down “risky” REITs.

At the end of the day, we find ourselves in a world in which REIT valuations are attractive, but the path of near-term cash flows is uncertain. In the short term, this means we need to watch the data like a hawk, managing risk proactively as the current recession and health crisis unfolds. Planning over a longer-term horizon, however, suggests an approach that many REIT investors currently find quite unsavory – value investing.


The more time I spend in the capital markets the more I recognize how cyclical all types of phenomena are, particularly conventional wisdom. When I started in the REIT industry, warehouse rents never grew, mall REITs were considered invincible, and value investing was THE strategy of REIT investors. Momentum? Not in the REIT lexicon in 2010. Fast forward 10 years and warehouse rents are the fastest growers in real estate, malls are barely clinging to life, and value investing has been left for dead in favor of “secular growth” (a non-quant way of saying… momentum). How the REIT world has changed in a decade. To the typical 2010 REIT investor, the modern-day world would be surprising. As a student of factor (or “style”) investing, however, it is no surprise that a once-vaunted investing “style” has fallen out of favor. If you study the history of the stock market, this has happened repeatedly. Value has under-performed meaningfully for 10-year periods, just to roar back and dominate the moment it is left for dead. We would argue that this is one of those moments. As a quick case study, let’s rewind the tape back to 2008-2009. As the world emerged from the worst recession since the great depression, nobody felt good about the prospects for most REITs. Companies of all shapes and sizes traded at huge discounts to NAV, were selling for single-digit multiples and were legitimate risks for bankruptcy. Anyone that pitched GGP (malls), PLD (warehouses), or SLG (NYC Office) as a value investment was likely laughed out of the room. Those companies were massively cheap because they had massive problems. But what happened over the next 5-years? Value emerged as the best performing strategy and outperformed the REIT index by a wide margin. It handily outperformed momentum and quality factors and even outperformed the Serenity CORE model, which is a blend of value, momentum, and quality factors. Seasoned investors will not be particularly surprised to learn that just when value was the most painful to embrace…was the right time to embrace it. Fear truly is the mind-killer. The chart below shows the five-year performance of the Serenity CORE model versus the Serenity Deep Value model from 2010-2015. While the CORE model impressively outperforms the REIT index at +21.9% per year (versus +16.9% per year for the REIT benchmark), the Deep Value model absolutely smashes the market returning +26.1% per year. One dollar invested in the Deep Value model in January of 2010 had doubled by May of 2012. Now, keep in mind these are back-tested returns (Serenity was founded in 2016), so all the normal caveats apply. That being said even shaving 5% a YEAR off of these returns would still make them phenomenally attractive.

Most REIT investors are not embracing value today. Their minds are scarred with memories of buying Retail or Mall REITs as value investments during the last five years. Instead, they have embraced momentum, crowding into extremely expensive “secular growth” REITs such as Equinix (EQIX – 32x cash flow), American Tower (AMT – 28x cash flow), or Equity Lifestyle (ELS – 33x cash flow). In fact, the valuation gap between the haves and have nots in the REIT market has never been wider. This is not to say EQIX, AMT, and ELS are not great companies and will not continue to produce excellent returns. They certainly will. The problem is that even if a shred of growth returns to the overall economy, value REIT returns will TROUNCE those of hyper-expensive momentum names. *Again, see REIT performance on Monday 11/9/2020 as evidence

Let’s take a look at a few of the most distressed REITs in the market today. These names all qualify as “value” REITs, and trade at wide NAV discounts and fractions of their 2019 values.

One thing that may stand out immediately from the chart above is that REIT occupancy levels are still fairly robust. Simon Property Group, the largest Mall owner in the US, trades at less than 10x cash flow, and yet still has 92.9% occupancy. While the challenges in the Mall space are real, it stands to reason that a truly distressed real estate portfolio would likely have occupancy levels below 90%. This is why taking a longer-term perspective in these value names is important. The potential returns for many of these REITS are incredibly powerful assuming the world eventually returns to a state that even slightly resembles 2019. Even using conservative assumptions, many REITs have the potential to double in the event their cash flows returned to 75% of 2019 levels over the next 5 years. These names have been left for dead by REIT investors. There is much more cash flow certainty in large-cap tech REITs, which is why they trade at massive premiums to value REITs. This extreme crowding of the greater REIT investing community, however, lends conviction to our current tilt towards value in the portfolio. It is the proverbial pile of dynamite at the end of the gunpowder trail that could ignite value REIT returns with the slightest spark of growth.


As the world continues to work through an unprecedented global health crisis and an economic recession unlike any other in history, investors now more than ever need to take a levelheaded approach. There are two choices; let perceived uncertainty cause decision paralysis or lean into opportunities created by the current climate. While many investors struggle to find their footing in 2020, our strategy has weathered the storm and slowly climbed higher, reaching its highest point of sophistication and conviction since our 2016 founding. It’s a funny effect the summits of big mountains have on the human body. They are strangely energizing. The grinding upward slog is over, the view is immaculate, the future looks bright and your motivation skyrockets. There is still plenty of work to be done, and descending can be just as treacherous as ascending, but it’s quicker, its happier, and with experience it can be attacked with more gusto. After 5 hard years of research, execution, mistakes, mini-triumphs, and an exhausting final push, Serenity Alternatives Fund I has reached its highest point. The fund is poised on the verge of a potential multi-year bull market in REITs armed with an arsenal of finely tuned investing weapons. We are nowhere close to finished, but the next phase in our firm’s evolution will be extremely different than our first five years. REITs are cheap, value REITs are extremely cheap, our framework is incredibly flexible, and very few investors think the way we do. We move towards the end of 2020 with huge levels of confidence in our process and outlook. – We have a unique strategy, a non-consensus view, an energized portfolio manager, and a track record that is pointed up and to the right. The time is now to join us on our journey… or we can wave to you from the next summit.

Martin D Kollmorgen, CFA CEO and Chief Investment Officer Serenity Alternative Investments Office: (630) 730-5745

**All charts generated using data from Bloomberg LP, S&P Global, and Serenity Alternative Investments

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