“I found the crown of France in the gutter. I picked it up with the tip of my sword and cleaned it, and placed it atop my own head." – Napoleon (2023)
PERFORMANCE: Serenity Alternative Investments Fund I returned +5.1% net of fees in August vs the REIT index at +6.4%. In 2024, the fund has returned +15.4% vs +12.8% for REITs.
A QUIET REVOLUTION: Are we at the beginning of a transformational period for Healthcare REITs?
SOLDIERS WIN BATTLES: Two REITs on the frontlines of the Healthcare industry are poised for continued growth.
THE POWER OF SCALE: How REITs create economic moats and dominate certain industries.
Napoleon’s rise to power was not a loud, raucous, celebrated affair.
His emergence was mostly quiet, with even his fellow revolutionaries not expecting it until the last moments.
Once accomplished, the new Emperor of France went on to completely re-shape the face of Europe.
Similarly in 2024, there is a quiet revolution occurring in commercial real estate. And it’s not where everyone is looking. Office, Data Centers, Warehouse, Apartments…all these stories are well known and highly scrutinized.
Healthcare real estate, on the other hand, passes quietly under the radar.
But seismic changes are occurring in this property type that the pandemic seemingly left for dead. As the baby boomers age into their 70’s and 80’s, senior living facilities are set to experience a surge in demand almost a century in the making.
Simultaneously, savvy REIT management teams are building scale within the industry, applying tools such as revenue management that have been historically absent from most healthcare REIT operations.
This is a change investors should not take lightly. When Self-storage REITs began flexing their scale muscles following the GFC, the sector posted +24% annualized returns for 5 years (2010-2015). Apartment landlords similarly captured huge operational upside in the early 2000’s implementing new technology into an established asset class.
With healthcare REITs up +30% YTD and dominating the top quartile of our proprietary multi-factor model ranks, Serenity is poised to ride the healthcare wave into 2025. As these companies quietly revolutionize a still young commercial real estate property type, the lack of fanfare is our friend. We can join the quiet revolution on our path to commercial real estate domination!
PERFORMANCE: +5.11% in August +15.36% YTD
Serenity Alternative Investments Fund I returned +5.11% in August net of fees and expenses versus the MSCI US REIT Index which returned +6.44%. Year to date Serenity Alts Fund I has returned +15.36% with only +70% net exposure vs the REIT index at +12.84%. On a trailing 3-year basis, Serenity Alts Fund I has returned +5.3% annually net of fees versus the REIT index at +2.1%. Over the past 5 years Serenity Alternatives Fund I has returned +13.2% annually net of fees and expenses with a 1.07 Sharpe ratio, versus +5.5% for the REIT index.
One of the most profitable positions in the fund in August was American Healthcare REIT (AHR), up +31.3% for the month. AHR is a prime example of the changes occurring in the Healthcare segment of the REIT universe. A new IPO in February of this year, AHR has returned +80% since it came public. In their second quarter report, AHR increased their same-store NOI guidance by +117%, citing strong underlying portfolio trends. Because of the company’s strong fundamental outlook and discounted valuation, AHR made it into the top of the Serenity CORE model a few months ago. In August, the fund benefited handsomely. Stay tuned for more on AHR later in this newsletter.
The least profitable position for the fund in August was Century Communities (CCS), a homebuilder that returned -4.18% during the month. While CCS has historically generated strong returns in the Serenity portfolio, in August the company gave back some of its 2024 gains. Coming into the month, CCS was up +20.4% YTD, and due for a bit of a correction. We have since closed our long position in CCS, taking our remaining chips off the table after a strong run. While lower mortgage rates should be a positive for homebuilder stocks, recent data on the demand side of the housing market has us a bit concerned. For now, we can afford to wait and watch, looking for a better opportunity to buy this fast-growing homebuilder.
VIVE LA REVOLUTION! The rise of Healthcare REITs…
Nothing is worse for healthcare real estate than a global pandemic.
Collecting rent checks is difficult when your tenant base is high risk, and your facilities are ground zero for a poorly understood new virus. Amidst the height of the 2020 uncertainty, many investors rightfully questioned the long-term viability of seniors housing and other healthcare real estate categories.
But the difficulties of the pandemic had a silver lining. For those landlords that stayed in the game, and survived the worst-case scenario, they emerged into a new landscape virtually free of competitors.
Fast forward to 2024 and the Healthcare REITs are very quietly becoming the best growth story in all of REITs. Healthcare occupancies are recovering steadily, rents are growing simultaneously, and supply growth is moderating. That is a near perfect trifecta of positive fundamentals in commercial real estate, and one that is extremely rare.
It’s worth spending a minute discussing how powerful the current momentum in Healthcare REIT fundamentals is. Let’s say you own a building that is +75% occupied. Ideally you would like to lease your building up to 100%, as that would mean more $$ in your pocket. What can you do to lease your remaining space up? Assuming that nobody is willing to lease the space at the rent level you are currently asking (we can refer to this price as asking rent), then the obvious solution is to lower your price. Lowering your asking rent is traditionally the best way in commercial real estate to increase your occupancy.
For this reason, it’s rare that rents and occupancies move in the same direction. Usually, as rents move down, occupancies move up, and as rents move up, occupancies either stay steady or move down. This is kind of like real estate physics, tenants want to pay the lowest rent, and landlords need to balance between charging as much rent as possible and keeping their buildings full.
Which is why the current phenomenon in Healthcare REITs is so strange. Occupancies are increasing, and rents are increasing simultaneously. There is literally nothing better for a landlord. This means that tenants are actively competing for your remaining space.
The question then becomes, how did Healthcare real estate (Seniors Housing in particular), go from nearly dead during the pandemic to commercial real estate nirvana in just a few short years?
There are a few key forces at work that we believe have propelled Healthcare REITs to their current levels of success.
Starting with demographics, the “silver wave” that many prognosticators have discussed over the last decade is beginning to hit with force. Simply put, the baby boomer generation gets older every year, creating more and more 80+ year old US citizens every day. Since the boomers are such a large generation, this impact is significant and is a key driver of the demand for Seniors Housing that we will see over the next 10 years.
Interestingly, real estate developers saw this coming almost a decade ago, and over-built
seniors housing supply badly from 2015-2020. But one pandemic and +500 basis points of interest rate hikes later, and most of these developers have exited stage left. Supply in Seniors Housing is now moderating rapidly, and many of those developers are financially distressed.
This leaves the remaining owners of seniors housing in the ultimate position as a landlord. Supply is moderating, while demand is increasing. And there is a significant amount of under-leased senior housing supply available for sale from “financially challenged” developers.
Put it all together and a demographic wave of tenants is colliding with a diminished supply of seniors housing. That’s just about Healthcare REIT nirvana.
Now enter the game changer. Technology.
One of the unintended consequences of a large boom in private equity development of Seniors Housing assets from 2015-2020 was an extremely fragmented asset class. In the previous building cycle, developers often did not want to be long-term owners of healthcare real estate assets, and therefore did not become operational specialists. Add to this the fact that Seniors housing (from an institutional asset class perspective) is a young industry, and there are historically few large-scale players in the seniors housing space.
The reason this is important is that scale and technology in commercial real estate tend to have a symbiotic relationship. The larger and more geographically diverse your CRE portfolio, the more you can utilize technology (revenue management, search engine optimization, etc) to improve the operating efficiency of your portfolio. The Apartment, Self-Storage, and Data Center REITs have proven this thesis time and time again through history, consistently delivering much stronger same-store results than smaller scale peers over time.
In Seniors Housing, these tools have historically been completely absent. Until now.
In 2024 a handful of healthcare REITs are beginning to implement powerful changes on the operations side of the business. As these portfolios grow, they generate more data, further enhancing the benefits of technology, and creating a self-perpetuating virtuous cycle. History suggests this could add anywhere from +1-3% to same-store growth rates annually as these changes work their way through REIT portfolios. This can be a significant edge over time, as evidenced by the success of the Self-Storage REITs from 2010-2015 (more on this later).
The Bottom Line: Favorable demographics, moderating supply, and the introduction of new technology are three powerful forces converging on the Healthcare REIT space, particularly in the Seniors Housing property type. With five healthcare companies in the top 25 ranks in the Serenity CORE model, and our fundamental research efforts validating these scores, Serenity’s portfolio has significant exposure to Healthcare REITs, as we expect these favorable trends to drive compounded cash flow and NAV growth over the next few years.
SOLDIERS WIN BATTLES: WELL & AHR leading the charge
With the top-down case for Healthcare REITs looking compelling, the next step in the Serenity process is to dig into individual companies. Do the fundamentals of individual REITs support the broader bullish narrative? And what do the companies have to say?
Examining the past 2 years of data for Welltower (WELL), the largest Healthcare REIT and largest owner of Seniors Housing (SHOP) assets, firmly supports our top-down narrative. Over the past 2 years, both occupancies AND rents have increased for Welltower, leading to some of the best NOI growth within any property segment in REITs.
Welltower has also emerged as the leader in technology implementation within the industry, going as far as to build out an operating team led by John Burkart, a former Apartment REIT operating expert. From WELL’s 2Q earnings call, it’s clear that John is hard at work building operating efficiencies into this traditionally fragmented property type.
“Our communities will be able to eliminate most paperwork and materially reduce administrative time and simplify many processes, including the onerous move-in process. Our objective of leveraging technology to improve the overall resident experience and enabling employees to focus more of their time on residence is being realized.”
These are two key tenants of our bullish thesis validated at the company level. As WELL has moved up the rankings in Serenity’s CORE model, we have been more than happy to allocate to what I view as one of the best run companies in the industry.
Now, the key risk here is that WELL is also the most expensive Healthcare REIT from a valuation standpoint. This means they have set a high bar for themselves going forward. It also means, however, that the company has a very attractive cost of capital, allowing it to be aggressive on the acquisition and development front. This external growth engine is another arrow in the WELL quiver.
Serenity is also bullish on WELL’s much more modestly valued peer American Healthcare REIT (AHR). While AHR has a much shorter history, early indications are that they are benefiting from many of the same trends as Welltower, at a much lower valuation.
AHR also has a slightly different portfolio. With more exposure to higher acuity healthcare real estate (higher acuity means higher labor costs, lower margins, and higher volatility), AHR’s portfolio will most likely support a lower multiple over time than Welltower. That being said, the current gap is VERY wide. As of this writing, Welltower trades at +25.6x 2025 EBITDA, versus +15.5x for AHR.
This large valuation gap is a reflection of AHR’s short growth history and higher acuity portfolio. There are signs, however, that AHR may be able to achieve growth similar to that of Welltower. As we mentioned earlier, AHR raised their full portfolio SS NOI growth guidance to +12-14%, from +5-7%, just one quarter earlier when reporting 2Q 2024 results. This has proved to be a game-changer for the companies multiple, as reflected in the stocks +30% move in August.
This +12-14% estimate is higher than Welltower’s +10-12.5% guidance for 2024. On a company that trades at a +10x multiple turn discount.
Again, AHR has a shorter operating history, a less developed platform and reputation than Welltower, a higher-acuity portfolio, and less external growth. All of these factors play a role in the companies’ discounted valuation. Serenity’s framework has determined, however, that this valuation gap is too large, and AHR’s fundamentals are too strong to not allocate capital to AHR, and it also has a prominent weight in the fund’s long portfolio.
The Bottom Line: Fundamental momentum is evident in Senior Housing portfolios from both a top-down and bottom-up view. Both Welltower and American Healthcare REIT are experiencing extremely strong organic growth that shows few signs of abating. As Welltower continues to innovate and AHR gains a more favorable cost of capital, we may still be in the early innings of an incredibly powerful Seniors Housing REIT bull market.
SCALE: How REITs create sustainable moats.
Per Investopedia…
“The term "economic moat," popularized by Warren Buffett, refers to a business's ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share. Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders.” – www.investopedia.com
Finding economic moats is a task allocated to fundamental analysts the world over. Whether you work at a family office, endowment fund, or are a student in a Finance 301 class, you likely want to find businesses with moats to invest in, as they tend to compound cash flow powerfully over time.
The problem is…this can be extremely difficult. Most economic moats do not exist in plain sight.
Take the Self-Storage REITs for instance. In an asset class that is widely available (there are many options for self-storage investment), how on earth can you create an economic moat? I can buy a self-storage facility myself with a relatively modest amount of capital.
This is true. It is also true, however, that when you try and advertise your new self-storage facility, you will run into an interesting problem. You may find it extremely difficult to get your facility to show up on google before page 5 or 6. Instead, your search results are likely to return a long array of results for 3 primary companies, Extra Space Storage (EXR), CubeSmart (CUBE), and Public Storage (PSA).
You may also find that competing with these three from a pricing standpoint is incredibly difficult. With websites that constantly re-fresh their pricing schedules, customers will have a very easy time finding a good deal on a storage unit that is NOT in your facility. Really, your only chance at capturing internet traffic will occur when all your publicly traded competitor’s facilities are full.
Now, this may seem like a hyperbolic hypothetical, but this is in fact reality for many self-storage owners. Due to the size, scale, and technological prowess of EXR, PSA, and CUBE, most mom-and-pop self-storage owners cannot compete for internet search words or charge market competitive rates.
These companies have built a huge economic moat in self-storage using technology.
What does this look like from an economic perspective?
Let’s look at Public Storage (PSA). Since PSA has been around for over 30 years, we have same-store data going back to 2004. From 1Q 2004 to 4Q 2008, PSA’s same-store NOI growth averaged +4.7%. Following the GFC, from 2011 to the end of 2016, PSA’s same-store NOI growth averaged +7.4%. What changed?
Technology.
Following the GFC, the Self-storage REITs began to introduce two key technological innovations into their portfolios. Revenue management and search engine optimization (SEO). We have already touched on both in our examples above.
Revenue management is the efficient use of data to set prices in a Self-Storage (or Apartment…and soon to be Seniors Housing) portfolio. This is how the airlines set ticket prices…as demand increases, prices increase, and as demand fades, prices fall. With multi-billion dollar portfolios spread across every top commercial real estate market in the US, the Self-Storage REITs are swimming in data that they use to set prices at an extremely granular level. If you search for self-storage from an Android phone as opposed to an iPhone…you may get a different price. That is how precise these algorithms are.
Now add SEO into the mix. With huge budgets to spend on marketing (PSA spent $70 million on marketing in 2023), the publicly traded REITs dominate the most relevant google ad-words in self-storage. When I google “self-storage Denver”, the top results are EXR, CUBE, PSA, EXR, CUBE, RentCafe (which directs me to PSA assets), and Greenbox. I have to scroll nearly to the bottom of the page to find a single non-publicly traded self-storage option. This search engine domination allows these companies to disproportionately drive incremental traffic into their assets.
Interesting, you may say, but why should I care?
This discussion is relevant because when REITs introduce these technologies, their operating results tend to improve quickly and remain elevated for years at a time. While Self-Storage REITs are now excellent businesses to own long-term, Healthcare REITs may be an even better current opportunity for investors due to the low hanging fruit available from added technological innovation.
Bottom Line: Self-storage REITs are a strong example of how publicly traded REITs can use their scale to create economic moats relative to competitors. The results can be up to +3.0% annual growth on a same-store NOI basis as illustrated by Public Storage’s documented history. While these scale advantages are especially pronounced in Self-Storage, they also exist in Apartments, Data Centers, Warehouse, Lodging, and increasingly Healthcare.
VICTORY BELONGS TO THE MOST PERSEVERING
Healthcare REITs survived an existential threat from 2020-2022 and are now thriving in an environment with very little competition and a trifecta of sustainable tailwinds. As baby boomers continue to age, supply continues to moderate, and technology becomes increasingly utilized, these companies could post some of the most impressive growth numbers in REITs from 2025-2028.
At Serenity, we have seen this story play out before, covering the Self-Storage REITs from 2010-2015 as technology changed their portfolios. Now highly ranked in the Serenity CORE model, Healthcare REITs look primed to experience a similar run, with Serenity investors along for the ride.
Like the polarizing French emperor, these companies are overlooked but primed to dominate.
Vive la Healthcare REITs,
Martin D Kollmorgen, CFA CEO and Chief Investment Officer Serenity Alternative Investments Office: (630) 730-5745 MdKollmorgen@SerenityAlts.com
*All charts generated using data from Bloomberg LP, S&P Global, and Serenity Alternative Investments
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