ARTIFICIAL REIT-TELLIGENCE: November 2022 Newsletter
“Computers are incredibly fast, accurate, and stupid. Human beings are incredibly slow, inaccurate, and brilliant. Together they are powerful beyond imagination.” - Albert Einstein
WILL I EVER WRITE A NEWSLETTER AGAIN? Or should I hand the keys over to our inevitable robot overlords?
TIME TO BUY DURATION? Could a significant headwind to REIT performance be beginning to fade?
HAPPY HOLIDAYS! While many investors “hunker down”, Serenity is hard at work preparing for what could be a volatile 2023. Here are a few stocking stuffers.
I remember the first time I heard the term “Google.”
As a student touring the library of my future high school, I was listening to a librarian explain how to access this newfangled thing called the “internet” using the schools’ computers. To search for something, she explained, you just needed to open a web browser, and go to this Google website. There you could type in a request and the search engine would deliver information.
A 14-year-old at the time, I certainly did not appreciate how profound that short lesson would prove within the context of a rapidly changing world. Fast forward over 20 years, and the computer has moved out of the library and into our pockets. Many of us spend almost our entire day in front of a computer, doing research, building models, and monitoring stock quotes in real time.
It’s a far cry from the daily newspaper price quotes that originally taught me how the stock market worked.
And the rate of change in technology continues to amaze. Take the recently released “Chat GPT” from OpenAI. It does not take more than a few moments of interacting with Chat GPT to understand how powerful it could potentially be. It does make one wonder…are the robots coming for my job?
Don’t worry, I’m not here to grinch up your Christmas with doom and gloom. The stock market is a complex system, which means it can never truly be “solved.” My personal view is that there will always be room for a human touch in investing, as it requires creativity, and complex strategic thinking, to succeed sustainably.
That being said, those investors not using computer models to leverage their creative and strategic thinking risk falling behind those of us that do. If nothing else, a cold, calculating computer model can help an investor rid themselves of behavioral biases, as it un-emotionally points out opportunities or risks.
So, in the spirit of the holidays and year end we are going to have some fun with technology. This newsletter will be a bit shorter than usual with an interesting twist. Readers can ponder the question…did a human or machine write this paragraph, this sentence, this entire newsletter?
PERFORMANCE: +1.57% in November, -9.4% YTD
Ok so this part was written by a human (me). Not yet willing to hand over performance reporting to the robots.
Serenity Alternative Investments Fund I returned +1.57% in November net of fees and expenses versus the MSCI US REIT Index which returned +5.78%. Year to date, the fund has returned -9.4% net of fees versus the REIT benchmark at -20.4%, the NASDAQ 100 at -25.7%, and the S&P 500 at -13.1%.
On a trailing 3-year basis Serenity Alternatives Fund I has generated annualized returns of +16.0% net of fees and expenses. Over the same period, the REIT benchmark has returned +1.5% on an annualized basis. The fund’s Sharpe ratio over the past 3 years sits at +1.09, versus +0.07 for the REIT benchmark (remember higher is better, more return per unit of risk).
The largest positive contributor to the fund’s return in November was Equinix (EQIX), a long position that returned +22.5% during the month. We have written about EQIX fairly frequently as of late, highlighting multiple positive attributes that stand out amidst the current challenging market.
As a quick reminder, EQIX owns the premier Data Center portfolio in the world. The company was quite literally invented at one of the earliest internet connection points in the country and it is quite probable that the internet connection that brought you to this newsletter at one point passed through an EQIX data center. EQIX has guided to 10% revenue growth through 2025, is on target to achieve said goal, and was an excellent performer through 2008/2009 as demand for their brand of collocated data center space tends to be more mission critical than cyclical.
We like EQIX due to its size (large cap), strong balance sheet (low leverage), quality (best quality among Data Center REITs), and low cyclicality. We also believe that any stabilization in interest rates (long term rates in particular) would be meaningfully beneficial to the Data Center REITs. These companies tend to have higher duration than many other REITs.
The worst performing position in the fund this month was Medical Properties Trust (MPW), a short position that returned +14.6% for the month. MPW remains our favorite short, but unfortunately, even highly risky, potentially distressed REITs do not go down in a straight line. MPW caught a bid in November, along with the broader market. The stock is still down almost -50% year to date, with a business that continues to show signs of deterioration.
One of the reasons we remain short MPW is that their largest tenant, Steward Healthcare (~30% of MPW’s revenues) has yet to refinance a credit facility that came due months ago. The company announced an extension until December 15, but with no news and the deadline in 0 days (by the time you read this)…we are skeptical that a positive outcome is forthcoming. Companies that cannot re-fi credit facilities are huge red flags. This indicates there could be going-concern issues for Steward, in which case 30% of MPW’s revenue is at risk. Not…good.
DOMO ARIGATO MR ROBOTO – What does AI have to say about REIT hedge funds?
This newsletter is no stranger to shameless self-promotion. It is quite difficult not to promote your ideas about investing when you have basically devoted your life to them. So, in the interest of fairness, let’s ask the robots (chat GPT) what they think of investing in REIT hedge funds. Tell me robot, why should someone invest in a REIT hedge fund?
“A REIT hedge fund is a type of investment that can provide investors with a number of potential benefits. REITs, or Real Estate Investment Trusts, are companies that own and manage income-generating real estate assets, such as office buildings, shopping centers, and apartment buildings. By investing in a REIT hedge fund, investors can potentially benefit from the income generated by these real estate assets, as well as any appreciation in the value of the properties.”
Well said computer. Are there benefits to using a quantitative model when investing in REITs?
“A quantitative model is a mathematical approach to investment analysis that uses numerical data and statistical techniques to identify potential investments. When applied to the real estate investment trust (REIT) market, a quantitative model can help investors identify REITs with favorable characteristics, such as strong financial performance, stable cash flows, and potential for growth. Some of the potential benefits of using a quantitative model when investing in REITs include:
1. Objectivity: A quantitative model can help investors make unbiased investment decisions based on numerical data, rather than emotional or subjective judgments.
2. Consistency: A quantitative model can be used to consistently apply a set of investment criteria, helping to ensure that investment decisions are made in a disciplined, systematic manner.
3. Diversification: A quantitative model can help investors identify a diverse range of REITs that meet their investment criteria, allowing them to build a well-diversified portfolio.
4. Risk management: A quantitative model can be used to assess the risk associated with different REITs and help investors manage their overall portfolio risk.
5. Performance evaluation: A quantitative model can be used to evaluate the performance of REIT investments over time, allowing investors to monitor their progress and make any necessary adjustments to their investment strategy.”
Quite Insightful. Is Serenity Alternatives a good name for an investment fund?
“In general, the name of a business is a matter of personal preference and there is no "right" or "wrong" answer when it comes to choosing a name. However, it is important to choose a name that is memorable and conveys the nature of your business. In the case of an investment firm, a name like "Serenity Alternatives" could potentially convey a sense of calm and peace of mind, which could be appealing to potential clients. However, it is ultimately up to you to decide if this name aligns with your vision for your business and will help you achieve your goals.”
Frighteningly profound. Now for the final test. Did I marry someone more attractive than myself both physically and personality wise?
Well done computer, well done.
*One of these responses was generated by a human
INTEREST RATE STABILIZATION - Has the 30y peaked?
Ok back to investing reality. For the un-initiated, we have been and remain a resident bear on most things REIT investing related. We believe a recession is on the horizon, with the potential for higher unemployment and the start of a bankruptcy cycle increasing by the day. This means higher credit spreads, worsening real estate fundamentals, and lower equity values.
One data series that gives us a bit of hope, however, is the 30y yield. While the short end of the curve will be heavily influenced by fed policy and current inflation levels, the long end of the curve tends to be more reflective of longer-term economic trends. As growth expectations have moderated along with inflation expectations, the 30y treasury yield has fallen from almost +4.5% to +3.5%.
Now let’s be clear, this is a double-edged sword. A lower 30-year yield tends to mean lower mortgage rates, lower costs of capital for long-term borrowers, and a bid for high duration equities. Many REITs certainly fall into this category. These would be positive developments on the margin.
A lower 30-year yield, however, also means lower growth, which is bad for cyclical companies and the overall economy. And more importantly, a lower 30-year yield does NOT necessarily mean lower borrowing costs. If credit spreads remain elevated or increase, any positive benefit from a lower 30-year yield will not translate to the investing public or the overall economy.
So, are we ready to load up on high duration REITs? Not so fast. While we firmly believe that the housing market is likely to bottom before other parts of the economy, and that the 30-year is an excellent leading indicator for housing, the credit spread part of this story is still scary. Moves in credit spreads SWAMP moves in benchmark interest rates in relation to high duration equity performance.
Said another way, if the spread between mortgage rates and the 30y increases or stays the same, housing equities are NOT likely to move higher sustainably (the same holds for high-duration REITs). With a recession potentially in the cards in 2023, we are not ready to wave the “all clear” with regards to credit spreads just yet. So, while a reprieve in mortgage rates over the last few months is welcome, caution is still warranted as we move into 2023.
As always, we are watching the 30-year, credit spreads, and mortgage rates like a hawk. If the housing market shows signs of bottoming, investors may find our tone here turning meaningfully more bullish…
HAPPY HOLIDAYS! Here are a few ideas in our portfolio and on our watchlist…
After 11 months of inflation increases, Fed rate hikes, equity market volatility, and televised Kanye interviews, we understand that many investors are likely exhausted at this point in 2022. I’m amazed that you are still reading this. Well done! You truly are highly intelligent and motivated. Or a glutton for punishment. Potentially both.
The point is I’ll stop bloviating now and just give you some of the goods. Here are a few REITs in our portfolio, why they are there, and a few to put on the watchlist. FYI…this is not investment advice…read our disclaimer below.
IN THE PORTFOLIO - Longs
First Industrial (FR) – FR is a warehouse REIT that trades at a meaningful discount to peers. +5.72% implied cap rate on our 2023 #’s, with the potential for +10% annual earnings growth over the next few years. That means that FR’s +5.7% cap rate turns into a +7% cap rate quickly with very conservative assumptions. Good portfolio, good management team, huge discount to NAV.
Gaming and Leisure Properties (GLPI) – GLPI is the largest owner of regional Casino assets in the US. GLPI’s rental income held up incredibly well during the pandemic, indicating that GLPI’s revenues are truly non-cyclical. A +14x AFFO multiple (versus +17x for REITs), and a growing +5.3% dividend yield mean GLPI is a high-quality portfolio trading at a reasonable valuation. We are buyers on potential interest rate spikes that cause the stock to dip.
Century Communities (CCS) – A homebuilder with a large portfolio of assets in the Mountain and West regions of the US. Don’t get us wrong, fundamentals for homebuilders are TERRIBLE right now. CCS has backlog to work through and needs house prices to fall for demand to return. The company has wood to chop (figuratively). Because of this, the stock is incredibly cheap. -18% discount to book value, 0.6x 2022 sales, 3.8x 2022 EBITDA. Historically housing bottoms FIRST in recessions, and a soft-landing would mean off to the races for CCS. Call this bet soft-landing insurance, a small position we are willing to be early on and are likely to buy more of in the case that housing truly starts to bottom.
WATCH LIST - Longs
Innovative Industrial Properties (IIPR) – This one-time highflyer has round-tripped from absurdly expensive to surprisingly cheap. A +9.2% implied cap rate and a +6.4% dividend yield give this highly shorted name an interesting total return profile. Potential passage of the SAFE banking act could be a boon based on recent stock performance. RISKS include small cap, some tenant issues, fewer acquisitions in the near term.
WeWork (WE) – This one is on the watchlist and NOT in the portfolio for many reasons. I love this business long-term. My view is that office users are going to DEMAND flexibility in the new economy, and nobody can deliver flexibility in Office better than WE. Unfortunately, the company has “hair” as we say on Wall St. A messy balance sheet, a management team lacking credibility, and style factors that are NOT favorable in a recession. When the economy eventually bottoms though…could we get a chance to buy WE at $0.30-$0.50? Now that would be interesting…
ENJOY THE SNOW! Or whatever regional weather phenomenon December brings…
From our hearts to yours, thank you for reading! And for all those we have interacted with this year, we appreciate you. Many of the conversations these newsletters spark make us better investors and remind us how lucky we are to have such an incredible network at Serenity.
As always, don’t be strangers!
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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