“As I shuttled back and forth from New York to Tokyo on a monthly basis, it was inspiring over the years to watch a coordinated effort between the government and its citizens to reinvigorate a nation” – Scott Bessent “The International Economy” (Fall 2022)
PERFORMANCE: Serenity Alternative Investments Fund I returned +4.09% net of fees in February vs the REIT index at +3.7%.
ARROW #1: DEFICIT REDUCTION: Fiscal discipline could reduce interest rates, which is positive for bond like REITs.
ARROW #2: GDP GROWTH: Cyclical REITs (Apartments, Self-Storage, Warehouse), would benefit from a high GDP growth economy.
ARROW #3: INFLATION FIGHTING: Low inflation, leading to accommodative monetary policy and strong GDP growth would be nirvana for deeply discounted Office and Lodging REITs.
Treasury secretary Scott Bessent created a prodigious amount of wealth for his clients investing in Japan.
He had a front row seat to a reformational time in the modern Japanese economy, investing through the tenure of prime minister Shinzo Abe, and his famous “Three Arrows” policy framework.
The influence of Abe is evident in Bessent’s recent “3-3-3” framework for the US economy. In summary, Bessent’s goals are a +3% budget deficit, +3% GDP growth, and energy cost savings via +3 million barrels in additional US energy production.
These policy goals have real and impactful implications for the US REIT market.
Deficit reduction could bring down 10-year interest rates, bolstering REIT costs of capital and potentially catalyzing REIT inflows. Higher GDP growth would likely lead to a new bull market for cyclical REITs, particularly Apartment and Warehouse REITs. And finally, reducing inflation would free up the Federal Reserve to become more accommodative from a policy perspective, potentially catalyzing rallies in deeply discounted REIT sectors.
Serenity’s recent newsletters have focused on specific REIT sector fundamental trends that we are confident will drive individual REIT performance over the next few years. This month, however, we broaden our focus to discuss these potential macro regimes and how they could impact REITs as a whole and the Serenity portfolio. As always, our process will adapt to changes in economic and REIT data, but we are assembling playbooks for the scenarios below.
PERFORMANCE: +4.09% in February, +11.8% TTM
Serenity Alternative Investments Fund I returned +4.09% in February net of fees and expenses with +86% net exposure versus the MSCI US REIT Index which returned +3.7%. On a trailing twelve-month (TTM) basis, the fund has returned +11.8%. Over the past 5 years Serenity Alternatives Fund I has returned +12.1% annually net of fees and expenses with a 0.94 Sharpe ratio, versus +6.8% for the REIT index.
The most profitable position in the fund in February was GDS Holdings Ltd (GDS), a long position that returned +75.2% during the month. GDS is an international Data Center company with a large portfolio in China and southeast Asia. In recent quarters the company has seen accelerating absorption and revenue growth as it adds capacity in Thailand, Malaysia, Singapore, and Indonesia. Serenity has followed GDS since its IPO in 2017, underwriting the company when former US data center REIT Cyrus One (CONE) took a position in the company years ago. We established a small position in GDS near $7.85 in mid-2024, as fundamentals inflected positively, and the company traded at a deeply discounted valuation. Over the past few months, GDS has reverted to a more normal multiple, and a price of $36, more than doubling Serenity’s investment, with continued momentum in fundamentals. We remain long.
The worst performing position in the fund in February was Iron Mountain (IRM), a long position that returned -8.27% during the month. Iron Mountain is a hybrid Self-Storage/Warehouse/Data Center REIT that has transformed itself from one of the sleepiest “melting ice cube” stories in the REIT universe into a cash compounder with top decile NAV and earnings growth over the past 5 years. In February, IRM announced 4Q earnings and 2025 guidance that slightly disappointed the street, along with a slow-down in the pace of same-store growth in the company’s services business. The company also suffered from negative Data Center headlines, and even a DOGE expose regarding the Federal government’s retirement process, which is hosted in an IRM facility. Serenity remains long IRM but has trimmed the position as the company recently hit all-time highs from a valuation perspective. We would look to add more at lower prices if the stock price remains under pressure.
ARROW #1: Deficit reduction and high-duration REITs.
“Don’t fight the fed” is a common adage on Wall Street that although trite, is in most instances very correct. Taking a position opposite the world’s top central bank, which has theoretically infinite buying power, is not a profitable game.
A less flashy corollary of this saying might be, “when the Treasury secretary speaks…you might want to take a peak.” Yes, that is the best I could come up with.
With many 2024 trends reversing in 2025, it’s extremely important to contemplate the goals of this new administration and how policy may impact portfolios going forwards.
Which brings us to the “3-3-3” framework, and how Scott Bessent and the current administration intend to put their stamp on the US economy over the next four years.
We begin with “arrow” #1, US budget deficit reduction.
Bessent’s +3% budget deficit target has a variety of consequences for the REIT market. Setting aside the likelihood of hitting this target, one of the goals of deficit reduction is to lower the yield on the 10-year treasury. The administration is focused on the 10-year treasury yield because it has a wide variety of impacts on the economy. Bringing down the 10-year yield would almost certainly bring down mortgage rates and potentially allow the treasury to refinance and term out the national debt at more attractive levels.
The logic on the deficit is straightforward. A lower budget deficit requires less debt issuance to finance. Less supply of treasuries should push the price of these bonds up, and the yields down.
For REITs, lower 10-year yields are almost always a good thing. Lower yields mean a lower cost of capital, potentially increasing commercial real estate prices, and opening the capital markets for more activity. More importantly to REIT shareholders, however, is that lower yields almost always translate to higher REIT prices, as investors view REITs as high-duration (bond like) equities.
As a quick example of how this plays out, we can examine the chart to the right. In each
recent instance of rapid drops in the 10-year yield, REITs have performed exceptionally well. In 2014, the 10-year yield fell from +3.0% to +2.17% (-86 basis points), while REITs returned +28.0%. In 2019, the 10-year yield fell from +2.6% to +1.9% (-77 basis points), while REITs returned +28.7%. In 2020, the 10-year yield fell from +1.9% to +0.91% (-100 basis points), while REITs returned -5.08% (but went on to return +41% in 2021).
Certain property types stand out as well. Manufactured Housing was a top performer in both 2014 and 2019. Data Centers performed extremely well in all three recent interest rate episodes.
Lodging and Regional Malls conspicuously lagged over these time periods, indicating that highly cyclical REITs may not benefit as much as other REITs in times of falling interest rates.
The caveat here is that deficit reduction is rarely a painless process to go through. Cyclical REITs may struggle if significant spending cuts trigger a US recession (a real possibility). High duration REITs, however, offer an excellent hedge for portfolios in this scenario, due to their high correlation with bond yields.
The Bottom Line: Deficit reduction could be extremely beneficial to high duration REITs if it accomplishes the administration’s goal of lowering the 10-year Treasury yield. In this scenario, Regional Malls and Lodging REITs may under-perform due their highly cyclical nature, while Free Standing Retail, Manufactured Housing, Homebuilders, and Self-Storage REITs are likely to perform well.
ARROW #2: Accelerating GDP = Accelerating cyclical REIT revenues?
While 2021 may seem like a lifetime ago from an investing perspective, it was only 4 years ago that we experienced the last true cyclical REIT bull market. What did the REIT scoreboard look like that year? Apartment REITs returned +63.1%, Industrial (Warehouse) REITs returned +66.1%, and Regional Mall REITs returned a whopping +93%.
Attractive going in valuations combined with accelerating revenue and NOI growth to produce one of the best years in REIT history in 2021. And in 2025, we may be approaching something very similar.
The second stated goal of Scott Bessent’s “3-3-3” plan is +3% GDP growth, which would be the top end of the typical range over the last 20 years. High GDP growth is unequivocally good for cyclical REITs, as these companies tend to have top-line growth that is highly correlated with GDP growth. Said another way, the higher growth is in the US, the faster Apartment rents and Apartment REIT NAV’s tend to grow.
This is important because cyclical REITs make up over +25% of the REIT universe and have seen growth slowly tick lower since 2022. In 2025 we continue to be in a cyclical REIT bear market.
The chart above shows year-over-year same-store revenue growth for the Apartment REITs (the blue line). It illustrates the growth deceleration these companies have experienced since the post-covid spike in 2021. It also makes an acute point relevant for REIT investors.
That is, that forward looking returns (the yellow bars) tend to be strongest when revenue growth for these companies accelerates.
There are reasons to be optimistic on this front in 2025. First, regardless of the success of the administration’s “3-3-3” plan, Apartment and Warehouse competitive supply is moderating rapidly. This means the operating environment for cyclical REITs is almost certain to be more friendly going forward. If GDP growth is able to accelerate while competitive supply continues to fall? That would be a potent combination for the cyclical component of the REIT universe.
Again, it’s worth noting that the path to superior GDP growth may be quarters or years in the future. Cyclical REITs do NOT perform well during recessions. If deficit reduction takes precedence over GDP growth (something that currently seems to be the case), it likely means that these REITs get cheaper before the next bull market arrives. As always, Serenity will monitor real time cyclical REIT data like a hawk, getting ready to pounce once a sustainable recovery takes hold.
The Bottom Line: Cyclical REITs have been mired in a bear market since late 2021. If the current administration can achieve their stated goal of +3% GDP growth, cyclical REIT revenues are likely to accelerate meaningfully. This would be a massive boon to the overall REIT market, as the most recent cyclical acceleration (2021) saw REITs return +45% in a single year.
ARROW #3: Reaching for REIT Nirvana.
The third “arrow” of Bessents plan for the US economy is explicitly lower energy costs via increased oil production. While energy production is important, a bit of reading between the lines reveals the true goal, keeping a lid on inflation.
Few investors need to be reminded of what happens when inflation accelerates rapidly. 2022 was a potent lesson in this regard. REITs down -25%, the S&P 500 down -18%, and the Nasdaq down -33%. Bonds suffered as well, delivering one of the worst years for the 60/40 portfolio on record. The negative impacts of inflation are still being dealt with, and the administration very clearly would like to keep it under control.
Now let’s assume momentarily that they succeed. What would happen if the budget deficit fell to +3%, GDP growth accelerated to +3%, and inflation stayed below the Fed’s target of +2%?
REITs would absolutely thrive in this environment. Contrary to popular belief, REITs perform
their best when growth accelerates, and interest rates remain range bound. For evidence of this we can once again reach back into recent history and examine the year 2021. Growth across the REIT spectrum accelerated, interest rates increased but remained below 2%, and REITs posted one of their best years in history.
Even the worst performing REIT sector in 2021 (Lodging), returned +19.6%.
The Bottom Line: A world in which inflation remains muted, growth accelerates, and interest rates move lower due to a shrinking budget deficit would approach REIT nirvana. Office and Lodging REITs, some of the most challenged REIT subsectors of the last few years, could post incredibly strong returns in such an environment due to their depressed valuations and significant underweights in many institutional REIT portfolios.
HITTING THE TARGET
As a new administration takes the reigns of the world’s largest economy, it’s important to contemplate the stated goals of the US treasury secretary. +3% budget deficit, +3% real GDP growth, and +3 million barrels of incremental oil production.
The implications for US REITs are positive for many of these goals but remain path dependent. Deficit reduction would most likely benefit high duration REITs as interest rates moderate. Accelerating GDP growth would benefit cyclical REITs that have seen growth decelerate over the past few years. Continued inflation reduction coupled with achievements in goals 1 and 2 would likely lead to the most REIT friendly economic environment since 2021.
The path to success in the capital markets, however, is never a straight line. Cyclical REITs may suffer if deficit reduction causes GDP to temporarily head lower. High duration REITs are unlikely to outperform if tariffs prove inflationary. And REIT nirvana is a far cry from the high-interest rate environment we find ourselves in today in 2025.
And yes, there are other significant Trump policy initiatives concerning immigration, tariffs, and taxes. We are keeping a keen eye on the effects of these start and stop policy changes as well.
As always our process is vigilant for changes in the data, and our REIT portfolio is concentrated in names that we believe will deliver strong results in any macro environment. Our disposition remains optimistic, and even in a recessionary scenario, REITs could be an attractive portfolio hedge.
Stay on target,
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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