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  • Writer's pictureMartin Kollmorgen

JUNE 2023 - REITs: Soft Landing or Recession?

Updated: Jul 20, 2023

"Success depends upon previous preparation, and without such preparation there is sure to be failure." - Confucius

  • PERFORMANCE: Serenity Alternative Investments Fund I returned –0.74% net of fees in June. Over the past 5 years the Fund has returned +11.8% annually versus +4.6% for the REIT index.

  • FACTORS OR SECTORS: In a rapidly changing economy, how should we approach REITs?

  • QUANT INTELLIGENCE: Is the model signaling a soft landing or recession?

  • PREPARATION: How Serenity is preparing for multiple economic scenarios.

It was a beautiful Christmas eve in suburban Iowa.

Snow blanketed the ground, covering the forested backyard in a beautiful layer of pristine white. The family was gathered, relaxing and enjoying some stress-free holiday time. Dogs chasing each other through the house, Christmas classics drifting over the airwaves as the smell of warm cookies wafted through the air. The scene was right out of a Hallmark Christmas movie.

And I felt like I was going to throw up.

The REIT market was down -4%, and the fund’s year to date returns were approaching -20%. The fund was losing money, my performance was miserable, and my confidence was melting like a snowman in the Sahara.

The contrast was stark. While everyone else in the house smiled and relaxed, I was doing everything in my power not to turn into an enraged version of the grinch. I was learning on the fly how to stay calm in a rapidly changing REIT environment.

By the end of that year (2018), the fund closed near all-time lows. The future of Serenity was very much in doubt. We had a choice to make. Stick to our guns despite our recent losing streak or close shop. It was not an easy decision.

In the end, it was our process that turned out to be the deciding factor. Was our quant model broken, or had we just suffered a few bad months? Had I suddenly forgotten how to pick REITs, after 7 years of doing so successfully? Or had we made a few mistakes in a tough market? At the end of the day, we leaned on our foundational principles, made a few tweaks to our strategy, and buckled down for the ride ahead.

The result? It turned out that Christmas eve was the bottom, and the fund returned +32% in 2019, +18% in 2020, and +45% in 2021 net of fees. That’s a three-year stretch of almost +30% annualized returns following the worst year in the fund’s history.

The moral of the story? Despite economic crosswinds and some recent under-performance, Serenity has a time-tested strategy that we continue to rely on. Whether we experience a soft-landing, a recession, or heck, an alien landing, we will continue to build a REIT portfolio that has strong historical cash-flow growth, attractively priced companies, and strong balance sheets and management teams.

Those foundational principles of our strategy will not change.

The economic data will change. REIT fundamentals will change. And as they do, our model will adapt, and our portfolio will change.

But the core of what we do will not change. We have faced challenging markets before and learned the importance of sticking to our knitting. Value, momentum, and quality REITs, chosen with precision, will always be the backbone of our portfolio. This makes us prepared for anything in the upcoming REIT market. With numerous economic crosswinds, this adaptable approach is more important than ever.

PERFORMANCE: -0.74% in June vs REITs +5%

Serenity Alternative Investments Fund I returned -0.74% in June net of fees and expenses versus the MSCI US REIT Index which returned +5.04%. So far in 2023, Serenity Alternatives Fund I has returned -0.23% vs the REIT benchmark at +5.5%. On a trailing 3-year basis, Serenity Alts Fund I has returned +15.9% annually net of fees versus the REIT index at +8.9%. Over the past 5 years Serenity Alternatives Fund I has returned +11.8% annually net of fees and expenses, versus +4.6% for the REIT index.

The REIT market went firmly “risk-on” in June, as market sentiment has broadly improved on the back of lower inflation data and continued strength in the jobs market. As can be seen in the property sector performance chart below, Homebuilders and Hotel C-corps continue to lead the way within commercial real estate, posting big gains in June and leading all sectors in 2023.

As it pertains to Serenity’s performance, the fund came into the month defensively positioned, preferring counter-cyclical cash flows and low leverage REITs in the face of elevated recession odds. In June this positioning was punished, with Industrial and Infrastructure REITs lagging peers. Infrastructure has been weak in 2023, with investors preferring more cyclical sectors because economic data has not deteriorated as rapidly as once feared.

The shift in risk attitudes in June and July is notable in that the market is pricing in a much higher likelihood of a soft landing than only a month or two ago. While we do not see support for this in the underlying macro-economic data (Apartment rent growth and retail sales both just dropped into NEGATIVE growth territory YoY), increased confidence can become a self-fulfilling prophecy. Essentially, if investors feel better about the economy because of inflation cooling, this can have positive knock-on effects that eventually translate to improvements in economic data.

Suffice it to say, our interest is piqued. A true soft-landing would set the stage for an extended rally in REITs that could be extremely lucrative (REITs are VERY cheap relative to the S&P 500). If we begin to see data that backs this up (rent growth bottoming for Apartments and Self-storage companies, BBB spreads contracting, mortgage rates easing), our positioning will get more bullish.

For now, we remain cautious but optimistic. REIT fundamentals continue to slow and need to reverse higher for REITs to mount a sustainable rally. When they do, we will be ready. Our shopping list is mouthwatering…

FACTORS OR SECTORS: Why a different approach may be necessary in the current market…

In my years of running a REIT hedge fund I’ve found two things to be consistently true.

  1. Investors like REITs. They consistently see the value of owning high quality commercial real estate portfolios that are liquid and diversified.

  2. The REITs that investors gravitate towards often share a common characteristic. They have recently outperformed.

Consider the following anecdote.

When I started in the REIT industry in 2010, the two most important and coveted sectors in the REIT industry were…drumroll please…Office and Mall REITs. Uhh…what?

Let’s take a second to appreciate how amazing this is. The two WORST performing property types over the subsequent 10 years, were investor FAVORITES when my career in REITs began.

On the other side of the spectrum there were two property types that were mostly out of favor, so much so that they were not included in REIT indexes at the time. Cell Towers and Data Centers. What has the performance been of the top stocks in each of these sectors since?

EQIX – Data Center +21.3% annually (2011-2023)

AMT – Cell Tower +14.5% annually (2011-2023)

BXP – Top tier Office +1.35% annually (2011-2023)

SPG – A quality Malls +6.2% annually (2011-2023)

It was common knowledge in 2010 that Offices were fundamental to the CRE industry and that Malls were “special” (in a good way). Fast forward 13 years and that conventional wisdom looks ridiculous.

Similarly, Data Centers and Cell Towers were…weird. They didn’t fit the traditional CRE box, so most investors just chose to ignore them. This also seems ridiculous…but only with the benefit of hindsight!

What’s the point of this rant? Simply put, picking property sectors in REITs, while popular due to its simplicity, is EXTREMELY DIFFICULT. Even the best, most educated and experienced REIT experts consistently get property sector “calls” wrong. Remember the bull market in 2021 (REITs +45%)? Remember the best performing property type? It was Malls (+91%). How many REIT investors pounded the table to get long Malls in late 2020?

This is why our process is NOT built around picking property sectors. Their performance is simply too volatile and hard to predict in a top-down fashion. Instead, we adhere to an approach that is more mathematical, more stable over time, and forms the backbone of some of the most successful asset managers in the industry.

Factor investing.

The beauty of factor investing is that factors that worked well in 2010…still work well in 2023. Factor performance tends to be much more stable than sector performance, as factors are always adapting to the current opportunity set. If I say I want to invest in REITs that grow their cash flows, trade at attractive valuations to peers, and have strong balance sheets, I can isolate those factors and build a model that ALWAYS picks those types of REITs.

At its core, Factor investing simply tries to isolate what truly makes REITs succeed over the long run. Hint…it’s often independent of the company’s property type. So instead of picking REITs based purely on the types of properties they own, we pick them based on their cash flow characteristics. Or their valuation relative to peers. Or the quality of their balance sheet.

What you find when you study REIT factors is that best in class REITs have a few simple shared characteristics.

1) Strong cash-flow growth and opportunities for reinvestment

2) Management teams that add value

3) Balance sheets that support growth

These are criteria are not beholden to property type.

Now, does Factor investing completely ignore property types? Of course not. What it does differently, however, is build property type exposure in a portfolio from the bottom up, as opposed to the top down. Instead of picking the best REITs within a property type, Factor investing just picks the best REITs…and the property type exposures manifest themselves from the data. This helps us avoid the behavioral human trap of falling in love with narratives either positive or negative.

That last sentence is a real key to the power of our proprietary multi-factor REIT model. It’s a model based on fundamentals, that has 0 feelings.

The question investors need to ask themselves then, is what is the foundation of your REIT picking process? Is it “experience?” Experience taught you to be overweight Malls and Office in 2010.

Our foundation is data, and an un-emotional model that shows us EXACTLY which REITs are creating value for shareholders. We don’t have to pick sectors or let our emotions get in the way. Our model does the dirty work.

So what does it have to say about the soft landing/recession debate?

WHAT IS THE MODEL TELLING US? The soft landing has yet to appear for REITs…

Just to be clear, our quant model does not make macro-economic predictions. Again, it simply looks for which REITs are growing their cash flows, trade at reasonable valuations, and have high quality balance sheets and management teams. But the composition of REITs that rise to the top can be informative. For instance, when economic growth is accelerating, cyclical REITs tend to rise to the top of the model. This means Lodging, Apartments, Self-Storage, and Office REITs tend to shine as their underlying cash flows are the most sensitive to the macro economy.

Conversely, when growth is slowing, counter-cyclical REITs tend to rise to the top. It’s the same phenomenon in reverse. Cyclical REITs see large cyclical downturns in their cash flows, which push their rankings lower in the model. Meanwhile REITs with less cash flow variation (more bond-like REITs) rise to the top. Valuation weaves itself through this process, ensuring that at equal levels of growth, the model leans toward cheaper REITs.

What is the model currently telling us? The top ranked property sectors currently (based on average ranks of their constituent REITs) are Industrial (Warehouse) and Free-Standing Retail (Net Lease) REITs. This is a fairly defensive positioning, as Free-Standing Retail tends to be one of the most bond-like sectors in all of REITs, while Warehouse has become like the “FANG” stocks of REIT land. PLD is essentially a large cap growth stock which trades at a big premium to everything else when growth is slow (see MSFT, AAPL, GOOG).

To reiterate from above, in a growth accelerating environment we would expect to see more Lodging REITs, Apartment REITs, and even Mall REITs in the top ranks of the model. For now, the model continues to emphasize more defensive exposures, indicating that underlying cash flow growth remains moribund.

On the other side of the spectrum, the lowest ranked REITs continue to be Office and Shopping Center REITs. These are also cyclical REIT sectors, indicating that the model has little appetite for cyclicality currently. Despite the recent bounce in Office names, there have not (as of yet) been significant revisions higher for Office REIT fundamentals. While we would love to jump on the Office bandwagon (the names are supremely cheap), we need more positive data. If fundamentals begin to surprise to the upside, these companies could move up the model ranks quickly. We have our eyes peeled for just such a phenomenon.

Sector level fundamental data supports the model’s conclusions. While many REIT investors love multi-family (Apartments) due to their valuation discount relative to the private market, fundamentals in the space remain un-inspiring at best (and borderline frightening in the recession case). The chart below shows rent growth for Apartments as tracked by This metric just went negative for the first time since 2020. And multi-family construction is still rising…meaning we have not yet seen the peak in supply.


Self-storage REITs have a similar setup. Slowing same-store revenue growth, with little evidence of improving demand as the housing market remains extremely slow. Even the Hotel companies have issued cautious guidance as leisure travel slows and business travel remains well below peak.

Long story short, in the REIT market we see few signs of any sort of “landing,” as data continues to trend towards 0 or negative growth on a year over year basis.

Does this mean we are headed for recession? Not necessarily. But a period of slow growth is the best guess based on current trends. When that changes (for better or worse), our model, and our fundamental research will be ready.

PREPARED FOR ANYTHING: Our process has a playbook for what’s to come…

Let’s recap some key takeaways as we wrap up our monthly missive.

  1. Sector picking is EXTREMELY difficult. Today’s hot property types are often the worst performers going forward and vice versa. If Office REITs outperform Warehouse REITs over the next 3 years, nobody should be surprised. Nobody is positioned for it, which perversely makes it more likely to happen.

  2. Factor picking is extremely stable. We have had the same factors in our REIT model for over 5 years, and they continue to perform well. Would you rather pick a property type to ride with over the next 5 years or a favorable characteristic such as cash flow growth?

  3. Fundamental data for most REITs continues to deteriorate, showing few signs of a soft landing or growth re-acceleration. Could a recovery be just over the horizon? Possibly. When the data turns higher, our model and our investment team will be ready.

The over-arching message for this month’s newsletter is that having an adaptable process that is disciplined and rooted in data is more important than ever. Investor expectations for the economy have never been this wide. Having a process that can succeed in both a soft-landing and a recessionary scenario is paramount. At Serenity our process is…

Prepared for anything,

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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