“ARE YOU NOT ENTERTAINED?" – Maximus, Gladiator (2000)
PERFORMANCE: Serenity Alternative Investments Fund I returned -0.55% net of fees in October vs the REIT index at -2.88%. In 2024, the fund has returned +18.1% vs +12.5% for REITs.
INFLATION HEDGES: Apartment and Healthcare REIT revenues are highly correlated with inflation.
GOVERNMENT EFFICIENCY PROXIES: High duration REITs would benefit from deficit reduction.
NO LANDING DEEP VALUE: Lodging and Office REITs would benefit from economic growth re-acceleration.
Americans, like our republican predecessors in Rome, love entertainment.
Just look at the last days or our presidential election. Donald Trump working a shift at McDonalds, then appearing on Joe Rogan. Kamala Harris appearing with Oprah and Beyonce.
The two presidential campaigns knew the truth of the famous maxim from our titular classic…
Win the crowd, win your freedom.
Or in this case the presidency.
With the multi-year spectacle now behind us, it is time again to ponder the investing corollary… which themes will win the investing crowd in 2025 and beyond?
And how does a Trump presidency impact the outlook for REITs?
While it’s still early to analyze the implications of a policy agenda in its infancy, we can formulate a playbook for various economic scenarios. A soft or no-landing scenario would be very favorable for deeply discounted Lodging and Office REITs. Conversely, an Elon Musk led government purge could benefit Net Lease and Healthcare REITs at the expense of economic growth.
Whatever the outcome, Serenity has a raft of compelling REIT ideas that should weather any set of challenges. Our battle tested REIT gladiators are not daunted by the swirling sands of the financial coliseum.
PERFORMANCE: -0.55% in October +18.1% YTD
Serenity Alternative Investments Fund I returned -0.55% in October net of fees and expenses with +80% net exposure versus the MSCI US REIT Index which returned -2.88%. Year to date Serenity Alts Fund I has returned +18.1% with only +72% net exposure vs the REIT index at +12.5%. On a trailing 3-year basis, Serenity Alts Fund I has returned +4.8% annually net of fees versus the REIT index at +1.4%. Over the past 5 years Serenity Alternatives Fund I has returned +12.8% annually net of fees and expenses with a 1.04 Sharpe ratio, versus +4.6% for the REIT index.
One of the most profitable positions in the fund in October was Medical Properties Trust (MPW), a short position which fell -20.9% during the month. We have remained short MPW as it re-tenants numerous hospitals following the bankruptcy of its largest tenant, Steward Healthcare. With significant debt maturities in 2025, a tenant roster that continues to struggle financially, and a management team with little remaining credibility, a path to MPW’s continued survival looks extremely difficult. The company continues to sell assets, cut the dividend, and attempt to raise capital to meet upcoming maturities. In the REIT industry we refer to this predicament as the “death spiral.” Until MPW can significantly improve its balance sheet, Serenity is likely to remain short.
The least profitable position for the fund in October was National Healthcare Investors Inc (NHI), a long position that returned -8.8% during the month. On October 10th, NHI issued a business update in which they disclosed that one of their tenants was financially challenged, and not expected to continue paying rent (about 2-3% of NHI’s revenue). While losing a tenant is always a negative, NHI announced proactive steps to re-tenant some of the impacted assets, sell one, and collect a financial guarantee which should cover some of the lost rental payments. Contrast this with the approach of MPW, mentioned above, which is to loan capital to struggling tenants and never recognize rent impairments. Investors much prefer the more sustainable option of acknowledging and addressing tenant weakness. Due to NHI’s proactive approach and continued momentum in their external growth pipeline, the stock has recovered the majority of October’s -8% loss in November. Serenity remains long.
INFLATION’S RETURN? Apartments and Seniors Housing could benefit
While the results of the election are still only a week old, there have been some clear winners and losers in the REIT space over the past 7 trading days. As of this writing, Apartment REITs have returned +3.3% and Lodging REITs have returned +5.3% since November 5th. Contrast this with Cell Tower REITs (-7.6%), and Self-Storage REITs (-2.8%).
While not exactly a crystal ball, this type of sub-sector performance suggests investors are betting on higher interest rates, driven by some combination of higher inflation and growth. Lodging stocks are economically sensitive, Apartments are an excellent inflation hedge, and Self-Storage and Cell-tower REITs tend to have high inverse correlations with bond yields.
A brief perusal of the financial press presents a similar picture. Many investors expect a
Trump presidency to be inflationary, with the rationale that tariffs increase the cost of goods, and continued deficit spending is both inflationary and bad for interest rates (a higher supply of treasuries needed to plug the deficit hole will require higher rates to attract buyers).
While it’s worth taking such early prognostications with a grain of salt, the implications for REITs are important to ponder.
On the inflation front, Apartment REITs present an excellent inflation hedge, as Apartment revenue growth is almost explicitly a component of CPI. Said another way, if inflation accelerates from here, Apartment REITs are likely to benefit by passing this inflation on to their tenants. In the chart above, the 2021 inflation acceleration is clear in Apartment asking rents, and the Apartment REITs performed extremely well as inflation accelerated (+65% in 2021). Add to this the fact that Apartment competitive supply pressures ease meaningfully in 2025, and the outlook for Apartment REITs looks very rosy in an inflationary economy.
Seniors Housing REITs (a subset of the Healthcare REITs) could be a secondary beneficiary of inflation, as they have similar pricing power to Apartment REITs. These companies are also benefitting from positive demographics and similar supply tailwinds going forward.
The Bottom Line: Apartment and Senior Housing REITs can pass inflation along to their tenants and could therefore see growth accelerate if inflation increases. Both property types should benefit from fading supply pressures in 2025, and Serenity is long multiple REITs within each sub-sector.
DOGE (Department of Government Efficiency): Lower for longer.
Another possible economic scenario getting much LESS airplay in the mainstream media is one that is much less positive for economic growth. While Elon Musk’s stated goal to cut $2 Trillion from the government spending rolls seems a bit far-fetched, it’s important to ask the question…what if he succeeds?
Even if Elon, as an extension of the Trump administration can cut a fraction of this amount from government spending, the results would likely be the OPPOSITE of this week’s market reaction. That is, economic growth would slow, the deficit would shrink, inflation would likely fall, and the path of least resistance for bond yields would be LOWER.
I find this path personally intriguing. Consensus is very clearly NOT baking in this scenario, which, in my mind, is not farfetched.
What is the REIT playbook for a Musk led DOGE purge?
The most recent period of falling interest rates we have to draw on occurred from 4/25/2024 until 9/17/2024. Over this period, the best performing REIT sub sectors were Healthcare (+38.5%), RE Services (+37.7%), Self-Storage (+35.8%), and Cell Towers (+34.3%). You will notice two of these have been the WORST performing sectors of the past week.
A period of lower deficits and lower interest rates may not be on many investor bingo cards for 2025, but we should not rule it out. For this reason, Serenity is likely to add some inexpensive duration exposure to the portfolio as interest rates move higher, and discounts in some high-quality, high-yielding REIT portfolios emerge.
The Bottom Line: Investors may be sleeping on the possibility of deficit reduction with this new administration. If the department of government efficiency becomes a reality, and government spending is meaningfully reduced, interest rates are highly likely to move lower, buoying high duration REIT property types such as Cell Towers and Self-Storage.
NO LANDING: Can animal spirits awaken dormant Lodging and Office portfolios?
The last scenario worth discussing this month is referred to by the press as the “No Landing” scenario. Said another way, the economy does not experience a “soft landing” or a recession, but instead quickly re-accelerates as animal spirits re-awaken with this new administration.
There is certainly some evidence the market is buying this outcome. Small cap stocks, the most economically sensitive cohort of the market, have returned +5.8% since November 5th, in line with Lodging REITs, the most economically sensitive of the REIT sectors. This is a clear bet on economic re-acceleration by market participants, and worth noting.
The implications of this scenario for REITs are extremely interesting. Periods of rapid growth acceleration tend to benefit REITs that are cheap and cyclical, which in this instance means the Lodging and Office REITs, two property types that have been all but left for dead over the last few years.
The charts above show historical AFFO (cash flow) multiples for two blue-chip REITs in Office and Lodging, Boston Properties (BXP) and Host Hotels (HST).
Boston Properties sported an AFFO multiple north of 20x for the better part of a decade from 2010-2020. Its current valuation is +15.9x, and the company sunk as low as +9x cash flow in 2023. While BXP has recovered from its worst ever valuation levels of a year ago, it still trades well below its historical valuation range, all while Office leasing is improving in many parts of the country.
Host Hotels is a similar story. Host was an 11-15x AFFO multiple company for much of the previous cycle, but currently trades at +9.1x 2025 cash flow estimates. The company sports one of the lowest multiples in the REIT universe despite a 10-year cash flow CAGR of +5.29%!
Now, the struggles of the Office and Lodging REITs are real. Office companies are just now starting to see positive absorption after 2 years of slow leasing. Lodging REITs have cut RevPAR guidance in 2024 due to weak leisure travel.
But the bar for these companies going forward is VERY low. And an economic acceleration could easily spark small amounts of good news in both property types. That may be all it takes to move some of these beaten down companies up a few multiple points in the market, delivering +10%, +20%, or +30% returns to investors in relatively short order.
The Bottom Line: Economic activity has been weak in Office and Lodging portfolios but would likely accelerate in a no-landing scenario. If growth accelerates from here, investors tend to reach towards value and cyclicality, and Office and Lodging REITs sport deeply discounted valuations and are some of the most highly cyclical of all REIT property types. Serenity has limited exposure to REITs within these sub-sectors but is watching like a hawk for signs of economic strength that could propel these companies higher.
ROME IS THE MOB
In the ever-changing arena that is equity investing, new ideas are constantly vying for investor attention.
Which will win out in 2025 is yet to be seen.
In the REIT market, you will notice Healthcare REITs as winners in multiple scenarios we have outline above. Serenity is heavily long Healthcare REITs.
Apartment REITs similarly have a very clear path to success in 2025 and make up another significant chunk of the Serenity portfolio.
As insurance we can scoop up deep discounts in high duration REITs as interest rates move higher, and vigilantly monitor economic data for strength in hyper-cyclicals.
Thus, our portfolio is prepared for almost any outcome under the new US governance regime, be it inflation, deficit reduction, or rapid growth acceleration.
With an always sharp multi-factor model and nearly 15 years of experience brawling in the REIT arena, the outlook for the Serenity portfolio is bright.
Strength and Honor,
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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