“I think my acceleration is very good. That's the key for me. ” – Usain Bolt
PERFORMANCE: Serenity Alternative Investments Fund I returned +2.87% net of fees in February vs the REIT index at 2.0%. In 2024, the fund has returned +3.6% vs -2.23% for REITs.
ACCELERATION: Signs of a growth acceleration continue to accumulate in REITs. What does this mean for the Serenity portfolio?
A HISTORY LESSON: What can we learn from the 2021 growth acceleration and what might be different this time?
THE RUNWAY: REITs are extremely cheap relative to the broader stock market. Could this extend the runway for the current REIT bull market?
Imagine trying to beat Usain Bolt in a 100-meter race.
Sounds impossible, no?
Pretty much 100% of human beings would stand no chance.
Now imagine being offered a large head start, a Porsche 911, and a $1 million reward if you win.
Would you decline the offer because of the dangers of driving automobiles? Or because you had a bad experience with Porsches in the past? Would you think that because your private equity automobile had recently crashed, that you should avoid cars all together? Or would you decline because a friend of yours saw a car accident on CNBC the other day?
This is a silly hypothetical, and yet, almost perfectly reflects the consistent behavior of investors.
When offered the opportunity to get a leg-up on the market, they pass due to emotional baggage or uninformed financial media gossip.
The current appetite for REITs is a perfect example. An asset class with a history of posting market-beating returns is barely on investor radars. The turmoil in highly levered, obsolete, Office assets is consistently conflated with a broader CRE “crash” or “disaster” in the financial media. Meanwhile REIT fundamentals are beginning to accelerate…while the sector trades at a massive discount to the broader stock market.
After a two-year REIT bear market, investors have the chance to jump into the race with a large head start, riding a finely tuned REIT investing machine. But unfortunately, many will stay on the sidelines, waiting for the perfect moment while REITs will leave their portfolios in the dust.
At Serenity, the message is clear. We are not equivocating, we are accelerating.
PERFORMANCE: +2.87% in February vs REITs +2.0%
Serenity Alternative Investments Fund I returned +2.87% in February net of fees and expenses versus the MSCI US REIT Index which returned +2.0%. Year to date Serenity Alts Fund I has returned +3.60% vs the REIT index at -2.23%. On a trailing 3-year basis, Serenity Alts Fund I has returned +8.5% annually net of fees versus the REIT index at +4.9%. Over the past 5 years Serenity Alternatives Fund I has returned +13.2% annually net of fees and expenses, versus +4.4% for the REIT index.
The most profitable position in the fund for February was Caretrust REIT (CTRE), which returned +7.84% for the month. Caretrust is a healthcare REIT that owns skilled nursing facilities. Skilled nursing facilities (SNFs) are one of the most operationally intense property types in all of REITs and thus require a high level of operating expertise. CTRE is one of the best respected REITs in this subsector and has worked through its share of challenges since the 2020 global pandemic. As fundamentals have continued to improve, CTRE has moved up the rankings within the Serenity CORE model, finding itself as a top ranked name in early 2024. With a high-quality portfolio and well-respected management team, CTRE checked all the boxes for a Serenity long investment early in the year, and the fund was rewarded in February after a strong earnings report propelled the name higher.
The least profitable position for the fund in February was Hilton Worldwide (HLT), a short position which rose +7.08%. Hilton has been a short position in the fund as a hedge against one of our top ranked long positions Marriot International (MAR). With Marriot hitting all time highs consistently in late 2023 and early 2024, we have tried to prudently trim the position by shorting Hilton against it (as Hilton is highly correlated but ranks lower in our CORE model). Alas, Hilton and Marriot have both continued to churn higher, proving this hedging decision to be ill-timed. While we still prefer Marriot to Hilton, the lesson here is that all-time highs are not a sufficient justification for hedging a position. As always, we have incorporated the lesson learned here and will improve our hedging decisions in the future.
ACCELERATION: REIT green shoots continue to emerge…
As we wrote last month, 2024 continues to be a breath of fresh air within the REIT market as the “bad news” train has finally stopped and potentially even reversed course. For the majority of 2022 and 2023, the news out of REIT land was one directional. Growth disappointed to the downside, interest expense disappointed to the upside, and most REIT management teams were forced into damage control as stock prices languished and capital costs worsened.
In 2024 many of these headwinds have abated significantly, and signs continue to emerge that a nascent re-acceleration in REIT growth may be under way. We use qualifiers here because a few data points do not make a trend; but more evidence is accumulating to support our bullish posture. For example, BAA bond yields (a proxy for REIT debt costs) are holding steady near +5.7%, a significant improvement to late 2023 levels closer to +6.5%. Mortgage rates have also fallen to +7.0%, down from +8.0% at the end of October 2023. This has re-invigorated the housing market a bit (off extremely low levels) with MBA purchase activity now +8% higher on a 3-month average basis.
Demand for Apartment REITs, a very strong indicator of broader REIT fundamentals, also continues to show promising signs in early 2024, after same-store revenue growth fell from +12% in 2022 to near +0% in 4Q 2023. As can be seen below in a recent update from Apartment REIT UDR, average concession usage and blended lease rate growth have both improved in early 2024 from adverse levels in late 2023 (lower concessions is good, higher lease rate growth is good).
REIT guidance in 2024 is also very conservative, something we did not see in 2023 as many management teams expected a re-acceleration in the back half of last year that never materialized. A common refrain of early 2024 REIT earnings conference calls is “our guidance assumes no improvement in demand in 2024.” From an investors perspective this is positive, as any improvement in fundamentals is likely to catalyze guidance beats and raises throughout the year (which have been a rarity since 2021).
A good example of this phenomenon comes from the Q1 2024 earnings call of Park Hotels (PK), a Hotel REIT in the Serenity long book.
“The first quarter has had an exceptional start with RevPAR growth up 13.4% in January and positive trends continue in February with preliminary RevPAR forecast to be up over 8% …”
This is interesting as Park has guided to RevPAR growth of just +4.5% for the full year 2024, indicating that they are already well ahead of guidance after two months. When asked about it on the call, Park CEO Tom Baltimore had the following to say…
“Admittedly, obviously, January and February very, very strong based on the trends that we're seeing. There will be a [deceleration] in March for all the reasons that we pointed out. Group is going to be down, and, of course, you've got the Easter shift will clearly impact. So yes, there is -- January and February don't make a year. So there's certainly conservatism built into that. But look, we are very pleased.”
While not all REITs are off to the start of 2024 that Park is, this sentiment has been common on REIT earnings calls in 2024. Let’s call it caution bordering on pessimism (Park keeping guidance low despite already being ahead). Again, this is the opposite of 2023, when many REITs had optimism baked into their guidance, setting up for eventual disappointment and guidance cuts when growth was challenged through the year.
The point is that REITs are set up for positive surprises in 2024 after consistent negative surprises in 2022 and 2023. More conservative guidance, growth bottoming or re-accelerating, capital costs stable or declining. These are the ingredients for the beginnings of a REIT bull market.
A HISTORY LESSON: What happened in 2021 and could history repeat?
The next logical question for REIT investors is then…what do we buy?
What does the growth accelerating playbook look like?
For some clues here, let’s examine performance of REITs in 2021, the last year in which growth truly accelerated following the worst of the pandemic in 2020.
The table to the right shows how REIT property sectors performed in 2021, as well as the
performance of each relative to the composite Serenity Universe.
In the most recent growth acceleration, Regional Malls led all sectors in performance up +93%, which was +49.8% better than the broad REIT industry. Not far behind were Self-Storage, Industrial, and Apartment REITs, all outperforming peers by over +20% for the year.
Major laggards were Health Care, Free Standing Retail, Diversified REITs, and Data Centers.
The common theme here? Cyclical sectors outperformed, while high duration, more defensive sectors underperformed.
This is exactly what we would expect to see at the outset of a REIT bull market. As growth bottoms and re-accelerates higher, cyclical REITs see positive earnings revisions, beat and raise guidance, and grow their NAV’s faster than more defensive peers.
As we discussed in the previous section, we believe the odds of cyclical companies beating and raising guidance throughout 2024 are much higher than they have been since…wait for it…2021. In our view, the 2021 playbook is not a bad place to start, and our multi-factor model agrees. Mall REITs have shot to the top of our model rankings in recent months as growth has been strong and valuations remain relatively modest. Self-storage REITs have also begun to climb the ranks but have not quite broken into the top quintile yet. When they do, we will own them in size as discussed in previous newsletters.
Apartments (again as we have discussed previously) are likely be the last of the cyclical sectors to move up in our model, as fundamentals tend to lag self-storage by about a quarter, and supply is still peaking in early 2024. But we fully expect to own Apartments as well at some point in 2024 assuming growth continues to tick higher.
Now there are a few key differences in 2024 relative to 2021 that are worth mentioning.
The first has to do with Lodging. The Lodging REITs are the most hyper cyclical of all REIT property types, but in the lingering pandemic era of 2021 they were excluded from the growth cycle due to the slow recovery in travel. In 2024, the Lodging REITs have pandemic recovery tailwinds at their backs, as group travel continues to accelerate, and urban demand for hotels finally inches back towards 2019 levels. Loding REITs look great in the Serenity model, and early reports for the year have been positive. We believe this sector will be a top performer early in 2024, which is a key difference relative to 2021.
Interest rates are also much higher in 2021, and inflation is much more of a focus for investors than it was three years ago. This will put a damper on the multiple expansion possibilities for REITs, limiting total returns to a more normal +5%-+15% as opposed to 2021’s +43%. From a relative performance perspective, however, could we see cyclical REITs up +20-30% with high durations REITs down -5-15%? Yes, which would represent a very similar relative performance year to 2021.
The moral of the story is that if growth continues to accelerate, we expect to see cyclical REITs outperform more defensive, higher duration peers. Our model is tilting the portfolio in that direction, and our fundamental work backs up this thesis. While higher-for longer interest rates could pose a headwind, REIT growth often trumps interest rates in importance when it moves meaningfully higher. In fact, we can use interest rate driven selloffs to buy more of our favorite cyclical REITs as we execute our process.
THE RUNWAY: Historical REIT bull markets show great potential…
While the path forward is always uncertain, investor NEED to consider the possibility that we are in the early innings of an extended REIT bull market. The opportunity cost of ignoring this possibility is significant. Previous REIT bull markets lasted years and delivered total returns of 100’s of percent's, as seen in the chart below.
The current REIT rally is barely noticeable when compared to the REIT bulls of 1999-2004 and 2009-2014. Those bull markets both allowed investors to double their money in REITs in less than 5 years. In 2021, it happened inside of 18 months!
Now we don’t expect a 2021 style rally in 2024. The post-covid bull market was clearly an outlier in every sense of the word. But could REIT fundamentals slowly improve over the next 3-5 years as a more normal commercial real estate cycle plays out? They sure could. Could REITs deliver 10-20% annualized returns in that environment? You bet. Can Serenity beat the benchmark by a few hundred basis points each year over that period? We certainly have in the past.
Again, we cannot see the future and the next 3-5 years contain a lot of uncertainty. But there are a few things that we do know with confidence. 1) Cyclical REIT growth is currently well below it’s long-term average and tends to revert to the mean. 2) Apartment and Self-Storage supply will be drastically lower in 2025/2026, setting up the potential for much stronger fundamentals. 3) Most REIT balance sheets are in great shape, making REITs uniquely prepared for higher interest rates.
REITs may not be sexy investments and can struggle to keep investors attention, but the setup over the next 3 years in cyclical REITs looks extremely attractive from where I am sitting. And just remember the chart below. REITs went on an incredible tear from 2010-2015, leading all asset classes in 5/6 years. If they repeat the performance will you wait until year 5 to tune in this time?
EQUIVOCATE OR ACCELERATE?
One of the major difficulties of investing is that there are no layups. Value investing, one of the most common and researched investing styles, by its nature looks for companies that most investors dislike. It takes some serious mental fortitude to go against the crowd and buy things that are cheap…because they are most likely cheap for a laundry list of reasons.
REITs are cheap because their growth stinks, interest rates are much higher than a few years ago, and everyone knows that Office assets are doomed. Might as well pile into Microsoft and Google, then, because they have AI.
But what if growth accelerates? And inflation and interest rates move sideways? And <gasp> Office leasing improves*? Could a bid come back into the REIT market after a challenging 2-year post-pandemic hangover?
We would encourage investors not to fall victim to lazy narratives or emotional baggage regarding commercial real estate. REITs are cheap, growth is accelerating, and almost nobody is talking about it. Ignore at your own peril.
*This is happening believe it or not
Stop equivocating,
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
DISCLAIMER: This document is being furnished by Serenity Alternative Investment Management, LLC (“Manager”), the investment manager of the private investment fund, Serenity Alternative Investments Fund I, LP (the “Fund”), solely for use in connection with consideration of an investment in the Fund by prospective investors. The statements herein are based on information available on the date hereof and are intended only as a summary. The Manager has been in operation since 2016 and the Fund commenced operations on January 14th. The information provided by the Manager is available only to those investors qualifying to invest in the Fund. By accepting this document and/or attachments, you agree that you or the entity that you represent meet all investor qualifications in the jurisdiction(s) where you are subject to the statutory regulations related to the investment in the type of fund described in this document. This document may not be reproduced or distributed to anyone other than the identified recipient’s professional advisers without the prior written consent of the Manager. The recipient, by accepting delivery of this document agrees to return it and all related documents to the Manager if the recipient does not subscribe for an interest in the Fund. All information contained herein is confidential. This document is subject to revision at any time and the Manager is not obligated to inform you of any changes made. No statement herein supersedes any statement to the contrary in the Fund’s confidential offering documents.
The information contained herein does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential offering memorandum and only in those jurisdictions where permitted by law. Prospective investors should inform themselves and take appropriate advice as to any applicable legal requirements and any applicable taxation and exchange control regulations in the countries and/or states of their citizenship, residence or domicile which might be relevant to the subscription, purchase, holding, exchange, redemption or disposal of any investments. The information contained herein does not take into account the particular investment objectives or financial circumstances of any specific person who may receive it. Before making an investment, prospective investors are advised to thoroughly and carefully review the offering memorandum with their financial, legal and tax advisers to determine whether an investment such as this is suitable for them.
There is no guarantee that the investment objectives of the Fund will be achieved. There is no secondary market for interests and none is expected to develop. You should not make an investment unless you have a long term holding objective and are prepared to lose all or a substantial portion of your investment. An investment in the Fund is speculative and involves a high degree of risk. Opportunities for withdrawal and transferability of interests are restricted. As a result, investors may not have access to capital except according to the terms of withdrawal specified within the confidential offering memorandum and other related documents. The fees and expenses that will be charged by the Fund and/or its Manager may be higher than the fees and expenses of other investment alternatives and may offset profits.
With respect to the present document and/or its attachments, the Manager makes no warranty or representation, whether express or implied, and assumes no legal liability for the accuracy, completeness or usefulness of any information disclosed. Certain information is based on data provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such. Performance information and/or results, unless otherwise indicated, are un-audited and their appearance in this document reflects the estimated returns net of all expenses and fees. Investment return and the principal value of an investment will fluctuate and may be quite volatile. In addition to exposure to adverse market conditions, investments may also be exposed to changes in regulations, change in providers of capital and other service providers.
The Manager does not accept any responsibility or liability whatsoever caused by any action taken in reliance upon this document and/or its attachments. The private investment fund described herein has not been registered under the Investment Company Act of 1940, as amended, and the interests therein have not been registered under the Securities Act of 1933, as amended (the “1933 Act”), or in any state or foreign securities laws. These interests will be offered and sold only to “Accredited Investors” as such term is defined under federal securities laws. The Manager assumes that by acceptance of this document and/or attachments that the recipient understands the risks involved – including the loss of some or all of any investment that the recipient or the entity that he/she represents. An investment in the Fund is not suitable for all investors.
This material is for informational purposes only. Any opinions expressed herein represent current opinions only and while the information contained herein is from sources believed reliable there is no representation that it is accurate or complete and it should not be relied upon as such. The Manager accepts no liability for loss arising from the use of this material. Federal and state securities laws, however, impose liabilities under certain circumstances on persons who act in good faith and nothing herein shall in any way constitute a waiver or limitation of any rights that a client may have under federal or state securities laws.
The performance representations contained herein are not representations that such performance will continue in the future or that any investment scenario or performance will even be similar to such description. Any investment described herein is an example only and is not a representation that the same or even similar investment scenarios will arise in the future or that investments made will be profitable. No representation is being made that any investment will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between prior performance results and actual Fund results.
References to the past performance of other private investment funds or the Manager are for informational purposes only. Other investments may not be selected to represent an appropriate benchmark. The Fund’s strategy is not designed to mimic these investments and an individual may not be able to invest directly in each of the indices or funds shown. The Fund’s holdings may vary significantly from these referenced investments. The historical performance data listed is for informational purposes only and should not be construed as an indicator of future performance of the Fund or any other fund managed by the Manager. The performance listed herein is unaudited, net of all fees. YTD returns for all indices are calculated using closing prices as of Jan 14th, the first day of the funds operation. Data is subject to revision.
Certain information contained in this material constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Such statements are not guarantees of future performance or activities. Due to various risks and uncertainties, actual events or results or the actual performance of the Fund described herein may differ materially from those reflected or contemplated in such forward-looking statements.
Our investment program involves substantial risk, including the loss of principal, and no assurance can be given that our investment objectives will be achieved. Among other things, certain investment techniques as described herein can, in certain circumstances, maximize the adverse impact to which the Fund’s investment portfolio may be subject. The Fund may use varying degrees of leverage and the use of leverage can lead to large losses as well as large gains. Investment guidelines and objectives may vary depending on market conditions.