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  • Writer's pictureMartin Kollmorgen

Serenity + Blackstone? +1.15% in March, +4.8% YTD

“Veronica: Oh, well, when in Rome. Ron Burgundy: Yes? Please go on." - Anchorman

  • PERFORMANCE: Serenity Alternative Investments Fund I returned +1.15% net of fees in March vs the REIT index at +1.96%. In 2024, the fund has returned +4.8% vs -0.32% for REITs.

  • THE UPCOMING APARTMENT BULL MARKET: Serenity and Blackstone seem to agree… Apartments are set for a multi-year bull run.

  • DIVERSITY – NOT THE OLD WOODEN SHIP: Other bets within the Serenity portfolio could be equally or more exciting than the Apartment REIT trade in 2024/2025.

  • GREAT ODINS RAVEN! Could inflation’s re-acceleration kibosh the nascent REIT bull?

What is the commercial real estate equivalent of “When in Rome, do as the romans do?”

When in commercial real estate, do as Blackstone does?

That might not be a bad strategy. As one of the heavyweights of the CRE investing landscape, Blackstone can move markets with the size of its checkbook.

Their latest big bet is a good example.

Apartment Income REIT (AIRC), returned +22.4% on April 8th as Blackstone announced they were buying the firm for $10 billion or $39.12 per share (a +5.9% implied cap rate).

The takeaway here seems clear. Blackstone is betting on an Apartment REIT renaissance. They are not pulling their hair out over every 10-basis point move in the CPI, waiting for conditions to be perfect before allocating capital. They just put $10 billion on the table with a huge bet on multi-family.

And at Serenity…we agree with this decision! Not only that, since we do not have to deploy capital in $10 billion chunks (yet), we can get Apartment REITs at more attractive valuations.

We have been foreshadowing our bullishness on Apartments for most of 2024 in multiple newsletters. This month we make the case for a multi-year bull market for Apartment REITs beginning in late 2024 or early 2025. Blackstone has made their bet, and Serenity in this instance will ride with them.

When in Rome…

PERFORMANCE: +1.15% in March vs REITs +1.96%

Serenity Alternative Investments Fund I returned +1.15% in March net of fees and expenses versus the MSCI US REIT Index which returned +1.96%. Year to date Serenity Alts Fund I has returned +4.8% vs the REIT index at -0.32%. On a trailing 3-year basis, Serenity Alts Fund I has returned +7.0% annually net of fees versus the REIT index at +4.0%. Over the past 5 years Serenity Alternatives Fund I has returned +12.5% annually net of fees and expenses, versus +4.2% for the REIT index.

The most profitable position in the fund in March was Essential Properties Realty Trust (EPRT), a long position that returned +12.8% during the month. EPRT has been the highest ranked Free-Standing Retail (Net Lease) REIT in the Serenity CORE multi-factor model lately and was a top ranked REIT early in the year as interest rates were falling rapidly. It has since fallen in our model ranks (as interest rates have risen), and we closed our long position in March. As a high duration REIT (most net lease REITs have a high inverse correlation with bond yields), the recent acceleration in inflation has led to poor performance for EPRT in April. We are unlikely to own EPRT again without more confidence that inflation has stabilized or is headed lower.

The least profitable position for the fund in March was Medical Properties Trust (MPW), a short position that returned +11.6%. We have written about MPW extensively in these pages and the company remains our favorite short position as we believe the equity is worth $0. After a disastrous start to 2024, MPW found some relief in March after falling -37% in January. As a heavily shorted stock, we expect MPW to be volatile, and can use short covering rallies to add to our position. Very little has changed fundamentally in this slowly unraveling story.

SERENITY + BLACKSTONE: Triangulating the Apartment REIT bull market…

Blackstone’s announced $10 billion take out of Apartment REIT AIRC should serve as a warning shot for investors that are ignoring REITs as an asset class in 2024. While Apartment REIT growth decelerated for most of 2022 and 2023, Blackstone just laid down a $10 billion bet that the worst is behind the Apartment market. So what data is one of the premier commercial real estate investing platforms looking at to justify such a significant bet?

The chart below has appeared in a multitude of Serenity newsletters over the past 2 years. It illustrates a simple concept. When same-store revenue growth is positive (the blue line is above 0) and falling, Apartment REITs tend to have poor forward looking returns (thus our bearishness since early 2022). When same-store revenue growth hits 0 or goes negative (see the red circles), and then accelerates, Apartment returns tend to turn significantly positive on a forward-looking basis. Said another way, growth acceleration = good, growth deceleration = bad.

The data supporting this visual assertion is eye popping. Forward 1-year returns for Apartment REITs during quarters in which same-store revenue growth is negative, average +56% (versus +12% on average since 2004).

The message then for Apartment REIT investors is simple. Buy Apartment REITs when same-store revenue growth goes negative and then re-accelerates. In Q1 2024, most Apartment REITs have guided to…wait for it…0% or negative same-store revenue growth. We can assume with confidence that the blue line in the chart below lands somewhere near 0 when we update it for Q1 2024 results.

Now there is an important caveat here. How do we know that revenue growth is bottoming? We don’t want to buy these names if revenue growth is about to plummet to -2.5% or -5%. Our second Apartment chart below is the data set we rely on to measure the real time direction of Apartment rents. A key consideration here is that this chart leads Apartment REIT revenue growth as it is reported monthly (while Apartment REITs report quarterly with a lag).

The takeaway? There are early signs that revenue growth is bottoming near 0%.

Stepping back, let’s summarize the key points so far. 1) Apartment REITs exhibit their best returns when revenue growth is at 0 or below and headed higher. 2) Apartment REIT revenue growth is about to hit 0% and has the potential to turn higher later in 2024.

This ambiguity in timing is why Serenity is not massively long Apartment REITs YET. There is still substantial supply hitting the Apartment market in 2024, and rents are clearly still under pressure. While we are confident revenue growth will mean revert higher in 2025/2026 (more on this in a minute), 2024 is still a bit murky. Personally, I want to see more evidence of positive momentum before loading up the portfolio.

Blackstone, however, does not have the luxury of being so tactical with their positioning. They are likely looking out to 2025/2026 and saying, we want to ensure we capture the coming opportunity in size NOW, while there is still uncertainty in the market.

Why are they looking out to 2025/2026? Because of the chart below.

As interest rates have risen during the current Fed tightening cycle, multi-family developers have gradually curtailed new construction starts due to higher financing costs and lower Apartment rental rate growth. Multi-family starts and permits are both down more than 20% on a year-over-year basis and are likely headed lower in the months and quarters ahead. Just as the surge in Apartment supply in 2021 and 2022 has led to lower rental rates today, the upcoming ebb of Apartment supply should act as a rental rate tailwind in 2025 and 2026. Add in the fact that comps get much easier later in 2024 and throughout 2025, and the stage is set for a meaningful mean reversion in rental rate growth (from +0% now potentially back to +3-5%).

As we discussed earlier, accelerating revenue growth, especially from low levels, tends to produce excellent forward-looking returns for Apartment REITs. This is what Blackstone sees over the next 1-3 years; apparently with enough clarity to bet $10 billion. The purchase of AIRC gives them a national platform to capture this potential rental revenue mean reversion at scale.

In the Serenity portfolio, we are no longer shorting Apartment REITs and are actively looking for opportunities to increase our long exposure. We will be patient, however, as headwinds in early 2024 should keep many REIT investors sidelined for the time being. With more data we hope to increase our exposure throughout the year, looking forward to better days ahead for Apartment REITs in 2025/2026.

DIVERSIFICATION: The only free lunch…

While Blackstone captures the headlines with their huge foray into the Apartment REITs, there are quietly other REIT opportunities in 2024 that are comparably interesting. One sector in particular has climbed the ranks of our multi-factor model in recent months, mounting what could be described as a Lazurus level comeback.

That’s right, Mall REITs, which were supposed to be dead (and some of them are dead), have been some of the best performing companies in the REIT universe over the past 6 months. Wait…what?

Investors likely have vivid memories of the “death of the mall” narrative that punished Mall REITs from 2016-2020. The shift to e-commerce culminated during the pandemic and had many wondering if anybody would ever shop in a mall again. But very quietly over the same period, retailers mostly solved the riddle of e-commerce versus physical retail, discovering that BOTH are important to a thriving modern retailer. In 2024, retail tenants are no longer contracting, mall occupancy is steadily rising, and Mall REITs have quietly staged an epic comeback.

It's worth stepping back for a moment and mentioning that A Mall REITs were at one-point premier companies in the commercial real estate investing market. “A quality” malls traded at low +4% cap rates (while most other REITs traded closer to +6%), and Simon Property Group (SPG) was the largest company in most REIT indexes. Malls rode the wave of suburbanization from 2000-2006 to become bell-weather REITs.

I mention this point because malls find themselves at an interesting crossroads in the modern economy. With remote work pushing employees further and further from central business districts and more work being done from home, the center of many people’s daily lives is moving away from CBD offices and closer to…you guessed it…the local mall.

The key to Mall’s success in the early 2000’s was their proximity to dense, wealthy population centers, and the center of commercial real estate gravity may be moving back in that direction. As millennials move to the suburbs in droves and start families, where are they increasingly going to spend their time? It’s not at restaurants downtown, it’s at local destinations. Modern mall owners know this and have used the last few years of turmoil to transform their tenant bases. More and more malls sport dining options and kid friendly attractions that cater to a millennial generation that is +14% larger than the baby boomers. And with 0 new supply, mall economics are beginning to reflect this new reality.

Valuations, however, suggest that we are still in the “dead” mall world where everyone buys everything online. As can be seen in the chart below, Simon Property Group (SPG, the largest Mall REIT), currently trades at a forward AFFO multiple below +14x. From 2011-2016, +16x AFFO was the valuation FLOOR for Simon. Now it appears to be the ceiling.

This may still be appropriate. Earnings growth for the Mall REITs, while improving, is still in the low single digits. Occupancy has improved substantially since 2020, but rental rate per square foot growth has not shown a meaningful acceleration - yet.

However, if high occupancies give way to higher rental rates (as they usually do in real estate), Mall REITs could see NOI and earnings growth creep up towards +5% or higher in the coming years. A return to this level of growth could very easily lead to continued multiple expansion, with +16x AFFO (again the previous valuation floor for these companies) not an un-realistic target. That would be +15% upside from multiple expansion, on top of +5% or higher earnings growth.

Serenity’s proprietary CORE model likes the Regional Mall REITs precisely because of this valuation/momentum/quality combination. Trends are improving, valuations are modest, and the quality of the remaining Mall REIT portfolios is extremely high. Until one of these factors changes, the Serenity portfolio is likely to be long malls.

The Mall is dead…long live the Mall!

INFLATION: Has the boogeyman returned?

While growth prospects are improving for Apartments and Mall REITs, the proverbial fly in the ointment in 2024 so far has been the return of inflation. April 10th’s CPI report has sent the REIT market rapidly lower, as investor fears of the inflation boogeyman have been re-kindled. While inflation is certainly worth monitoring closely, we believe it’s important to step back and take a brief look at longer-term trends.

First let’s address owners’ equivalent rent (OER), the most REIT-relevant component of inflation. OER comprises about 25% of the overall CPI metric, making it one of the most important components of inflation. While extremely imperfect, OER attempts to measure the cost of shelter for the average US consumer. Clearly this is a real estate metric, and one that is highly correlated to…you guessed it…Apartment rents. How correlated you may ask? Well, see for yourself.

Apartment and Self-Storage REIT same-store revenue growth is an excellent leading indicator for OER. This makes sense, as Apartment rents are a large component of US housing costs. Using some basic logic, we can confidently surmise that the OER component of inflation will continue to move lower on a forward-looking basis, as these leading indicators have both fallen to near +0% YoY. Unless this relationship breaks, we can expect shelter inflation to head lower for the foreseeable future.

That is about 1/3 of the CPI, so what about the other 2/3?

The chart below shows the remainder. CPI less shelter costs. The most recent print for this data series? +2.3%, up from +1.4% in November of 2023.

Now an increase from +1.4% to +2.3% in less than 6 months is concerning. But this data series peaked north of +10% in 2022. And now it is BARELY above the Fed’s target of +2%.

Could ex-shelter CPI head back to +3% this year? Certainly. But with OER coming down at the same time, the worst-case scenario here is sideways inflation.

This is where Serenity diverges from the new consensus that “inflation is still a problem.” In our view the path of OER is clear, it will continue to fall towards +0%, dragging overall CPI lower over the next year. While other components of CPI may accelerate, until they break +5.9% they mathematically cannot exert upward pressure on the headline number.

So no, Serenity is not panicking about the recent increase in inflation. Remember, certain REIT property types are excellent inflation hedges (Apartments, Self-Storage, Lodging), so even in the event of another inflation spike, there are REITs to own. We will continue to monitor the situation closely but will likely use these inflationary episodes to add to our favorite long ideas.


Frenzied trading around short-term events is a reality of the modern stock market. Fewer investors exist with long-term time horizons and patient views looking out 3-5 years.

For Serenity, this lack of perspective represents opportunity. With Apartment REITs priced as if the current 0% growth regime is here to stay, we will gladly take the over, looking towards 2025 and 2026.

And we have an astute running mate in Blackstone to make that trade with.

While we wait for the market to come our way, other opportunities abound, with our proprietary CORE multi-factor REIT model grinding away daily.

Some headwinds persist, but that is the nature of the game. Our tried-and-true portfolio is ready for anything.  

Cyclical REIT bulls…assemble!

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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