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  • Martin Kollmorgen


Updated: Jun 13

“To be or not to be…that is the question”

– Hamlet, Act 3, Scene 1

  • TO BUY REITS? – REITs are undeniably cheap relative to private market values.

  • NOT TO BUY REITS? – Recessions last on average 12.5 months…and we may be just entering one.

  • THE QUESTION – If falling asset values are a problem…are REITs the solution?

To buy REITs, or not to buy REITs…that is the question. On the one hand, REITs trade at a significant discount to private real estate values, REIT’s have strong earnings growth, and REIT’s own the highest quality commercial real estate portfolios in the country. On the other hand, leading macroeconomic indicators are pointing towards recession. The ISM new orders index has fallen below 50, the Atlanta Fed GDP Now forecast is negative, pending home sales are down -8.2% year over year, and consumer sentiment has fallen to below 2008 levels. With the average recession lasting 12.5 months, the US economy, the stock market, and the broader commercial real estate market may be far from a bottom. What is the ideal real estate investment product in this type of environment? I imagine it would have the following characteristics: 1) A high-quality portfolio of recession-resistant real estate 2) Low leverage and a high cash balance to make opportunistic investments 3) A method for hedging (or even profiting from) recession risks 4) The flexibility to deploy capital quickly if the Fed turns dovish…

Can the standard core real estate fund offer any of these? Maybe #1 or #2, but certainly not #3. What about a REIT ETF? Maybe number 1 depending on the weighting scheme…and maybe number 4 (but not likely…most ETFs carry 0 cash). Hmmm…if there were only a long/short REIT hedge fund with a differentiated strategy and a history of capital preservation amidst adverse capital markets conditions…


Serenity Alternative Investments Fund I returned -1.73% in June net of fees and expenses versus the MSCI US REIT Index which returned -7.4%. Year to date, the fund has returned -10.5% net of fees versus the REIT benchmark at -20.3%, the NASDAQ 100 at -29.2%, the S&P 500 at -20.0% and the Russell 2000 at -23.5%. On a trailing 3-year basis Serenity Alternatives Fund I has generated annualized returns of +18.7% net of fees and expenses. Over the same period, the REIT benchmark has returned +4.1% on an annualized basis (that is +14.7% ANNUALIZED outperformance net of fees over a 3-year period). The fund’s Sharpe ratio over the past 3 years sits at 1.17, versus 0.21 for the REIT benchmark (remember higher is better, more return per unit of risk). The largest positive contribution to the fund’s return in June was Nexpoint Residential (NXRT), a short position in the fund that fell -14.5%. NXRT is a sunbelt focused Apartment REIT with an active value-add pipeline. In an accelerating economy, we love NXRT’s business, and would be happy to be long the name. In the current environment, however, NXRT is one of our largest shorts, as it has multiple characteristics that we wish to hedge out of the portfolio. Particularly, NXRT is a smaller cap, higher leverage, higher beta stock within the Apartment REIT sub-sector. The company is also externally managed (this is bad corporate governance) and has an average tenant household income of ~$70,000/year. In a capital markets environment that is risk-off, with economic data getting worse by the month, small cap, high beta, high leverage companies are exactly what our strategy seeks to avoid. It is worth emphasizing the power of short selling here (which we have discussed frequently in recent newsletters). Not only can we AVOID small cap, high beta, high leverage REITs, we can eliminate (OR EVEN PROFIT FROM) this type of exposure in our portfolio by shorting them. When NXRT’s debt costs predictably rise, earnings erode, and rent growth slows due to the lower income (inflation sensitive) nature of their tenant base, our fund will not only avoid downside exposure, but profit from it. This is a massive differentiating factor between Serenity and almost all other commercial real estate investment vehicles. The worst performing position in the fund in June was Host Hotels (HST), a long position that fell -21.3% during the month. While a blue-chip within the Lodging REIT sector, HST was not able to avoid the rapid sell-off in risk assets that occurred in June. Hotel REITs are the most pro-cyclical sector in real estate, and despite discounted valuations, conservative estimates, and continued gains in urban hotels and business travel, deteriorating economic data sent all hotel REITs lower for the month. While we continue to like Host for a variety of reasons, we have hedged our lodging exposure with shorts in more expensive, leisure focused C-corps. We believe these companies will feel the brunt of potential consumer demand softening, as their valuations reflect expectations of continued strength in leisure travel. With $5 gas prices and a plummeting stock market, we are skeptical that US consumers will continue to vacation at 2021 rates in late 2022.


Game theory can be a useful tool in the investor toolbox. Exploring various scenarios and preparing for their possible outcomes is part of a portfolio manager’s job description. What happens if I buy REITs right here right now? What happens if I buy commercial real estate assets in the private market right now? How do I think about REITs within the context of my broader portfolio? To answer these questions, let’s explore a few scenarios. But first, an important piece of data.

  • REITs currently trade at an -18% discount to Net Asset Value (NAV). Said another way, REITs are -18% less expensive than the value of their real estate portfolios in the private market.

    • As an example, EQR (Equity Residential), a blue-chip Apartment REIT, trades at a 4.9% implied cap rate. Private market transactions for Apartment portfolios of EQR’s quality are currently occurring near 4.0%. Remember, lower cap rate = higher value, thus a 4.9% implied cap rate is an -18% discount to a 4% cap rate. Hence, EQR trades at an -18% discount to the private market value of its portfolio, as does the broader REIT market.

This means that REIT stock prices are significantly cheaper than the real estate that makes up their portfolios. Now for some scenarios. First let’s tackle the bull case for risk assets. In this scenario inflation abates, the Fed becomes more dovish, risk appetite returns to the market, and we avoid a recession. With REITs trading at an almost -20% discount to private market values, should you buy REITs or private equity real estate (or neither)? The answer is clear… REITs have significantly more upside than private real estate in this scenario. So given the choice…buy REITs. Scenario 2: Inflation remains elevated, the Federal Reserve remains hawkish, cap rates continue to move higher (real estate values move lower), and the economy either significantly slows or enters a recession. In this scenario, REITs and stocks will likely continue to struggle, but private real estate values will also come down. This is where things get messy. With much greater leverage than the REITs and higher valuations, private equity real estate values have the potential to fall RAPIDLY. This has not happened since the great financial crisis of 2008-2009, but with a hawkish Fed that is hamstrung by inflation, the probability that private market values fall is higher than it has been in over 10 years. REITs, with lower leverage, higher quality balance sheets, and already discounted valuations, are the answer in this scenario as well. A REIT portfolio with recession factor hedges would be particularly attractive in this type of environment. And yes, that is a shameless plug for Serenity. Again, almost no other fund in commercial real estate can hedge recession risks actively. At Serenity, we are doing so as we speak. The point here is that in both the bull and the bear case, REITs look attractive relative to private equity real estate. THAT DOES NOT MEAN THEY ARE A BUY. But it does mean they should be the preferred solution for investors putting money to work in real estate right now.


The reason we cannot say with confidence that REITs are unequivocally a “buy” here has to do with one of our favorite topics. Macro-economic data. Keeping a keen eye on macro-economic data is an integral part of our process at Serenity Alternatives, and stems from my early days on Wall Street. I watch macro data because my career began amidst the chaos of the last true global economic meltdown. Let’s rewind quickly to the fall of 2008. As a fresh faced 22-year-old in my first job, I have vivid memories of the October – December 2008 period. For the sake of context, it is important to remember that in late September of 2008 the S&P 500 had been slowly grinding lower for a calendar year and was -24% off its all-time high reached in 4Q of 2007. Macro-data was steadily getting worse, with jobless claims rising, the ISM manufacturing index dipping towards 50, and the NAHB market index well off it’s 2006 highs. Economic prognosticators were concerned, but not overly so. Many believed in September 2008 that the economy was about to stabilize, and that the risk of recession was low. Then the stock market crashed. From October of 2008 to March of 2009 the S&P 500 fell another -41%, the Nasdaq 100 fell -33%, and REITs fell -63%. I’ll never forget my boss at the time, one of the smartest people I have ever met, walking out of his office to say, “I’ve never seen anything like this.” As a 22-year-old, I was scared out of my pants. After the dust settled, however, (I was lucky enough to keep my job), I could not help but think…how did nobody see this coming? I worked on Wall Street and NOBODY I knew had been warning about an impending collapse. At that point I took it upon myself to learn about macro-economic data, diving into every blog and data series I could get my hands on to ensure that I was never run over like so many investors were in 2008-2009. Fast forward 14 years and I am still constantly analyzing macro-economic data. It is an integral component of the Serenity process. And just like in late 2008, MOST MACRO-INDICATORS ARE MOVING IN THE WRONG DIRECTION. I can’t tell you if the current slow-down will be better or worse than 2008. It will certainly be different. I will tell you that until key data series turn around and look more positive, at Serenity, we will remain bearish. What am I talking about specifically? Let’s look at four leading indicators of the economic health of the US. 1) The ISM (Institute of Supply Management) New Orders Index. 2) NAHB (National Association of Home Builders) Market Index. 3) BBB Spreads 4) Consumer Confidence All four of these data series tend to lead broader economic activity by 3-9 months. Let’s dig into them one at a time. 1) ISM New Orders – This is a forward-looking indicator that comes from the Institute of Supply management and their monthly surveys. The ISM composite index is one of the best leading indicators for US GDP growth, and the new orders component leads the composite index. In February, this series hit 61.7, and has fallen to 49.2 in June. A value below 50 indicates economic contraction, meaning at 49.2…this data series is already signaling the dreaded R word.

2) The NAHB Index – The Housing market is a huge part of the US economy. By some measures it comprises as much as 15-18% of total GDP. The last time the housing market tanked, the US economy felt it (2007). With the average mortgage payment up over 40% in under six months in 2022, house prices have rapidly stalled and started to move in reverse. The NAHB index measures builder sentiment and is an excellent leading indicator of housing activity. Like ISM New Orders, this series is moving rapidly lower.

3) BBB Corporate Bond Spreads – The spread between the yield on corporate bonds and the 10-year treasury is an excellent indicator of the health of the financial economy. When financial conditions are favorable, spreads compress (go down), when they are unfavorable, spreads widen (go up). Spreads for BBB rated companies (REITs are on average BAA, so slightly higher credit quality) have increased by 80 basis points since January. To put this into context, spreads have only reached these levels 3 times since the great financial crisis. For debt intensive industries such as commercial real estate, this is BAD. It means debt costs have risen substantially, lenders are willing to take less risk, and projects are in general harder to finance. Wider spreads translate to less financial activity, higher cap rates, and an increased probability of a liquidity crunch (see 2008, late 2018).

4) Consumer Confidence – Consumer confidence is a measure of…you guessed it…the confidence of the US consumer. This data series is considered a forward-looking indicator because it tends to lead consumption trends. When consumers expect to buy less in the future, economic activity tends to slow. What is striking about this series is that according to the University of Michigan, consumer sentiment has dropped BELOW 2008 LEVELS. If that does not raise a red flag in your mind as an investor, nothing will. This just shows the extremely negative psychological effects of inflation. Consumers know their dollars will not go as far in the future and are already curtailing spending plans according to this data series.

These four leading indicators paired with 40-year highs in inflation and a tightening Fed inform our bearish economic outlook in the fund. The counterpoint that most bulls rely on to rebut the data above is that the labor market remains very strong. Payroll growth is robust, wages are increasing, and jobs remain plentiful. All true. But the labor market is also a LAGGING economic indicator. By the time the labor market is truly in pain, the stock market could be down another 20% along with broader real estate prices. That is why these LEADING economic indicators are so important. They are not perfect, but when most of them are pointing in the wrong direction…investors can ignore them at their own peril. This is also why we remain extremely cautious on the REIT market. While values have certainly gotten more attractive all else equal, earnings and cash flow estimates are at risk. Lower earnings are NOT priced into REITs and could easily take the entire sector down another -20% over the next 3-12 months.


This leaves us with the conundrum with which we began…to buy REITs or not to buy REITs? In the short term, we remain cautious, holding high-quality, low leverage, mostly blue-chip REITs and counter-cyclicals in the long portfolio, and shorting REITs with high leverage, high beta, and outsized exposure to the consumer. At Serenity, we have the luxury of flexibility in our positioning. But what about investors who are required to put capital to work? Let’s compare REITs to a typical “Core” Real Estate allocation. Using data from NCREIF (National Council of Real Estate Investment Fiduciaries), we can compare REIT benchmark returns, “Core” private equity real estate returns (as reported by NCREIF, a well-regarded benchmark for these types of funds), and a diversified blue-chip index of REITs.

To construct our blue-chip REIT index, we have selected REITs from 11 distinct property sectors that have returns going back to 2004. These REITs have strong balance sheets, well regarded management teams, and high-quality portfolios. They have been equal weighted in our analysis, with the property type distribution detailed in the pie chart to the right. The results are presented in the chart below for the period 2004-2021. The NFI-ODCE index is compiled by NCREIF and represents returns from open-end diversified core equity funds using a value-weighted framework. The FTSE NAREIT All-Equity REIT index (FNER) is used as our REIT benchmark.

As can be seen in the chart below, REITs in general outperform the NCREIF core index over this time period, but a blue-chip equal weighted portfolio of REITs absolutely crushes both private equity “core” returns and the REIT benchmark. With annual returns of +15.1%, the blue-chip REIT index would have turned a $100,000 investment into $1,263,976 over this 18-year period. That’s a 10x return in less than 20 years by investing in high-quality, core real estate portfolios. A comparable investment in the NCREIF Core Index or the FSTE NAREIT index would be worth $426,622 and $521,257 respectively, less than half of the blue-chip index. Now does this analysis contain a certain amount of look-ahead bias? Absolutely. There is no guarantee an investor could have identified this blue-chip basket of REITs in 2004. Our multi-factor “CORE” quantitative model, however, is designed to mimic this blue-chip strategy in REITs, and has done so with phenomenal success since 2018. In a look-ahead bias free backtest, our CORE model has returned +17.1% on an annualized basis since 2010.

The point here is that even with a minimum level of effort, it is possible to construct a well-diversified, low leverage, high quality “Core” commercial real estate portfolio using REITs. Over a short-term horizon, this type of portfolio should perform better than higher leverage, less diversified, less well capitalized real estate funds. Over a longer-term horizon, a blue-chip REIT portfolio has the potential to leave alternative “Core” real estate allocations in the dust. If the possibility of low teens returns from a basic blue-chip REIT portfolio over a 20-year period excites you… imagine what is possible with a 19 factor extensively back tested proprietary quant model and 12 years of in-depth REIT investment experience…


Many investors sleep on REITs as a real estate allocation. The combination of real estate and stock price volatility can seem too daunting to those not steeped in years of REIT study. For the initiated, however, REITs are not just a side dish, but the main course. They dream of finding the next Equinix, American Tower, Public Storage, or Equity Lifestyle Properties. These names have fueled excess returns across real estate portfolios for decades. Maybe our question needs revision. Instead of “to buy or not to buy”, maybe the real question is…when to buy? At Serenity we have built a process that attacks this question head on. We have taken arms against the sea of REIT troubles on behalf of our clients. Over the last three years, this has led to +18.7% annualized returns net of fees. Constructing a real estate portfolio without the REITs is like staging a Shakespeare production using only mimes. For our part we will continue to root out the REIT truth like the devious prince Hamlet himself. There is method to our madness,

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 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. 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