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  • Martin Kollmorgen


Updated: Sep 8, 2022

“The mountain decides whether you climb or not. The art of mountaineering is knowing when to go, when to stay, and when to retreat.”

– Ed Viesturs

PERFORMANCE – Serenity Alternative Investments Fund I returned +7.58% in October net of fees and expenses. Year to date the fund has returned +37.7%.

GO, STAY, OR RETREAT? – REITs have had a great run, but what does the future hold?

THE GOLDEN AGE – Evidence continues to accumulate that we may be entering a golden age for Apartment REITs.

OCTOBER ACCELERATION – Economic data slowed in September…but accelerated in October.

Navigating the REIT market can at times feel like climbing the face of an 8,000-meter peak. Sometimes conditions are perfect, and you can move rapidly up the mountain. Sometimes the wind is howling, or the slope is primed to avalanche, at which point you have to turn back.

To make it to the top, however, you have to continue climbing when conditions are favorable. This can be mentally anguishing when it takes 15 breaths just to take a single step.

Similarly in REITs, it can be tempting to turn around after an excellent 12 month run. Even though conditions are still excellent, many investors assume this is as high as they can go and will throw in the towel. Those investors will never stand on the proverbial REIT summit.

With a nearly 6-year track record of high-altitude risk management, our framework continues to prove its merit at identifying REIT opportunities. At the current juncture, conditions remain favorable for many REITs to continue ascending. Net Asset Values (NAV’s) are moving higher, earnings are moving higher, cap rates are compressing, and economic data is accelerating. Some of the low-hanging fruit has certainly been picked, but we have the tools to harvest the entire orchard.

When conditions change, our models will be quick to change with them, and we are happy to turn around when the market gets dangerous. Until then, however, we will continue to lean into REITs that benefit from accelerating growth and inflation, grinding towards the next REIT summit.


Serenity Alternatives Fund I returned +7.58% in October net of fees and expenses versus the FTSE NAREIT REIT index which returned +7.06%. The fund has now returned +37.7% for the year, versus the REIT benchmark at +30.3%. On a trailing 3-year basis Serenity Alternatives Fund I has generated annualized returns of +27.2% net of fees and expenses. Over the same time period, the REIT benchmark has returned +15.3% on an annualized basis. The fund’s Sharpe ratio over the past 3 years sits at 1.66, versus 0.85 for the REIT benchmark. With annualized outperformance of 11.9% versus the benchmark since 2019, our process has clearly illustrated its ability to create value within the REIT universe and rapidly grow our client’s capital. In 2019, 2020, and 2021, the fund delivered returns of 33.4%, 19.5%, and 37.7% (YTD). Remember in 2020 the REIT benchmark returned -5.1%. In other words, over the last three years, which includes a recession, our investors have more than doubled their money. We are incredibly proud of our recent results and will continue to grind on with our finely tuned and repeatable investment process. In order to continue to build the firm’s infrastructure, however, we have decided to raise our fees to 1.5% and 15% starting Jan 1 of 2022. Existing investors will see no change in fee levels, as we are incredibly appreciative of their ongoing support. Our clear record of value creation, however, we believe garners a higher fee level, which can help us grow and scale our existing business. Take this as an invitation to invest before year-end and lock in lower fees.


REITs have been an excellent investment over the past 12-18 months, outpacing most major asset classes as the economy has slowly and then rapidly emerged from the Covid-19 induced 2020 recession. Since October of 2020, REITs have returned +45.8%, versus the S&P 500 at +42.9%, tech stocks (the Nasdaq 100) at +44.4%, and Healthcare stocks (XLV) at +33.6%. So is this it? Is the move over?

When compared to the last two REIT bull markets, the current REIT recovery looks pretty average. REITs are actually recovering more slowly (from a stock price perspective) than they did following the 2008/2009 great financial crisis. Compared to the tech wreck-induced recession of 2001, REITs are recovering more quickly (but remember, that recession did not really end until 2002-2003).

In both cases, however, the recovery period following the recession stretched out over a multiyear time horizon. Neither recovery ended after 12 or 18 months.

Additionally, neither recovery ended until NAV growth leveled off. A sure sign that an expansion is losing steam is when fundamentals stop moving higher. As can be seen in the chart below, this is clearly not yet the case. REIT NAV’s continue to increase at a rapid pace, validating higher stock prices across the majority of REIT property sectors. While REITs can certainly correct over the short or medium term, investors would be wise not to fight such strong NAV momentum.

At the end of the day fundamentals continue to improve across most REIT property types, driving NAV’s higher along with stock prices. Assuming the REIT market is fully priced because it has surpassed pre-pandemic levels is an under-estimation of REIT earnings and NAV creation potential. Our portfolio remains positioned to take advantage of relative value opportunities in some of the fastest-growing REITs in the industry, and we are unlikely to take our foot off the gas until we see signs of fundamental deceleration. Abandon REITs at your own risk.


An excellent example of continued fundamental strength comes from the Apartment property sector. We’ve written regularly about the Apartment REITs in these newsletters as they are uniquely positioned as both an inflation and growth beneficiary, which we believe is advantageous this early into a new economic cycle. Simply put, the more the labor market heals, the higher wages go, and the flusher with cash the consumer is, the more they are willing to pay for rent. This has driven and will continue to drive Apartment NAVs higher.

Rent growth, however, is only one variable in the NAV equation. The other (cap rates) has recently become a more interesting topic; one that has the potential to add fuel to the Apartment REIT story. Per the third-quarter earnings call of one of the largest Apartment REITs Equity Residential (EQR). “The positive story on fundamentals not gone unnoticed by the investment community, as the overall theme continues to be enormous amounts of capital pursuing all types of apartment investment driving cap rates to new lows. This has caused the convergence in nominal cap rates in the 3.5% or so range for many markets and has created a positive climate for a strategic repositioning efforts.” Cap rates as low as 3.5%, especially for markets outside of the top 5 in the country, were basically unheard of prior to 2021. As a point of reference, in our Apartment NAV models, we have never used a cap rate below 4%, and we believe many of our peers on the buyside would say the same thing. On first hearing this statement, I had trouble believing it. Then NexPoint Residential (NXRT) made the following comments on their earnings conference call. “As you might have noticed, we updated our cap rate range, as Brian mentioned, to be 3.5% to 3.8% from 4% to 4.3% last quarter. We continued to see aggressive capital, compressed cap rates, as demand for quality affordable housing assets in our markets has never been stronger. During Q3’21, we ourselves, underwrote many deals in our target markets, and finished up as a bridesmaid on several, that went multiple rounds and ultimately culminated in a sealed bid process. During these processes pricing often moved 20% from initial broker guidance and in some cases pricing went into sub-3 cap rate land.” While NXRT is a well-run company, their portfolio does not consist of class-A assets in top tier markets. For NXRT to see mid 3% cap rates would indicate that the world has changed from a pricing perspective. Gone may be the days of 4-4.5% cap rates for Apartment portfolios in favor of cap rates 50-75 bps lower. Now what does this mean for the Apartment REITs and their stock prices? It is hard to under-state the ramifications. For one of our favorite mid-cap Apartment REITs lowering their cap rate to 4.0% increases their NAV by 20%. Lowering it to 3.5% increases their NAV by 40%. Said another way, a company that we thought was about fairly valued at its current stock price may be worth 20%-40% more in a 3.5% cap rate world. That is significant and would suggest the current bull market in Apartment REITs still has meaningful room to run. Now our framework is conservative by nature, and we are not changing all of our Apartment cap rates to 3.5%. We will, however, move them down as the evidence of cap rate compression in the private market is hard to ignore. This in turn moves our estimated NAV’s up, and makes some of our favorite companies look more attractive from a valuation perspective.


In addition to positive momentum in well-liked property sectors such as Apartments and Self-Storage, we are beginning to see fundamental momentum in out of favor property sectors as well. This is a noteworthy development because valuations are still depressed in Hotel, Office, Mall, and Shopping Center REITs relative to their history and most other REIT property types. With fundamental and economic momentum, these REITs could have significant re-valuation potential simply by returning to “average” multiples. We saw this begin to happen early in 2021, but economic momentum was de-railed by the Delta variant. The Hotel REITs are prime examples of this phenomenon. Pebblebrook (PEB) summarized the companies recent experience on their Q3 conference call: “Fortunately, as the trend of new COVID cases began declining in mid-September and has been falling for six weeks now booking trends began to reaccelerate in mid-September and this improving trend has continued into October. Both transient and group business demand has picked up with volumes exceeding levels earlier in the year before the delta variant and associated restrictions were imposed.” While it may seem trite to think of the economy as a switch that can be turned on and off by developments in the pandemic, that has pretty much been the story of 2021 in economically sensitive property types such as Hotels and Retail. As delta cases have subsided recently, travel has increased, hotel bookings have increased, and overall activity has picked up meaningfully (see the recent ISM services print). This was supported again by Hilton Worldwide (HLT), one of the widest reaching hotel brands on their 3Q earnings call: “These trends improved modestly in October with month-to-date RevPAR at approximately 84% of 2019 levels and rates in the US nearly back to prior peaks. Roughly 40% of system-wide hotels have exceeded 2019 RevPAR levels in October month-to-date. Additionally, bookings for all future periods are just 8% below 2019. With loosening travel restrictions and strong non-residential fixed investment forecast, we remain optimistic for future travel demand.” This reiteration is important because Hotel REITs in particular are dependent on travel and broad economic activity. The more confident people are to leave their homes, the more likely they are to visit the mall, hit the local shopping center, go into the office, or book a business trip. If the current momentum inactivity and lull in COVID cases persists, we could see slow and steady continued improvement in some of the cheapest REITs in the universe. Some of these we already own, and the more economic momentum increases, the more likely we are to add to these bets.


On the wall of my office is a signed picture of Mt. Everest by none other than Ed Viesturs. Ed was the first American to climb all fourteen 8,000 meter peaks, i.e. the fourteen tallest mountains in the world. While now famous for his Himalayan exploits, there was a time when Ed was just a 34-year-old mountain climber living in Seattle. Even after climbing Mt Everest, K2, and Kangchenjunga, all without bottled oxygen, Ed had trouble finding sponsors for his climbing career. Those that eventually partnered with him presumably watched with glee as Ed went on to summit the 11 remaining 8,000-meter peaks on his way to becoming arguably America’s most well-known mountaineer. While getting to the top of big mountains is never easy, the more you reach high altitudes, the better you understand what it takes to navigate your way back to that rarefied air. With annualized returns net of fees north of 25% over the past three years, the question becomes can we continue to consistently reach such lofty heights? The mountain (the market) will ultimately decide if we have the right conditions to bag more summits, but you can bet with confidence we will be prepared and poised should they arise. Onward and upward…

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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