• The MSCI US REIT index returned -0.78% in Q4 and 25.8% in 2019.
• Data Center REITs led all property sectors in 2019 up 56%, while regional malls and self-storage lagged.
• Rexford Industrial (REXR) and Duke Realty (DRE) were two top performing REITs in 2019 up 58% and 38% respectively.
• More cowbell? 2020 is unlikely to be a repeat of 2019, but the REIT market is still swimming in opportunity.
• Macro data has improved recently, but not enough to drive bond yields meaningfully higher. We continue to watch the lodging sector closely for signs of economic acceleration.

“Allow myself to introduce…myself”

– Austin Powers

What a difference a year makes. At this point in early 2019, the equity market was still reeling from a 20% drop, the fed was pivoting from hawkish to neutral/dovish due to awful economic data, and the REIT market was being driven to multi-year lows. It was not an enjoyable time.

Fast forward 365 days and REITs are up over 25%, the broader equity market has hit all-time highs, and investor sentiment has gone from near panic to incredibly complacent.

Talk about the market getting its mojo back. In the intervening period the fed has returned to growing it’s balance sheet, economic data has continued to grind slowly lower, the US and China have started and partially resolved a trade war, and earnings growth for the S&P 500 has gone negative for the first time in years.

It’s a lot to keep up with. Which is why it’s important to step back and allow the REIT market to re-introduce…the REIT market. In case you have been caught up in all the headlines, just remember that REITs still offer the following…

• Exposure to the highest quality real estate in the world via LIQUID securities.
• Performance that has historically rivaled the stock market with only a 0.55 correlation (+10%/year over 25+ years).
• Access to emerging property type investments such as data centers, casinos, and single-family rentals.
• The ability to SHORT commercial real estate, allowing for superior risk-management and alpha generation potential in up and     down markets.
• Dividend yields averaging near 3.5% that are stable and GROWING.

The REIT market represents the top tier of real estate investing. Its built on the highest quality commercial real estate in the world and run by the most sophisticated real estate investors in the market. REITs were left for dead in early 2019 and subsequently returned over 25%. Portfolio managers without a REIT allocation will be increasingly forced to justify non-ownership of a top performing asset class. For those that want to learn more about the market or how to build a well-diversified REIT portfolio, reach out to Martin Kollmorgen at Mdkollmorgen@Serenityalts.com.

Property Sector Performance – Data Centers destroy +56%, Storage stinks +14%

The best performing property sectors within the REIT universe in 2019 were data centers (+56.2%), Warehouse (+49%), and Manufactured Housing (+49.2%). The three worst performing sectors in 2019 were regional malls (-8.9%), self-storage (+14%), and lodging (+16.8%).

Data Centers at this point have become something of a staple in our newsletters. Our framework has historically favored the sector due to its consistently above-peer NAV (“net asset value”) growth, strong price momentum, and value proposition relative to more core (read; expensive) property sectors. Data centers lagged REITs in 2018 but out-performed handily in 2019 as the space came roaring back.

Despite concerns that large cloud players (MSFT, AMZN) were slowing their pace of data center spending, the data center sector was able to post its best leasing year ever. Enterprises continue to move applications to the cloud and outsource more and more of their tech needs, to the benefit of the data center REITs. While these types of customers buoyed the space in 2019, a return of hyper-scale cloud customers could prove very beneficial to the data center names in 2020 and 2021.

Self-storage on the other hand, suffered in 2019 from still elevated supply (over-building of new self-storage assets). New supply continues to act as a governor on same store results, and with fewer acquisition opportunities, smaller development pipelines, and elevated valuations the self-storage REITs did not represent an attractive risk/reward profile for most of the year, which is why they lagged most other REIT sectors.

Risk-On? – 4Q REIT performance reverses the 2019 narrative

The 4th quarter of 2019 saw an interesting reversal in REIT property sector performance relative to the first 9 months of the year. As can be seen in the chart on the next page, most of the best performing REIT property types in Q4 had not performed particularly well from Q1 – Q3.

In particular, hotel c-corps (Marriot, Hyatt, Hilton, etc), real estate services companies (JLL, CBRE), and mortgage REITs were some of the best performing property types in Q4, after lagging the broader REIT universe for the first three quarters of the year. The common denominator for these three sectors is that they have the highest beta to the S&P 500 within our real estate coverage universe. Said another way, they are the most tethered to the general stock market.

At the same time, healthcare and free-standing retail REITs struggled in Q4, which are the most bond-like REITs. This trade out of bond-like REITs into real estate companies that act more like stocks was evident in the general equity market as well, as more risk-on stock sectors within the S&P 500 outperformed in 4Q of this year after lagging for the first 9 months of 2019.

Now this is where things get interesting. While lodging REITs outperformed most REIT sectors in Q4, they have lagged so far in 2020, and still show few signs of improving fundamentals or meaningfully better sentiment. Lodging REITs are by far the most economically sensitive REITs in our coverage universe, and they act as the best leading indicator for economic growth within the broader real estate space.

In our view the lodging REITs and the broader stock market are sending conflicting signals. Hotel C-corps have traded to lofty multiples by historical standards, while lodging REIT multiples remain depressed. Put differently, the general stock market is pricing in future good news that is NOT being reflected in lodging REIT valuations or commentary. This is important because over the long-term something has to give. Either the economic data will improve, and lodging REITs will move higher, or the economic data will remain subdued and risk-assets may be forced to give up the multiple expansion that has driven them higher in 2019.

While the stock market is signaling the former (valuations up in the hope that future earnings improve), the bond market is signaling the latter (yields are way down from a year ago although up slightly in Q4). As risk assets have outperformed, the 10y treasury yield continues to make lower highs, and the 2y yield is only about 15 bps off its lows.

For this reason, we remain broadly skeptical that the economy has bottomed, and that S&P 500 earnings are set to accelerate meaningfully from here. We’ve written previously about weakening employment data, which remains a trend, and do not believe the “trade deal” will be enough to re-ignite a US labor market that has little to no slack remaining.

Uninspiring Economic data and elevated valuations – Opportunity, where art thou?

After an excellent year from a performance perspective, it’s reasonable to wonder if there is any opportunity remaining in the REIT space. After all a monkey throwing darts could have hit a few home runs in the REIT market in 2019. Luckily, we are neither monkeys nor dart throwers, we are a REIT specialist firm with a quant model. While there are far fewer REITs trading at large discounts to their intrinsic value in 2020, there are still compelling opportunities on the long side, as well as the short side. Where do we see developing opportunity? Reach out to Mdkollmorgen@Serenityalts.com to find out.

The decade ahead: 2020-2030

Long-term prognostication is not our game here at Serenity, but there are a few things that we can say for sure about the next ten years. We will continue to get older, my jokes will probably not improve, and the REIT market will continue to produce compelling opportunities. As an investment management firm with a quantitative framework at its core, we are uniquely positioned to find compelling ideas on the long AND short side within REITs, come what may in the overall economy.

Once again for a better understanding of REITs, our quantitative strategy, or how REITs fit into an overall asset allocation, reach out to Martin D Kollmorgen at Mdkollmorgen@Serenityalts.com.

Danger Kollmorgen?

No, it’s Martin Kollmorgen… Danger’s my middle name,

Martin D Kollmorgen, CFA
CEO and Chief Investment Officer
Serenity Alternative Investments
Office: (630) 730-5745
MdKollmorgen@SerenityAlts.com

* Model returns based on back-tested results of the Serenity Alternatives Core REIT model. Assumptions include equal weighting of positions, monthly re-balancing, using REITs with market caps > $750m.

**All charts generated using data from Bloomberg, LP, S&P Global, and Serenity Alternative Investments

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