PERFORMANCE – Serenity Alternative Investments Fund I returned -3.40% in September net of fees and expenses. Year to date the fund has returned +28.0%.
THE APARTMENT FRONTIER – Apartment REIT fundamentals are accelerating into hitherto unexplored territory.
DELTAS DEMISE – COVID-19 case counts are down 50% in the past month.
REIT SLUGGING PERCENTAGE – Is the market signaling the return of the cyclical trade?


“Towering genius disdains a beaten path. It seeks regions hitherto unexplored.”

Abraham Lincoln

Investing requires imagination. We search history for a detailed map of the way ahead, but the directions that we find are never fully accurate. The investing past never truly repeats itself and the market is constantly creating new narratives and breaking into regions hitherto unexplored.

The REIT market is no exception. Conventional wisdom one day is often turned on its head the next. Following the beaten path usually leads to mediocre returns. Readers of this newsletter demand more creative thinking! They are not satisfied with re-treading the REIT past. Towering genius’ never are.

This is why we explore scenarios that may seem strange at first blush. Scenarios that have no precedent in history. What if Apartment REITs experience 10-15% same store NOI growth in 2022? What if Retail Strip Center REITs have superior earnings growth to the Cell-tower REITs? What if inflation is in fact, not “transitory”?

Some of these scenarios are more likely than others, but they all mark a departure from the consensus REIT market narrative. And they can all be used to generate returns within the correct investing framework.

Is your framework ready to explore a brave new REIT world?

PERFORMANCE: -3.4% in September, +28.0% YTD

Serenity Alternatives Fund I returned -3.4% in September net of fees and expenses versus the FTSE NAREIT REIT index which returned -5.4%. The fund has now returned +28.0% for the year, versus the REIT benchmark at +23.1%.

On a trailing 3-year basis Serenity Alternatives Fund I has generated annualized returns of +20.9% net of fees and expenses. Over the same time period, the REIT benchmark has returned +11.7% on an annualized basis. The fund’s Sharpe ratio over the past 3 years sits at 1.28, versus 0.65 for the REIT benchmark.

The REIT index fell in September as COVID-19 cases peaked early in the month, and the 10y year treasury yield began moving higher during September’s second half. The positive inflection in economic sentiment and an increase in risk appetite from investors into months end induced selling in many high-duration, more defensive REITs, which have led the REIT market higher over the past few months.

More cyclical REITs were the beneficiaries of this reduction in defensive exposures as a second re-opening trade became front of mind for investors. With Covid-19 cases down about 50% in the US over the past month, cyclical REITs are showing signs of life, with Lodging, Mall, and Retail names all beginning to outperform the REIT index.

From a positioning standpoint, our model and portfolio continue to overweight REITs that we believe can thrive in both a low and high-growth economy. Apartments and Self-Storage REITs in particular are inflation beneficiaries, insulating them from some of the risk-on/risk-off volatility of more cyclical or higher duration REITs.

Uncharted Apartment Waters: Easy comps + rising rents = blockbuster results.

Over the next few quarters Apartment REITs are sailing into waters heretofore uncharted. A combination of rapidly rising rents and easing year over year comps are going to combine to produce the gaudiest growth numbers many public Apartment REITs have ever reported. This puts seasoned REIT investors in a strange scenario. While these numbers will not be a surprise to experienced underwriters of the companies, how will the generalist investor react to same-store NOI growth potentially reaching into the mid-teens?

First let’s dissect the drivers of the impending growth explosion. Equity Residential (EQR) included the chart below in one of their most recent investor presentations.

The bright blue line in the chart represents current rental rates, which have been on an upward trajectory since January of 2021. In late April of this year, they moved higher than year-ago levels (the dark blue line). Since that time, the gap between this year’s rents and last year’s rents has widened materially. As rents continue to increase (all recent reports suggest this trend has continued), the gap will widen even more rapidly. Even if they flatten out from here, by virtue of last year’s falling rents, year-over-year comparisons will continue to widen until November/December, when the easy comps finally bottom out.

So what does this mean? Again, Apartment REIT investors that consistently model the space are well aware of this trend and are likely to have double-digit NOI growth already incorporated into their models for the next few quarters.

The question remains, however, how quantitative investors and generalists will react when their machines and screens are suddenly populated with the strongest growth numbers ever reported by public Apartment REITs.

We can even take this mental exercise one step further, and ask the question “what prevents Apartment rents from continuing higher over the next few years?” With a strengthening labor market, inflationary pressures in housing, a large consumer savings glut, and a short slow-down in Apartment supply due to the pandemic, there are few fundamental forces that will impede rent growth for Apartment landlords over the next 18-24 months.

There is even a world in which inflation continues to accelerate, the Federal reserve remains accommodative, and Apartment REITs see continued high single digit rent growth without seeing increases in their funding costs. “Yield suppression” is not a policy that the fed is currently discussing, but in a world of Modern Monetary Theory, it is not a low probability outcome years down the line.

The bottom line here is this, Apartment fundamentals continue to accelerate, and we remain bullish on the Apartment REITs. While we are not counting on sustained levels of rent growth ad infinitum, we are not ruling out a scenario in which rent growth is higher for longer. As always we will keep our eyes to the data, which at this point continue to point up and to the right.

The Demise of the Delta Variant: Is the most recent COVID scare ending?

In the thematic corner of the REIT universe, it has now been more than six months since the “re-opening” trade ruled the roost. In the intervening period the 10y yield has fallen, COVID cases have risen, economic growth has slowed, and inflation has continued to creep higher. This anti-cyclical cocktail has left re-opening REITs waiting at the bus station, while high duration, secular growth defensive names have moved higher rapidly.

The obvious culprit to this early-cycle slow-down is the delta variant of COVID-19 that has spread through the country over the past 3-4 months. As cases increased, mask mandates returned, travel began to slow, companies delayed returns to the office, and consumer confidence began to fade.

All of this supported the defensive positioning of the market and encouraged the market bears.

At the current juncture, however, a new trend has clearly re-asserted itself, and it is NOT the same trend of even 1.5 months ago. Since September 1st, the 7-day average of COVID cases in the US has fallen by 47%, from over 160,000 new cases a day to 85,000 currently. 68% of the adult population is fully vaccinated, 13% of the population has contracted the virus itself, and treatment options continue to improve. While we are certainly not fully out of the pandemic woods, much of the country is fully open and experiencing declining case counts.

Will this cause a surge in economic activity akin to the original reopening of early 2021? Doubtful. But the economy remains a long way from being fully “normal”, and if cases continue to drop, mobility will continue to increase, economic activity will pick back up, and our world will slowly begin to trend back towards its normal level of economic capacity.

In fact, there is evidence that this is already occurring. Hotel traffic has already bounced off its August/September lows, as has air travel. Restaurant foot traffic has picked up, and most importantly, the market has firmly adopted a more risk-on mood. How do we know this….?

Slugging Percentage: What is the market telling us about cyclical REITs?

One of the benefits of having a quantitative framework within an investing process is that it allows you to build tools that are powerful and insightful with relative ease. One such tool we have recently examined (shout out to our dear friend JK for the recommendation) has an analog in professional baseball. Slugging percentage.

According to Wikipedia, Slugging percentage “is a measure of the batting productivity of a hitter…Unlike batting average, slugging percentage gives more weight to extra-base hits.” Using a bit of creative thinking, we can apply a similar concept to REIT property sectors. Namely, by measuring the percentage of time the property sector out-performs its peers, along with the magnitude of the out-performance, we can calculate a more nuanced measure of relative performance than pure total return or a simple batting average.

Examining slugging percentages over different durations illuminates some interesting nuggets that may not be visible using simple performance statistics. Office and Apartment REITs, for instance, have the best slugging percentages over a 20-day time horizon, followed by Malls and Shopping Centers.

Similarly, over a 60-day time horizon, Malls and Shopping Centers have the highest slugging percentages of the main REIT property sectors. These are not widely owned property types. Remember, Malls are dead and the US is badly over-retailed. That remains the conventional wisdom. The market, however, seems to have a more favorable view of these under-owned sectors based on this measure of slugging percentage.

Now a single data point does not tell the whole story, but when you couple the fact that COVID case counts are falling with the fact that re-opening sectors have begun to out-perform peers, a clear picture begins to emerge; one that looks more like the early part of 2021 than the middle of this year.

As data points of this nature have begun to accumulate, we have added cyclical exposure to the portfolio selectively. This means adding Office, Mall, Strip Center, and Lodging REITs to the portfolio in a measured and calculated way. While the risk/reward in these names is not as compelling as it was at this time last year, these REITs still, by and large, trade at much more attractive valuations than their peers in the Warehouse, Data Center, and Cell-tower sectors. As growth broadens, value stocks tend to outperform, and our portfolio is increasingly positioned to benefit from a re-inflection in economic growth.

Oh, the places you’ll go…

One thing I have learned about myself through the adventure of managing a REIT investment fund is that I have an instinctual revulsion to treading the beaten path in REITs. I am no towering genius, but our best calls in the fund have always been against the consensus and against the grain. While we watch the herd to see where other investors may be offsides, our process has been built to point in the highest slugging percentage direction, regardless of the direction of others.

Disdain the beaten path and find Serenity.

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.