“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” – Winston Churchill

PERFORMANCE – Serenity Alternatives Fund I returned +15.8% in November net of fees and expenses, bringing year to date returns to +14.9%. The FTSE NAREIT All Equity REITs Index returned +9.28% for the month and has returned -7.34% YTD. Fund I is now +22.2% ahead of the benchmark in 2020.

A NEW BEGINNING – The next multi-year bull market in REITs has begun. November’s strong performance validated the fact that REITs have the potential to move significantly higher over the next 5 years.

THE ROAR OF VALUE – Value REITs returned 31% in November while momentum REITs returned 4%. As REIT managers pivot towards cheaper REITs value should continue to work.

A LONG RUNWAY – Self-storage REITs illustrate the potential cash-flow growth that will propel REITs higher from 2021-2026.

Did you nail the bottom? Did you buy Office REITs before they went up 25% in November? What about Hotel REITs? They were up 44% in November. Mall REITs? Aren’t they dead? They returned 32% last month.

If you are suffering from feelings of ROMO (regret of missing out), you are in good company. Most REIT investors were not heavily allocated to ANY of the above property types going into last month. And for good reasons! Office REITs continue to suffer from low utilization, Hotel REITs are still mostly empty, and Mall REITs, well…Amazon.

So how could anyone see a month like November coming? Well, as we wrote in last month’s newsletter… “the REIT market is likely to move in anticipation of a bottoming in cash flows. This anticipation could be precipitated by a vaccine, a stimulus package, or even just plain old headline fatigue as we reach month 9,10, or 11 of a global health crisis.”

Believe it or not that was a pretty radical call only 1 month ago. Since then our fund is up over 15%, REITs are knocking on their June highs, and the investor community has been jolted awake by the re-emergence of value stocks and small caps.

So is that it? Have value REITs had their day in the sun? Not so fast. History suggests that this may only have been inning 1 of a much longer ball game. REIT cash flows still have a long way to go to reach pre-pandemic levels, REIT valuations still have meaningful room to expand relative to other stocks and bonds, and large REIT investors have significant re-balancing to do. This is not the beginning of the end…just the end of the beginning.

Performance: +15.8% in November, +14.9% YTD

Serenity Alternative Investments Fund I continued to distance itself from competitors in November, returning 15.8% net of fees, a comfortable 5% better than the benchmark and between 6% and 9% better than other large REIT funds. The chart below illustrates performance for November, Year to Date, and annualized returns from 2019 to the present. Since 2019 Serenity Alternatives Fund 1 has out-performed the index and peers by an order of magnitude, returning 24.1% on an annualized basis versus only +6.4% for the MSCI US REIT index (RMZ), and +11.9% for our best performing competitor (Cohen and Steers).

The best performing position in the fund this month was Boston Properties (BXP) up +35.5%. Like many of its office peers, BXP traded to historically low valuation levels in October. Near the end of the month BXP actually traded to a lower price than during the panic lows of March and April, illustrating how pessimistic investors had become regarding the prospects for office space going forward.

Fast forward a month and the likely reality of multiple vaccines going into production before the end of 2020 has breathed life into the office sector in spite of most companies continuing to delay the return to office properties. While the long-term effect of the pandemic on the demand for office space remains to be seen, BXP only has 6.7% of it’s portfolio expiring in 2021, is a comfortable 77% leased in it’s development pipeline, and still trades at a 20% discount to consensus NAV. It remains one of the funds core positions.

The worst performing position in the fund this month was Hyatt Hotels (H), up +30.4%. We were short Hyatt as a hedge against some of our long exposure in the Lodging sector. On a relative basis this was a profitable trade, as our long position in Host Hotels (HST) was larger than our short position in Hyatt and returned +33.9% during the month. Over the intermediate-term, we see much greater upside in the Hotel REITs (HST, PEB, PK), than the hotel C-corps (MAR, HLT, H). Hotel REITs tend to be more levered to the economic cycle, and with accelerating growth, we are more inclined to include these types of names in the portfolio.

REITs Awaken: November’s performance may be only the beginning…

The story in REITs in November was the re-animation of many companies that had been left for dead because of the global pandemic. As we discussed in our previous newsletter, it did not take a complete reversal in fundamentals or a tangible “return to normalcy” to reignite beaten up REITs. Vaccine news by itself was enough of a shot in the arm (get it?) to start REITs moving higher.

Now where do we go from here? It’s important to remember that historical REIT bull markets have lasted on average around 5 years and seen the REIT index double on a consistent basis. While the space has moved higher off the lows of March and April, REITs are still 10% below their February highs, while many other sectors trade at all-time highs. As the coronavirus pandemic subsides and cash flows begin to accelerate, the potential for continued strong returns in the REIT market is significant. When viewed in a 5-year context, it’s clear that this REIT bull market is still in its infancy.

The ROAR of Value: Consensus continues to be caught offsides…

With such a major rally in value REITs in November behind us, many investors are undoubtedly asking if some REITs have come too far too fast. While the answer obviously varies greatly by property sector, there is one structural issue that we believe could keep the “Value” rally moving for multiple quarters to come.

Using Serenity’s proprietary factor library, we can see that value REITs returned +31% in November, while “Momentum” REITs returned +4%. Our fund returned +15.8%, as we began allocating to value REITs over a month ago, while maintaining some exposure to momentum and quality REITs.

Momentum, however, has outperformed value significantly since 2016 (as seen in the chart below). Because of this most REIT mutual funds are heavily over-weight momentum and under-weight value, as indicated by their under-performance in November. The rapid ramp in value last month will likely force many of these multi-billion-dollar mutual funds to reduce their over-exposure to momentum names, while at the same time covering their under-exposure to value names (a process that takes months due to their size). This persistent re-allocation will likely act as a continued support for out of favor, under-owned cheap REITs, bringing inexpensive names back towards long-term averages at the expense of over-owned large caps. Remember, following the previous recession, “Deep Value” REITs returned 26.1% on an annualized basis for 5 years.

Additionally, value investing as a style tends to exhibit its best performance during periods in which growth accelerates. Coming off the crater that was GDP growth in Q2 of 2020, economic growth has already begun to

move higher, and is likely to continue as the world starts to get a handle on the global health situation. With growth broadening out and most REIT investors under-exposed to the cheapest names in the market, we continue to favor value REITs in the Serenity portfolio.

SELF-STORAGE REITs: A Case Study in the power of NOI Growth

Our final exploration into the early innings of the recent REIT rally comes from the Self-Storage sector. As we continue to emphasize, November’s momentum in the REIT sector is likely only the beginning of a much larger and longer move higher for the REIT market.

Self-Storage REITs are a great example of what may be in store for REITs over the next five years. Based on commentary from management teams, as well as real-time tracking of move-in rates, it has become clear over recent months that same-store NOI (net operating income) has bottomed for the Self-Storage sector. Demand for storage is strong, occupancies are increasing, and the companies have begun raising rents again, as much as +20% YoY in some markets according to recent industry data. Why is this important? Because same store NOI growth is still below 0 and has a massive potential runway ahead to move higher.

The chart below shows the last 20 years of same store NOI growth for the Self-Storage REITs. The peaks and valleys are clear. When SS NOI hits -5%, it tends to then re-accelerate, consistently peaking near +10% years later. This is currently occurring, but SS NOI growth has not even turned positive yet. It will take years for growth to reach the +10% of previous cycles, over which time NAV estimates will be revised higher and storage REIT stock prices will continue to move up. From the trough of the last 2 cycles to the peak in SS NOI growth, Self-Storage REITs returned +34.3% on an annualized basis for a 3-year period and 25.3% on an

annualized basis for 6.5-year period. That is a level of sustained performance that any investor would covet in their portfolio.

THE BOTTOM LINE: REITs have room to run…

Whether it’s the duration and magnitude of previous recoveries or the historical NOI runway that leads to durable NAV growth, evidence continues to mount that we remain in the early innings of a new bull market for REITs. With multiple years of 20+% returns following many past recessions, REITs may just be getting started on their journey to new highs during the next economic up-cycle.

At Serenity we remain poised and well-positioned for this new regime. Our contrarian positioning, flexible framework, and powerful models have combined to create significant value for our clients over the past two years. Going forward we will continue to scour the REIT landscape for favorable opportunities, deploying capital using our scientific process and a decade of experience in the REIT trenches.

To the end of the beginning,

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

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