“Viggo: They call him “Baba Yaga.”
Iosef: The Boogeyman?” - John Wick (2014)
PERFORMANCE: Serenity Alternative Investments Fund I returned -6.26% net of fees in December vs the REIT index at -7.39%. In 2024, the fund returned +14.3% vs +8.8% for REITs.
THE BOOGEYMAN: Will inflation kill the REIT bull market?
ALL EYES ON SUPPLY: Why declining CRE construction bodes well for REIT fundamentals.
THE SERENITY ARSENAL: Serenity’s REIT weapons of choice in 2025.
Headed into December REIT investors were riding high.
REIT fundamentals continued to improve, costs of capital were stable, and the outlook for 2025 looked extremely bright.
But then…BOO. An ominous shadow of that pesky 2022 asset price killer, inflation, emerged from a dark corner of the capital markets.
With both investors and the Federal Reserve spooked, REITs retreated in December as investor expectations re-calibrated.
But is this the re-emergence of the real boogeyman? Will inflation go full John Wick on the nascent REIT bull market as it did in 2022?
While inflation may re-accelerate modestly, this is not 2022. The money supply is not increasing by 20+% accompanied by large fiscal spending packages. Apartment rents are not skyrocketing, there are no bidding wars in the housing market, and supply chains are functioning properly. In fact, excluding owners equivalent rent (OER), inflation is +1.6%.
The fundamental outlook for REITs is also much rosier going into 2025 than it was headed into 2022. Competitive supply, the ultimate drag on REIT fundamentals, has peaked and will abate significantly over the next year and into at least late 2026. This sets up an incredibly attractive operating environment for many REIT property types from 2025-2027.
The bottom line here is that inflation is not nearly the threat to REITs that it has been in the recent past.
In fact, maybe inflation will not be the real killer in 2025. Maybe it will be REITs that come out of retirement, armed to the teeth with strong balance sheets and rampage through the CRE market…
PERFORMANCE: -6.26% in December +14.3% YTD
Serenity Alternative Investments Fund I returned -6.26% in December net of fees and expenses with +80% net exposure versus the MSCI US REIT Index which returned -7.39%. In 2024 Serenity Alts Fund I returned +14.3% with only +74% average net exposure vs the REIT index at +8.8%. Over the past 5 years Serenity Alternatives Fund I has returned +12.2% annually net of fees and expenses with a 0.98 Sharpe ratio, versus +4.3% for the REIT index.
Serenity has now produced double digit returns net of fees in 4 of the last 6 years. Our +12.2% trailing 5-year annualized return number includes a 500 basis point Federal Reserve hiking cycle, a global pandemic, and the most pronounced commercial real estate bear market since the great recession. Our outlook is extremely positive for the industry (absent a recession) from 2025-2028, and our portfolio is concentrated in companies with a multitude of growth tailwinds.
While 2024 did not end the way we would have liked, the current correction in REITs gives us the opportunity to add to some of our favorite positions. As supply pressures abate in 2025, we expect fundamentals for cyclical REITs to improve, external growth for healthcare REITs to ratchet higher, and the opportunity set in REITs to broaden.
As always, the Serenity portfolio is concentrated in some of the premier CRE portfolios on the planet. With secular bull markets in Seniors Housing and Data Centers, our portfolio companies are well positioned to thrive regardless of the broader macro environment.
The most profitable position in the fund in 2024 was current best idea American Healthcare REIT (AHR). AHR was a new REIT IPO in February and returned +134% from IPO until December 31st. A provider of Seniors Housing and Skilled Nursing, AHR is well positioned to benefit from the accelerating growth in the 80+ year old population currently occurring in the US. The company raised their same-store NOI guidance multiple times in 2024 as occupancy and rate growth in their core business surprised to the upside. With an enhanced cost of capital, AHR is set to build on their 2024 success by ramping up acquisitions and adding a development pipeline.
AHR remains one of the largest weights in the Serenity portfolio, as it has all the ingredients that go into a classic REIT bull run. These are; modest going in valuation (currently 65th percentile in REITs), sector leading organic growth (98th percentile amongst REITs), and an active pipeline of either acquisitions or development (AHR may have both in 2025). We believe AHR can achieve +15-25% growth in the company’s Net Asset Value (NAV) in 2025, and potentially again in 2026. Add in a +3.5% dividend yield, and the path to +20% annualized shareholder returns looks extremely achievable.
The worst performing position in the fund in 2024 was Plymouth Industrial (PLYM). Serenity was long Plymouth in 2024 as a value play in the Warehouse sector, as the company traded at a discount to peers, with growth that we argued was not low enough to justify said discount. Unfortunately, in an attempt to accelerate their growth, the PLYM management team decided to raise capital by contributing a portfolio of assets to a joint venture, selling preferred equity, and selling warrants to a private real estate investor called Sixth Street. This somewhat non-traditional route for raising capital was frowned upon by REIT investors, as it was expensive, complicated, and effectively ensured dilution above a specified share price thanks to the warrants.
The result was a lower NAV estimate for PLYM, and a stock price that fell from $24 to $17.24 as of this writing. Serenity Fund I liquidated our PLYM position in 2024 at a loss, as we moved down our management score significantly post JV deal. PLYM is an excellent example of how important REIT management teams are for long term value creation, or in this case, value destruction. In an attempt to grow earnings, the company sacrificed NAV and in doing so put themselves in the REIT investor “penalty box,” a place that is notoriously hard to escape.
THE BOOGEYMAN: Is inflation back to kill the REIT rally?
The capital markets Baba Yaga reared its ugly head again in December as YoY CPI increased from +2.3% at 9/30/2024 to +2.9% at 12/31/2024. This 60-basis point move during the quarter was enough to cause the Federal Reserve board of governors to drastically lower rate cut expectations for 2025, and send the REIT market almost -8% lower in a single month.
While a move of this magnitude should not be ignored, it’s also important to take a step back and examine the recent data within a broad context. Namely, let’s separate inflation into two components; shelter (1/3), and ex-shelter (2/3). As can be seen in the chart below and to the right, YoY CPI ex-shelter (2/3 of CPI) is clocking in at a whopping +1.6%. This has moved higher, from +1.1% at 9/30/2024, but is still below the Fed’s +2% target. Said another way…2/3 of the CPI calculation is printing at +1.6%.
The problem continues to be with the infamous owners equivalent rent (OER), the “shelter” component of the CPI that comprises the remaining 1/3 of the calculation. OER in December of 2024? +4.9%.
This would suggest that inflation remains stubbornly high because housing inflation continues to be sticky. There is only one problem. OER stickiness if not corroborated in ANY other real estate data.
Let’s look first at Apartment rents, which are tracked granularly at the national level. The chart below illustrates something regular Serenity readers have known for some time. Apartment rents have been flat since mid-2023. IE inflation in Apartment rents is 0. Quite literally…the average year over year rent growth for the top 52 MSA’s in 2024 according to ApartmentList.com was +0.0%. You can’t make this stuff up.
So what is OER picking up? Maybe it’s the continued inflation in home prices. For that let’s look at the Case-Shiller home price index, and heck, let’s overlay it with OER and same-store revenue growth for Self-Storage and Apartment REITs (chart at the bottom of the page).
Hmmm. It appears that the Case-Shiller index fell to +0% in mid-2023, like Apartment rents, then re-accelerated to +6%, but has since fallen to +3.6% in its most recent print.
That means that home price growth at +3.6% is also well below OER at +4.9%.
Let’s back up for a second and review these data points. Apartment rent growth is currently +0% and has been since June of 2023. Home price growth is +3.6% and has averaged +3.7% since January 2023. OER is currently +4.9% and has averaged +6.3% since January 2023.
One of these things is not like the others.
Serenity’s skeptical view on long-term inflation acceleration is rooted in the fact that OER is misleadingly high compared to on the ground real estate data. OER continues to move lower, following the path of rents and house prices on a significant lag. If we assume OER continues to normalize, headline inflation will continue to converge towards the ex-rent CPI value of +1.6%, well within the Fed’s comfort zone.
The Bottom Line: Leading indicators of inflation (Apartment rents in particular) do NOT point to higher for longer inflation, suggesting the recent rise in YoY CPI may be short lived. If so, the current REIT correction may be an incredible buying opportunity.
ALL EYES ON SUPPLY: The great REIT tailwind from 2025-2027?
From a fundamental perspective, the outlook for REITs in 2025 is rapidly improving. While the Fed Funds rate going from 0 to +5.25% caused a lot of pain in commercial real estate, the downstream impact is that CRE construction (2 years later) is tapering off rapidly. From 2025-2028, this will create the lowest competitive supply environment REITs have seen since the 2010-2015 REIT bull market.
This can be seen graphically in the chart below. Following the inflationary post COVID period of 2021, commercial real estate developers of all stripes built up some of the largest supply pipelines in US history. In Q1 of 2022 more than 200,000 multi-family units began construction. Due to shortages in building materials, these projects took over two years to complete in many cases, culminating in the largest supply wave of delivered multi-family units in 2024 since the 1970s!
This massive wave of competitive supply has pressured Apartment rents, as mentioned above, keeping them flat for the better part of the last 18 months.
But now fast forward to 2025, and even 2026. Multi-family starts began fading rapidly in 2023 and have continued downward ever since. In 2024 and 2025, these buildings will (are) being completed, but every quarter there will be fewer and fewer of them. This means less competition for Apartment landlords, and likely more pricing power going forward.
The story is similar in the Warehouse market. 2021 and 2022 witnessed the beginning of a massive wave of warehouse construction, which then faded in 2023 and continued lower in 2024. Pressure on Warehouse REIT fundamentals in 2024 was a direct result of this large wave of new Warehouse completions, that has peaked and will consistently wane over the next 1-2 years.
To hammer this point home, Welltower (WELL) publishes the chart to the right showing trailing twelve-month construction starts for Seniors Housing assets, their primary business. Seniors Housing starts have cratered since 2022, setting up the potential for continued strength in Seniors Housing fundamentals.
The Bottom Line: New competitive supply peaked in 2024 for multiple REIT property types and is set to flip from a headwind to a tailwind by 2026. This should bolster growth estimates across a variety of REIT property types as 2025 progresses, setting up one of the best operating environments REITs have seen since the post-GFC period from 2010-2015.
THE SERENITY ARSENAL: REIT bull markets with plenty of ammo…
As we look forward to the next few years of declining commercial real estate competitive supply, the Serenity portfolio is concentrated in REITs that have demand tailwinds independent of the broader economy. These demand trends will couple powerfully with lower levels of CRE construction to produce sector leading Net Asset Value (NAV) growth in specific REITs for years to come.
Seniors Housing (WELL and AHR): Regular readers will be no stranger to our bullishness on Seniors Housing, and our favorite ways to play the space in WELL and AHR. The US population that is over 80 years old has begun to grow at an accelerating rate and will continue to do so for the better part of the next decade. This demographic certainty is already creating a wave of demand for Seniors Housing of all stripes, particularly Independent and Assisted Living (IL and AL). WELL and AHR specialize in these types of properties and their portfolios and companies are designed to capture this accelerating demand.
Add in the chart above, illustrating the lack of competitive supply currently being built, and Seniors Housing is set for a bull run the likes of which may never have been seen previously in the REIT market.
Data Centers (EQIX, IRM): The current bull market in AI and by extension capital expenditures for the large tech companies has sent demand for Data Centers into overdrive. Digital Realty (DLR) announced that in Q3 of 2024 the company leased more Data Center space in a single quarter than it did in all of 2023. And 2023 was one of the companies’ best leasing years ever!
With over 20 years of experience in procuring land and power, the publicly traded Data Center companies are in our view the very best way to play this space. They have massive experience in Data Center construction and operation, large well-trained salesforces, and deep relationships with all the major players in the AI and cloud computing space. As power consumption becomes a major bottleneck to new Data Center construction, these companies have portfolios that are fully plugged in and operating, benefitting from the increased scarcity of power the entire industry will face.
There are also a few small, less discovered companies in the DC realm that are far from most investor radars. With over a decade covering the publicly traded DC space, Serenity has eyes on a few potential multi-baggers that may be overlooked.
Apartment REITs (UDR, IRT): With housing prices reaching historically unaffordable levels, Apartment REITs are primed to absorb continued housing demand in the US. As competitive supply pressures fade throughout 2025 and into 2026, these companies should see a return to more normal operating conditions, which means closer to 3% revenue growth and potentially 4-5% NOI growth. This would be a significant increase from current levels and would push Apartment NAV estimates higher rapidly over the next few years. While pricing power has remained elusive for Apartment REITs up to this point, it may only be a matter of time before more normal trends resume.
REIT investors love accelerating growth, and Serenity is willing to bet it arrives in Apartment REITs before the end of 2025.
The Bottom Line: Seniors Housing, Data Centers, and Apartment REITs all have demand tailwinds that will continue to propel these industries over the next few years. In certain cases, this additional demand will be met with a rapidly declining pipeline of competitive supply, setting up an operating environment that is extremely favorable for well positioned REITs from 2025-2027.
YEAH…I’M THINKING IM BACK
Despite the recent uptick in inflation, REITs are positioned for a “normal” operating environment for the first time in many years in 2025. For Apartment REITs, this means a potential return to positive revenue and NOI growth. For Seniors Housing, it means a continuation of industry leading organic and external growth. For Data Centers, this means continued strength in absorption, potentially coupled with margin expansion.
These powerful CRE trends should not be lightly excluded from investor portfolios.
And while inflation remains a risk, there are signs that this time it’s not John Wick, here to obliterate asset prices in 2025. Additionally, REITs have fundamental drivers that should accelerate as 2025 progresses, leading to an incredibly healthy market in 2026.
As always, retaining balance is key. The Serenity portfolio remains flexible, and our process is ever vigilant.
REITs are here to kill the Boogeyman,
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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