• The REIT market was flashing a strong “BUY” signal multiple times in 2018
• Investors who heeded these signals saw 16% returns on average over the next six months, and 17.8% returns over the next twelve months*
• Using NAV estimates to time the REIT market continues to generate significant excess returns
Net Asset Value or “NAV” is a hotly debated topic in REIT circles. At its best, it represents the underlying value of a REITs real estate portfolio, or the liquidation value a REIT would achieve were it to put itself up for sale. Knowing a REITs NAV gives REIT investors an immediate view as to whether a REIT is cheap or not. Does it trade above NAV? Then sell, as it’s likely over-valued. Does it trade below NAV? Then buy, as private market participants will eventually arbitrage away the difference.
At its worst, however, NAV can lure investors into value traps, or change suddenly based on outlying factors. It’s a notoriously difficult data point to triangulate, and it is still not widely published. Since 2016, NAV has been increasingly misleading, as REITs trading at discounts to NAV have consistently under-performed their pricier peers.
For these reasons it has become a polarizing discussion topic for professional and non-professional REIT investors. For the NAV skeptics, it represents an old-school methodology that doesn’t have any value in the modern REIT landscape. For NAV proponents, it is an under-performing value marker that will eventually have relevance again based on its strong theoretical basis.
Like most things in life and in finance, the truth may be somewhere in the middle. At Serenity, it’s our belief (backed by compelling empirical evidence) that NAV still has value as a data point, but not in the way it has been traditionally used. Picking stocks using discount to NAV as a primary factor for the past few years has clearly been an unmitigated disaster. Trading the REIT space as a single entity, or timing the REIT market using NAV, however, has been incredibly lucrative.
Regular readers of our work will be familiar with our prediction at the end of 2018 that REITs were incredibly cheap, and that the sector represented an incredible buying opportunity. Our main piece of evidence supporting this thesis was the chart that is presented below. This simple graphic displays the REIT universe’s collective premium or discount to “NAV”. In other words, when the blue line is highly negative, REITs are very cheap relative to NAV, and when the blue line is in the positive, REITs are expensive relative to NAV. The orange and yellow bars represent subsequent 1-year returns for a buyer of REITs on any particular day.
What this implies is that the higher the orange or yellow bar, the better returns an investor would have achieved by buying and holding for one year. We pointed out at the time that the highest orange bars are highly correlated with the lowest blue lines, which simply means that the best forward REIT returns tended to be available when REITs were the cheapest.
Now imagine the above chart without the yellow bars. Near the end of 2018, it was only clear that REITs were inexpensive, not that forward returns in this portion of the cycle were going to be extremely strong. Instead of the large yellow camel-hump, we had a large red question mark. The question we were positing was…are things different this time? Will large discounts in REITs lead to muted returns, despite their pattern of historically leading to excellent returns?
As the height of the yellow bars indicates, it was not different this time. The average return for buying the REIT index in 2018 was about 11%, and the average return for buying REITs when they traded at a 10% discount to NAV was 17.75%*. Had you bought REITs on Christmas eve as a gift for yourself and held until the end of July, your capital would be worth 23% more in just over 7 months.
From the perspective of a quantitative investor, the performance of REITs over the past 7 months supports the hypothesis that NAV estimates can still be used to create value within the REIT universe. This is a fancy way of saying that the signal still clearly works. Our 2018 expose and this follow up represent an out-of-sample test, and those that heeded our signal last year have been richly rewarded.
For this reason, we will continue to monitor the REIT universe for large NAV discounts or premiums. NAV remains a useful tool when used correctly, and at Serenity we specialize in building and applying quantitative tools within the REIT market. Please contact us for our current view on NAV valuations and future returns.
* Since forward 1-year return data is not available for dates after 8/2 (as of this writing) of 2018, we calculated these forward 1-year returns as total returns between the given date and 8/2/2019. These are subject to change as the year progresses and REIT values increase or decrease.
Martin Kollmorgen, CFA
CEO and Chief Investment Officer
Serenity Alternative Investments
Cell: (630) 730-5745
**All charts generated using data from Bloomberg, LP, S&P Global, and Serenity Alternative Investments
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