The market is brutal right now, with REITs giving up all of their 2017 gains. REITs are selling each market day as interest rates climb higher and the Fed seems more likely to raise 3 times or even 4 times in 2017. Despite this, I cannot justify selling any of the positions in 2CHYP as the fundamental value and dividend stream remains largely unharmed. Essentially, the gap between intrinsic and market value has widened in the sell-off, making the positions higher reward and lower risk going forward.
Will REITs continue selling off?
Honestly, I have no idea. I cannot predict the market’s short term whims and firmly believe that any effort to do so is futile or even destructive to value. Instead, my efforts are focused on understanding the companies underlying the securities we hold and assessing threats of the fundamental variety. A majority of our REITs are showing FFO/share growth and should be resistant to higher interest rates as they overwhelmingly do one of the following:
- Asset duration matched with liability duration. In this way, the increased expense of higher interest rates is matched with higher revenues as rental rates reprice to market.
- Fixed rate debt.
- Hedges or swaps on floating rate debt.
Further, I would point out that the Fed is basing their future policy on their dual mandate: inflation control and full employment. As such, interest rates hikes will be correlated with a stronger economy and higher inflation (perhaps 2% to 3% CPI).
REIT assets become more valuable in an inflationary environment and REIT cashflows improve with the economy. More jobs and other economic activity increases the demand for property which allows REITs to charge higher rent.
- Hotels will be able to increase rent immediately
- Apartments annually
- Triple net after a few years upon lease expiry
We hold a wide variety of REIT assets within 2CHYP which gives diversification and ladders asset rent duration. While we will continue to restlessly monitor threats, from a fundamental perspective we feel reasonably comfortable. In my opinion, it is best to just hold tight and wait out the Fed dip.
Erratic market behavior, such as what is going on now, can hurt the market value of our holdings, but it cannot take away the dividends. 2CHYP’s yield remains robust with many of our stocks increasing dividends and zero cutting.
If we see legitimate threat to the intrinsic value of a holding we will assess and sell if appropriate. This was the case with Lexington Realty Trust (LXP). Poor management decision making was taking a toll on long term value so we took the profit and got out. Alternatively, we are willing to sell to free up capital should superior opportunities arise. Usually erratic markets create opportunity, so we are anticipating some accretive trades. 2CHYP is a dynamic actively managed portfolio and we will make every effort to protect and grow capital.