REIT Total Return – Positioning for 2025

by | Jan 27, 2025 | REIT Total Return Portfolio

The turn of the calendar has some trading implications such as tax-loss-selling and perhaps some window dressing from the unscrupulous sorts.  More commonly though it is time in which people reflect on the year passed and the year ahead.  Our focus is always on the future. 

Heading into 2025 there are 4 positioning calls we are making.

  • Property location – job and population growth
  • Asset type – real estate subsector over and underweights
  • Value and Relative value – spreads are wide affording greater opportunity for discounts
  • Restricted supply – certain asset types have minimal supply, favoring existing properties

We shall begin with a look at the portfolio as a whole and follow with the targeted positioning.  The REIT Total Return portfolio’s dividend yield has increased to over 6%.  3 things precipitated the higher yield:

  • Purchase of highly discounted companies
  • Lower general valuation across the portfolio
  • Dividend increases

Within the RTR portfolio, 11 companies raised their dividends in 2024.  Overall, it was a significant updraft in the rate of dividend income. 

Property location – bias toward growth markets

Population relative to land mass is a key metric for land and real estate scarcity.  Many investors prefer big coastal cities like NYC and some of the California metros due to their very high population density.

We are less concerned with current density, instead focusing on the change going forward.

The coasts are dense, but property values are already high to reflect that.  Sunbelt areas are less dense, but property values are much lower in these areas.  The change in property value going forward is likely to be related to changes in density and changes in affluence.

We believe the market is entirely offside in attributing higher AFFO multiples to REITs with primarily coastal properties.  NYC and California are projected to have shrinking populations over the next 5 years

In contrast, sunbelt markets like Texas, Florida, Georgia, and Utah have excellent forward population growth.

Real estate value change should follow population change. 

We make it a priority to intentionally overweight our exposure to population and job growth MSAs.  In a more balanced market, it could be a difficult tradeoff between value and growth markets, but because valuations are so skewed, the growth market exposure co-exists with discounted valuation.  We think it is a fairly obvious advantage, but one we are happy to scoop up.

Asset Type

We have discussed this before, but it remains true today that one of the follies of index investing, particularly with REITs, is that market caps are heavily weighted toward certain asset types.

The index is overwhelmingly, towers, apartments, office, retail, industrial, data centers, and healthcare.  Some of these are strong asset classes, others are not.  More importantly, the index is missing out on many of the 20+ real estate sub-categories as many are almost non-existent by market cap weight.

Rather than basing weighting on market cap, we make intentional factor bets on asset types we believe will outperform the valuations at which they are trading.  Here are the sector exposures of RTR.

Land is our largest overweight relative to the index.  We view the sector as highly opportunistic right now because of the disparate movement of market prices as compared to asset values.

In the last 5 years, CPI measures 23% inflation.

Many people, me included, believe CPI under-reports true inflation.

Land is the epitomical inflation hedge.  Indeed, land prices have increased materially.  Timberland values are up significantly across all regions.

So timberland has properly worked as an inflation hedge.

The mysterious thing is that while timberland value is up 25%, Timberland REITs traded down.

Essentially, a gigantic rift has opened up between market price and asset value.

Value and relative value

REITs as a whole are trading at a roughly normal valuation which sets it in stark contrast to the S&P 500 which is trading at a historically high valuation. 

Within REITs, there is quite a bit of skew with large value gaps within sectors and between sectors.  In some instances, the value gaps are based on fundamental growth rate deltas, but in others, it seems to be more based on mispricing.  That is where we try to purchase better value without sacrificing growth.  

RTR is trading at 12X FFO while the index is at 19.85X.

Restricted supply

Supply and demand are the Yin and Yang of economics.  Each is equally important in setting equilibrant pricing, but demand gets all the headlines.

Sectors like data centers trade at absurdly high multiples because the demand is enormous and obvious.  However, supply of new data centers is equally enormous and there really aren’t substantial barriers to entry.  It is an okay sector fundamentally, but the high supply makes the equilibrium only mediocre for existing properties.  Thus, we really struggle to get on board with the exorbitant AFFO multiples.

Instead, we much prefer sectors that have restricted supply.  They aren’t as flashy and get almost no attention from the market, so multiples are much lower.  The low supply, however, facilitates excellent organic growth.  We are significantly invested in the following areas which have significantly restricted supply:

  • Manufactured housing – regulations, red tape and NIMBY
  • Billboards – largely not allowed to build new billboards with existing billboards grandfathered in.
  • Land – inherently 0 new supply while specific agricultural applications like timberland and farmland have negative net supply growth in the U.S.
  • Retail – prohibitive cost to build.

Retail does not have major regulatory barriers to supply, it is instead restricted by building costs.  Developers could build retail just about anywhere, but they largely don’t because building costs are somewhere around $200-$400 per foot depending on location and rent per foot is closer to $15-$45 (also varying by location).

NOI margins are not high enough to make a roughly 10% revenue return viable.  There are individual projects that have particularly high NOI yields which allow for development but those are rare such that new supply in retail has been minimal for about 18 years.

In the future, supply could pick up, but that would require rental rates to be about 20%-40% higher than they are today.

I think that is a great setup for existing shopping centers.  They largely will not have to deal with incoming competition until rents are substantially higher.  Demand has been healthy and vacancy is low resulting in strong NOI growth.  We see another 20%+ rental rate growth in this cycle.

Going forward

As always, we will actively manage the RTR portfolio with a goal of maximizing total returns.  Presently, we find opportunity in:

  • Relative value gaps that have gotten a bit too wide.
  • Property sectors with restricted supply
  • MSAs with higher population and job growth
  • Overlooked REIT subsectors

We will continue to examine the economy, sector fundamentals and market prices to flex to wherever opportunity is greatest. 

Evolving economies  create opportunity

Our REIT Total Return Portfolio is actively managed to pivot into wherever the opportunity is greatest.  We are now offering portfolio mirroring in which the trades in our REIT Total Return Portfolio are automatically executed in client portfolios simultaneously and at the same price.  

Important Notes and Disclosure

Material Market and Economic Conditions.   March 2022-2023: Significant increases in the Federal Funds Rate by the Federal Reserve have caused REIT market prices to decline more than the broader markets. REITs rely on debt financing to acquire properties and fund their operations; expiring lower-cost debt is being refinanced at higher interest rates due to prevailing market conditionsMarch 2020: REIT Total Return’s value declined substantially as COVID shut down the economy.  It recovered in 2021 as the economy reopened.  January 2019: Tax-loss selling’s calendar expired and the government reopened on January 25, 2019. The combined effect caused our shares to rise more than the broader markets.  December 2018: Another Fed-Funds rate hike, unresolved US-Chinese trade, a partial government shutdown, and an exaggerated tax-loss selling season put extreme downward pressure on equity prices.  All of these factors contributed to diminished liquidity and more significant share price declines in small-cap/value issues; REIT Total Return is focused on small-cap/value issues, so our decline was significantly more precipitous.

Material Conditions, Objectives, and Investment Strategies.  REIT Total Return is an actively managed investment portfolio of real estate equities, primarily common and preferred shares of REITs, with an aim to generate high total returns from a mix of dividends and capital appreciation.

All REIT Total Return Portfolio performance information on this page is based on the performance of the Portfolio Manager’s account, using the manager’s own funds. Performance of the Portfolio Manager's account is calculated by Interactive Broker on a daily time-weighted basis, including cash, dividends and earnings distributions, and reflects the deduction of broker commissions (when commissions were charged). Actual client returns will differ. **2nd Market Capital’s advisory fees are simulated and applied retroactively to present the portfolio return “net-of-fees”.

None of the performance information displayed on this page is based on the actual performance of any 2MCAC client account investing in this portfolio. The performance in a 2MCAC client account investing in this portfolio may differ (i.e., be lower or higher) from the performance of the account managing this portfolio and portrayed on this page based on a variety of factors, such as trading restrictions imposed by the client (resulting in different account holdings), time of initial investment, amount of investment, frequency and size of cash flows in and out of the client account, applicable brokerage commissions (when commissions were charged), and different corporate actions. Clients investing in this portfolio may view the actual performance of their investment in this portfolio by logging into their Interactive Brokers account and reviewing their customized dashboard.

Clients may restrict any of the securities traded in their account but should note that any restrictions they place on their investments could affect the performance of their account leading it to perform differently, worse or better, than (a) the above-portrayed account or (b) other client accounts invested in the same portfolio.

Forward-looking statements. Commentary may contain forward-looking statements which are by definition uncertain. Actual results may differ materially from our forecasts or estimations, and 2MCAC cannot be held liable for the use of and reliance upon the opinions, estimates, forecasts, and findings in these documents.

Past performance does not guarantee future results.  Investing in publicly held securities is speculative and involves risk, including the possible loss of principal.  Historical returns should not be used as the primary basis for investment decisions.  Although the statements of fact and data in this commentary have been obtained from sources believed to be reliable, 2MCAC does not guarantee their accuracy and assumes no liability or responsibility for any omissions/errors.

Use of Leverage or Margin. REIT Total Return Portfolio will utilize margin only for trading purposes (the ability to use the proceeds from stock sales immediately for new purchases instead of waiting for settlement), but not for borrowing purposes.

Benchmark Comparison. Our REIT Total Return Portfolio is compared to the Dow Jones Equity REIT Index and the MSCI U.S. REIT index because they are common REIT Indices.   The Dow Jones Equity All REIT Index is designed to measure all publicly traded equity real estate investment trusts (REITs) in the Dow Jones U.S. stock universe. The MSCI US REIT Index is comprised of equity real estate investment trusts (REITs) eligible included within the eight Equity REIT Sub-Industries of the Equity Real Estate Investment Trust (REITs) Industry. It is not possible to invest directly in the Dow Jones Equity All REIT Index or MSCI US REIT index.  Index returns do not represent the results of actual trading of investible assets/securities. Index returns do not reflect payment of any sales charges or fees an investor may pay to purchase the securities underlying the index. The imposition of these fees and charges would cause the actual performance of the securities to be lower than the Index performance shown. The results portrayed include dividend income. Our REIT Total Return Portfolio may include REITs that are not eligible for inclusion in the Dow Jones Equity All REIT Index or MSCI US REIT Index.

There can be no assurance that a benchmark will remain appropriate over time and 2MCAC will periodically review the benchmark’s appropriateness and decide to use other benchmarks if appropriate.

Expenses.   Returns reflect the deduction of any transaction expenses. REIT Total Return's advisory fees are simulated and applied retroactively to present the portfolio return “net-of-fees”.

Calculation Methodology.   Returns are calculated by 2MC with data from Interactive Brokers LLC using the Modified Dietz method, a time-weighted measure of performance in which cash flows are weighted based on their timing.    Dividends in REIT Total Return are reinvested.

S&P Global Market Intelligence LLC. Contains copyrighted material distributed under license from S&P.


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