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Isthmus Fund Newsletter (12/02/21) – Applied Real Estate Investment Track (AREIT)

By Wisconsin School of Business

December 19, 2021

The Applied Real Estate Investment Track (AREIT) team has been working hard to build the portfolio and monitor the markets. This newsletter will outline the team’s initial investments, view on macroeconomic conditions, and outlook on rising COVID cases. The team has invested in nearly 20 REITs and will provide the rationale behind several of the trades. We will provide an overview of fund performance and adjustments to our strategy. 

Isthmus Fund Update

The team has recently adjusted our investment strategy as COVID cases begin to rise heading into the holiday season and it appears inflation may be more than transitory. COVID will be discussed in further detail later in the letter as well as inflation and other economic conditions. In response, we adjusted the three ranking categories of our sector scorecard: REIT Metrics, Macroeconomic and COVID Sensitivity. 

Originally, we emphasized the REIT metrics by applying 70% weight in keeping with our philosophy that opportunities are found in sectors with healthy balance sheets, strong fundamentals, and reasonable valuations. Followed by 20% weight to macroeconomic factors and 10% weight given to COVID as we believed cases would continue their downward trajectory. Due to near term concerns regarding persistent inflation and a rise in COVID cases, that are unlikely to subside during the winter season as well as uncertainty surrounding the Omicron variant, we have decided to place more weight on both macroeconomic factors and COVID Sensitivity. 

The chart above is the updated scorecard results with sector rankings in order. The team’s strategy is to overweight the top three sectors (Single Family Rental, Industrial, Lodging) and underweight the bottom three sectors (Malls & Outlets, Triple Net Lease, and Data Center). As of 11/24, we were analyzing new data and refining sector weights. We will re-evaluate our cash positions as markets react to Omicron variant.

Under REIT property sector metrics, we adjusted the five variables. We originally considered capex and Gross Asset Value (GAV). We switched our balance sheet metric to net/debt to EBIDTA and switched GAV to NAV. These five variables were standardized using z-scores. The REIT metric ranking of the sectors are based on the sum of z-scores across the different variables for each sector.  

As of the end of November 2021, the Isthmus Fund’s allocation was 27% invested in the VNQ and 3% held in cash. The remainder of the fund is invested in individual REITs. 

Macroeconomic Outlook

Inflation has been more persistent than initially projected. Core CPI gained 0.2% in the past month and 4.0% year-on-year. Consumer confidence fell to the lowest in the past decade caused by increasing pricing of goods, especially gas. The CSM COVID beneficiary foot traffic index is up (grocery store, discount store, home improvement) and COVID recovery foot traffic index down (hotels, casinos, dining) indicating the rise in cases is impacting economic activity. 


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While inflation and a rise in COVID cases threaten economic expansion, real GDP growth is projected to be 6% in the 4thQuarter. Growth is forecasted at 3.8% for 2022 and expectations for inflation are closer to 2%. Omicron poses risk to global growth and inflation. The employment outlook continues to improve. Initial jobs claims totaled 199,000 last week, the lowest total since 1969. 

Jerome Powell was renominated for this second term as Chair of the Federal Reserve. The Federal Reserve plans to taper quantitative easing at the end of 2021. At the minutes meeting earlier this month, the Fed expressed concern about inflation and said they were willing to raise interest rates inflation continues to rise. Chairman Powell said it will back off using the word ‘transitory’ to describe the fast pace of increases. We are looking to the Federal Reserve meeting in December to see whether inflation pressures will force more aggressive action from the Fed. We will continue to monitor inflation and interest rates closely to determine if we need to reassess our sector-weights.

COVID Outlook

The team has used the weekly data of COVID infection cases, hospitalized cases and 7-day test positive rate in order to adjust our portfolio sector weights.  As of 11/30/21 total COVID cases in the US has reached 48 million cases. From the Daily Trends chart below, we can see the trend of the daily cases has experienced a decline from the August peak and has now started to rebound since early November. 

On 26 November 2021, WHO designated Omicron as a variant of concern on the advice of WHO’s Technical Advisory Group on Virus Evolution (TAG-VE). Markets were down sharply due to uncertainty surrounding the new variant. Countries have started to impose travel restrictions. The variant has been found in Europe, Canada, Australia. On Dec 1st 2021, the first cases in the US have been detected in California.

Even though both total 7-day infection cases rate and 7-day test positive rate have increased compared to the October newsletter data, the good news is the 7-day death moving average rate dropped –41.51% and the current hospitalized rate dropped –13.53%. From those data points we assume that most new cases have mild symptoms of COVID.

Vaccination rates: 59% of the US population have been vaccinated. Over 82% of 18 years old and above population have received at least one dose of the vaccine. Vaccines were effective to COVID and its variants. With more of the population receiving COVID vaccine, the rate of patients with severe illness are expected to drop.

Government measures: 1. Starting from November 8th, 2021, the US lifted the COVID travel ban to international travelers who received full COVID vaccines with proof of negative COVID test to enter the country. However, additional air travel restrictions were placed on South Africa and seven other countries where the Omicron is circulating. 2. Austria and Japan have returned to a full lockdown against the recent sharply rising COVID cases and the Omicron. 3. President Biden urged Americans to get a booster shot and announced, “fight with COVID this winter not with lockdowns, but with more vaccinations and boosters”.

Winter is the virus outbreak season, especially with Thanksgiving and Christmas, with increased risk of COVID spread. The team will keep monitoring the increase in cases and the spread of Omicron to determine if we need to further adjust our investment approach. 

Recent Investments

The team has provided a brief rationale for several of our stock picks below:

Brixmor Property Group (BRX)

Brixmor established our first position in the strip center sector. The company has outperformed sector peers throughout the pandemic. Despite below average current physical occupancy, BRX had the smallest decline year over year. It was the only REIT in the sector to decline less than 100bps. Foot traffic has been surprisingly strong up more than 8% vs. pre-pandemic levels. It also has sector leading same store NOI growth through 2022 in part due to strong relative performance in 2020. The reinvestment pipeline continues to drive value creation, with $20.3M stabilized projects delivered in second quarter at an average incremental NOI yield of 18%. The REIT offers a differentiated strategy relative to its coastal-focused peers with a greater proportion of centers in secondary and tertiary markets. Roughly half of the portfolio is in tertiary markets, mainly the fast-growing Sun Belt region.  Sector leading releasing spreads point to continued growth for the company.

The strip center sector accounts for 5.18% of the RMZ index. Brixmor is the 4th largest strip center REIT at 0.59% of the RMZ index. We overweighted our position in BRX by 250bps. Our price target is $27.50. 

Rexford Industrial Realty (REXR)

Rexford’s entire portfolio is located in Southern California, the nation’s current leading market for industrial space. We believe Rexford is situated very well for future same-store NOI growth through a combination of market fundamentals in southern California due to supply-demand imbalances along with the sector’s leading amount of external growth, done primarily through acquisitions. The Los Angeles market has the nation’s highest rents, alluding to Rexford’s 14.3% Q3 y/y same-store cash NOI growth. The Los Angeles market is also seeing record-low vacancies, dipping under 1% in some submarkets. The company believes they can accomplish 27% internal NOI growth over the next 18-24 months due to a combination of leasing spreads, repositioning in process, and Q3/Q4 acquisitions.

The industrial sector accounts for 15.73% of the RMZ index. Rexford currently constitutes .75% of the index. After triangulating between FFO multiple, NAV, and discounted cash flows, we reached a target price $75.66 and an expected return of 11.24%. We overweighted our position in Rexford by 300 bps. 

Host Hotels and Resorts Inc (HST)

Host Hotels and Resorts’ portfolio consists of 80 hotels with 45,400 rooms, the majority focused on the east coast and west coast market. Host Hotels was the first REIT we chose in the lodging sectors. HST has strong management team, above average FFO growth per share in both 2022 and 2023, lower leverage compared to other lodging company, and currently trading at discount to NAV. HST will benefit from strong demand from leisure travel in the upcoming holiday seasons, and the generally recover from business and group travel, given 42.9% exposure in the sunbelt market and the rest in San Fransico, New York, and other major urban cities.  The company also generate external growth by acquiring new properties in sunbelt market and deposing old properties in urban. 

The lodging sector accounts for 3.27% of the RMZ index, and HST accounts of 0.98% RMZ weighting. We overweight our position in HST by 300 bps.

Boston Properties, Inc (BXP)

Boston Properties is the second largest market cap in the office sector, at approximately 17.83 billion. BXP is the leading company in cash SSNOI growth at 7.5%, the whole office sector average is 1.67%. The company has outstanding management value add-on and ranked as the second in the sector. The office sector is sensitive to CapEx %NOI, BXP performs at 27% below the sector average 29%. Based on Q3 information, BXP’s clients have return to the office and its parking and retail revenue being restored is a strong signal. For the future growth strategy, BXP is looking for life science value-added opportunities in markets where there is currently not oversupply, presently it has 4.0 M SF in service and additional 5 M SF in future development phase.

The office sector accounts for 8.94% of the RMZ index. BXP currently accounts for 1.4%. After triangulating three valuation methods of NAV, FFO multiples, DCF, we estimated the target price is $134.24, expected return of 18.56%.  We overweighted our position in BXP by 197bps.

Alexandria Real Estate Equities (ARE)

Alexandria Real Estate Equities is a pure life science REIT within the office sector. Headquartered in Pasadena, CA and led by Chairman and Founder Joel Marcus, Alexandria uses a cluster model strategy to identify markets that currently or potentially can house life science and tech ecosystems. In search of the perfect storm of proximity to highly ranked academic institutions, leading scientific managerial talent, and sophisticated investment capital, Alexandria has positioned their 338-property portfolio in all of the core cluster Life Science markets, San Francisco, San Diego, and Boston, as well as emerging markets such as Washington DC and Durham. The life science sector saw record breaking funding and demand in 2021 with no signs of slowing down thus far. ARE also has a venture capital arm, Alexandria Venture Investments, that seeks growing life science companies, giving management even more insight into the future of the sector. ARE’s expected FFO growth in 2022 and 2023 are 7.47% and 7,67% on average, with relatively low leverage that will allow them to meet these estimates through continued external growth. 

The team anticipates a 7.6% total return on ARE from a forecasted 4.1% S.S. NOI return and 3.5% return from their development pipeline. At the time of initial investment, our target price was set at $220.58, and ARE was overweighted by 250 bp, bringing it from 2.39% of RMZ to 4.87% of our positions.

Sun Communities Inc (SUI)

Sun Communities Inc is the largest of the three manufactured housing REITs, with a market cap around $23.5 billion. As of 2021 Q3, SUI’s portfolio includes 584 properties in 38 states and an overall 97.4% occupancy. The company portfolio is split between the three segments: 282 in manufactured housing, 149 in RV communities, and 120 in Marinas. The sector has performed impressively through the pandemic, matching other sector favorites: industrial and self-storage. Supply and demand fundamentals are sound. The main draw of manufactured homes is affordability compared to single family ownership and other rentals. The communities have low recurring capex, an average $260 per site for SUI or 7% of NOI. Strong demand and low operating expenses support healthy NOI growth. SUI has consistently outperformed ELS in Same-Home NOI growth (‘21YE 28.2% vs 9.7%), NOI margin (68% vs 57%), and occupancy (98.9% vs 95.2%). SUI has the higher FFO growth (8.96% vs 7.15%), lower short interest, and higher management value add (4.2% vs 1.6%). Yet, SUI has the lower FFO multiple (27.6 vs 31.5) and lower premium (8% vs 12%) to consensus NAV compared to ELS. The sector overall has good balance sheets across the different REITs. Since the sector typically holds properties acquired, secured debt makes sense as there is low concern of prepayment penalty, relatively low interest, and amortized for longer term. SUI has 73% secured debt and net debt to trailing 12-month EBITDA of 4.9x. 

Manufactured Housing accounts for a little over 3% of the RMZ index, and it accounts for 16% of the residential sector weight within the index. Sun Communities is the largest manufactured housing REIT at approximately 1.8% of the index. We are neutral the sector determined from our sector scorecard process, but we are targeting 130 bps overweight for SUI since it will be our only position in manufactured housing unless conditions change in the next few months.

Risk Control and Portfolio Monitoring

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The team believes that risk control plays a significant role in achieving +165 basis points objective with low volatility. The portfolio and all individual investments have remained within risk parameters. There were several rebalance indicators reached in the past month. We determined the portfolio would require a reallocation following the rise in COVID cases. We sold a portion of our overweight position in Lodging and reallocated the funds to Industrial sector positions. Simon Property Group (SPG) reached our target price of $140, however, after careful analysis of earnings, we revised our target price upward to $170. We did trim our position in SPG in favor of increased exposure in Self-Storage following the announcement of the Omicron variant. Regarding performance monitoring, alpha has not exceeded +/- 50 basis points. Absolute returns are 3%.

Recent Events & Next Steps

In October, the team had the opportunity to travel to Chicago alongside our Private Equity Track peers to meet with REIT executives, portfolio managers, and other industry experts. During our trip, we met with executives from AIC Ventures, Artis Advisors, Heitman, Ventas, Brookfield, and Equity Residential. It was especially interesting to have the opportunity to compare our thoughts on sector trends, our philosophy, and strategy with the Brookfield Real Estate Public Securities team on our shared mission to generate alpha with our portfolios. The insight each of these meetings gave us will not only assist in our mission this semester, but in our real estate careers thereafter as well. We would like to extend our thanks and appreciation to all those who took the time to meet with us and Seth Singerman for the accommodation that made this experience possible. 

More recently, the team was able to virtually attend the NAREIT 2021 Annual Conference in early November. The conference provided an opportunity to hear directly from REIT management teams as they share their forecasts and plans as they close out the year and look on to 2022. Some of our key industry wide takeaways and how they impacted our thoughts moving forward are as follows:

  • There are concerns around the persistence of inflation, labor shortages and expenses, and supply chain constraints. 
  • REITs and their management teams are looking to grow externally through the coming year, despite restrictions from construction cost and supply chain issues. 
  • ESG is paramount and a more data driven approach of discretion may be in the industries future.

These concerns expressed by management teams are concerns we share and have been monitoring prior to NAREIT and have continued to monitor since. In response to inflation, should it continue, we may consider shortening the average lease term of our portfolio. Labor shortages and expenses will impact how we tackle property types most afflicted, particularly senior housing and skilled nursing. Companies will continue to divulge more and more ESG information, and we will continue to pay attention, with ESG considerations being built into our stock selection process. Overall, attending the NAREIT convention was an extremely informative opportunity and we have already begun to think through how the information presented impacts our investments

Lastly, the team has been meeting with board members individually to gain their thoughts on the state of different sectors as well as their thoughts on our recent actions. We would like to thank those we have met with thus far for taking the time to do so and look forward to continuing to get to know the rest of the board as we continue to reach out.

We are on pace to meet our goal of full investment by the end of this year and will continue to share updates on the portfolio’s performance. We look forward to the 2022 Winter Board Meeting and wish everyone a happy and relaxing holiday season. 


2021-2022 AREIT Team

James A. Graaskamp Center for Real Estate, Wisconsin School of Business

4440 Grainger Hall – 975 University Ave., Madison, WI  53706