Market Commentary | January 12, 2023
The World Repriced
Investors have removed their rose-colored glasses and now perceive the world through a glass, darkly. The overarching optimism that opened 2022 is all but gone.
In 2022, the S&P 500 delivered a negative 18.1% total return, its worst annual return since the Great Recession.
Energy had a banner year, but otherwise, the declines were broad and, worse for us in the real estate sector, not warranted by poor operating results.
REITs performed well and forecast more of the same. Our contention is that the markets collapsed not due to catastrophic events like the housing bubble or the COVID pandemic, but instead to earnings multiple compression.
A couple of examples from the real estate sector:
American Tower Corporation (AMT), the global communications infrastructure behemoth and the nation’s largest REIT, grew AFFO/share in 2022, even though the tower industry saw revenues decline due to the Sprint/T-Mobile merger. American Tower, with its large international exposure, was also pressured by the strong dollar and adverse Foreign Currency exchange (FX). Despite the solid performance, AMT saw its forward P/AFFO multiple compress by 28.41%. One year earlier, investors eagerly paid 29x AFFO; now it’s 21x. That multiple compression translated to a 27% decline in share price.
Development of the communications infrastructure is a global imperative; internet/communications are the lifeblood of all economies. On average, the sector components suffered even more than AMT. Today we can buy higher earnings and future growth at a lower share price. Our take is that the sector is oversold and AMT is a buy.
CPI
This morning (01/12/23), the Bureau of Labor Statistics reported that, month over month, CPI fell 0.1% in December as gasoline prices decreased. Since shelter is a major component of CPI, one could reasonably argue that inflation is dead; Apartment List reported that their national index fell by 0.8% over the course of December, marking the fourth consecutive month over month decline (CPI’s methodology won’t reflect these rent declines until at least 6 months from now, so many believe that inflation is actually much lower than current reporting suggests).
At the start of 2022, apartment REITs demonstrated one of the highest Price/FFO multiples of all asset classes. Coming off a strong 2021 performance, renewal rents logged year-over-year increases in the low teens. By July, however, the supply/demand engine started to lose steam. Rent growth slowed, stalled, and now in December may have reversed.
Various real estate reporting agencies now forecast that the apartment markets will return to historic trends of 94% occupancies (lower) and 3-4% annual rent growth. If that is the case, the 17X P/FFO pricing presented in the table above describes a fully valued sector.
We are largely in agreement with that assessment but make exception for REITs that are focused on providing affordable workforce housing within their submarkets. We have identified these companies; these REITs maintain significant pricing power. Since their shares are changing hands for half of what they were selling for in June, we are new buyers.
Look Forward
2MC has catalogued earnings multiple compression data on 13 distinct sectors. The information is compelling. The spectrum array portends outcomes ranging from peril to opportunity. We work to avoid peril and seize opportunity.
Look back to measure 2022 and forward to the promise of 2023.
Notes and Disclosure
Articles are provided for informational purposes only. They are not recommendations to buy or sell any security and are strictly the opinion of the writer. The information contained in these articles is impersonal and not tailored to the investment needs of any particular person. It does not constitute a recommendation that any particular security or strategy is suitable for a specific person.
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