REIT Total Return – Concentrating into Confirmed Opportunities

We continue to be presented with the problem of there being more opportunistic stocks than realistically fit into the portfolio.  It is tempting to just buy them all which would reduce the weight allocated to each position, but we will likely be doing the opposite.

There are quite a few unknowns right now in the economy which increases the uncertainty of fundamental trajectory.  Currently, the portfolio is positioned according to our best estimate of the future, but given the magnitude of the unknown, we must maintain humility about our ability to anticipate where things are headed.

So as of now, we are quite diversified, but there could be an opportunity to concentrate a bit more upon receiving confirmation of fundamental trajectory.   For example, say there are 2 stocks in the portfolio each with a 4% weight, and data points come out confirming that one is headed in the strong direction while the other one looks a bit shakier, we would be inclined to cut the weaker one and double up on the one confirmed to be fundamentally strong.

Why this trading tactic works right now

Under normal market conditions, an analyst more or less needs to predict fundamentals and get in before the strength is confirmed because the stock prices will swiftly adjust to reflect the fundamentals.  However, in recent months we have noted that stock prices are slow to adjust to fundamentals.  This affords a window of opportunity to increase position size AFTER the confirming fundamental data comes out without having to pay up for the new data.

The key will be finding near-term data points that confirm or reject a stock’s fundamental strength in ways that might not be immediately obvious to the market.

If we are looking for something like a 20% beat on earnings that will be inherently obvious to the market and get priced in by algorithms before we can reasonably buy.  However, if we are looking at leading indicators such as pre-leasing of a specific crucial development, that sort of data is not being priced in by the market despite being equally telling of fundamental trajectory.

The REIT Total Return Portfolio

The portfolio is split between income, value, and growth.  Income is derived from the value as the higher cashflow yield is what funds the higher dividend yield.  As of 3/31/23 REIT Total Return (RTR) had a 12.4X 2023 FFO multiple compared to the Dow Jones Equity REIT index at 16.99X.

Our average price to NAV is 81.2% and this is a big source of the 8.06% FFO yield.  If you buy a property at 100% of NAV it might produce a 6.5% yield, but if you buy that same property with the same rental stream at 80% of NAV it will yield over 8% against purchase price.

By finding value, we are able to source growth without losing that cashflow yield.  For example, industrial is a high growth area that normally trades at a low going in yield, but we own the discounted industrial REITs.

Industrial is the largest exposure in the portfolio at 24.2% which puts us on the growth path and due to individual stock selection I believe we are able to attain this growth without paying up for it.

Valuation within sectors is so disparate right now that there are good companies trading at 60% of the multiples of sector peers.  We think it is an obvious advantage and intend to fully exploit the mispricing.

Going Forward

We will be observing fundamental data as it comes out and leaning heavily into companies as they are confirmed to have strong earnings growth.  The atypical sluggishness of the market to price in company-specific data allows us to see the data before it gets priced in.

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 conditions. March 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.

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