A New Top Pick
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TRADE ALERT - Core Portfolio January 2025
For most of 2022 and 2023, REITs performed very poorly as inflation was hot and the Fed was forced to hike interest rates at an unprecedented pace.
But then in late 2023, it became clear that inflation was cooling and interest rates would soon be cut by the Fed.
This led to a strong rally with REITs earning a 44% average return from October 25th, 2023 till December 1st, 2024:
More recently, long-term interest rates surged as the policies of the new administration were perceived to be more inflationary (e.g., tariffs, changes to immigration policy, tax cuts, etc.). Additionally, stronger-than-expected economic data prompted the Fed to adopt a "wait-and-see" approach, pausing rate cuts to ensure inflation isn't accelerating.
This pushed pushed long-term rates even higher.
As a result of this, REITs gave up a big chunk of their recent gains. They are down 11% on average in this recent dip, and some individual REITs are down much more than that:
We think that this bumpiness is yet another opportunity to accumulate more shares at discounted valuations because as we explain in our recent Market Update:
"We believe the Five Horsemen have collectively put the economy on an unstoppable secular trajectory toward low inflation and low interest rates. Low inflation will come first, and interest rates will follow." You can read more by clicking here.
And the debt market does not seem to disagree. Today, the three-year ahead inflation expectations are back at just around ~2.5% and this should eventually bring back down long-term interest rates.
Moreover, the dot plot, which reflects the Fed's projection for long-term interest rates, have not changed materially. They expect fewer rate cuts in 2025 as they are taking a pause to make sure that they aren't overly aggressive, but they still expect rates to return to ~3% sometime in 2027.
This projection means that the Fed still anticipates a gradual return to a more neutral monetary policy stance over the next few years, which we expect to pull long-term rates to lower levels as well.
With the benefit of hindsight, we now understand how swiftly and significantly REITs can recover once it becomes evident that long term interest rates are on a downward trajectory. This presents us with a valuable second opportunity to strengthen our positions in REITs that remain heavily discounted.
Today, we continue to buy the dips to take advantage of this volatility. We are making a small addition to one of our Core Portfolio holdings that dropped much more than the others:
Armada Hoffler Properties (AHH)
Armada Hoffler Properties (AHH) has dipped in recent weeks and now trades at its lowest valuation so far in this 3-year long bear market - even lower than at its bottom in October 2023:
This is despite recent good news.
The company announced on the 6th of January that it had sold two retail properties for $82 million at a cap rate in the low 6s, resulting in a 20% profit over their development cost.
It then used the proceeds to repay $22 million of its most expensive variable-rate debt and it unlocked $60 million to fund future accretive investments.
Then a few days later, the company also announced that Morningstar had upgraded its outlook to stable and confirmed its BBB credit rating.
These are not significant positive news, but you would expect the stock to react at least slightly to the upside, but the surge in long-term rates overshadowed all of this and caused its stock price to drop to lower levels.
As a result, it now trades at just 8x its cash flow and an 8.8% dividend yield that's well-covered and growing. It was hiked in 2021, 2022, 2023, and 2024.
This is way too cheap in my opinion for a high-quality REIT that focuses primarily on mixed-use properties with attractive long-term prospects.
Simply repricing at 12x FFO would result in 50% upside and it would still trade at a large discount relative to most REITs.
You can read our investment thesis by clicking here.
We bought the dip, increasing our position size by 20%:
Closing Note
You can expect us to keep buying the dips over the coming weeks with small weekly additions as we continue to take advantage of the market's volatility.
This will pay off someday in the future when REITs finally recover from this bear market:
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