Portfolio Update - January: New Year, Higher Rates

• Rates soared again. The market is forecasting minimal rate cuts for 2025.
• The increase in Treasury yields had a negative impact throughout the sector with most valuations going down.
• We’re still sitting on a healthy pile of cash. I’ve been hesitant to deploy much due to the rate at which Treasury yields are climbing.
• Asking for member feedback on the readability of the chart for equity REIT positions. I want to make sure they are easy for our members to read on whichever devices they regularly use. Try using the comments to share your feedback.
• If you run into any difficulties, let me know and I'll help you through it.
• I’ll cover potential upcoming trades in the section for paid members. The rest of the article is available to everyone.

Article Begins

Interest rates are easily the biggest headwind we’re facing as REIT investors. Any light at the end of the tunnel just turns into another train.

The 2-year Treasury rate increased, despite the Federal Reserve reducing short-term rates.

Source: MBSLive

The market is pretty much done with relying on the Federal Reserve to cut rates. It is pricing in a “maybe” for one cut over the next 6 months. The full year projections give the following probabilities:

• 3 cuts 6.2%
• 2 cuts: 22%
• 1 cut: 40.7%
• 0 cuts: 29.9%

We knew from the start that higher interest rates were not going to solve inflation because the inflation was not created by excessive amounts of demand. Inflation is down dramatically, but it wasn’t because of higher rates. As much as the Federal Reserve would like credit, that simply wasn’t it. 

The primary tool for measuring inflation, the CPI, relies on severely delayed data for housing (rental) and insurance costs. That process results in smoothing out inflation and claiming it happens much later than it does.

Market rent for apartments is starting to trend higher again, but the Federal Reserve won’t see that. Why is it trending higher? Because much of the excess supply has been absorbed. We’re going to enter a period where there is far less supply coming to market because higher interest rates drove a sharp reduction in construction.

Rents are also supported by a combination of elevated prices for single-family homes and higher interest rates. Since home ownership became more expensive (insurance is also more expensive), rents can increase again.

The yield curve has a positive slope again as the 10-year Treasury rate is higher than the 2-year rate and higher than the short-term (1-month to 3-month) rates. 

Was the short-term reduction in inflation worth the trillions added to future interest expense?

I don’t think so, but the Federal Reserve never has to quantify the impact.

Not to fear, I’ll do it for them. I’m going to use 2% and 4.5% since 4.5% is about equal to the average rate across the curve today and it was well under 2% before the Federal Reserve took action.

• Take $36 trillion in debt. 
• Change the interest rate from 2% to 4.5%. We’ll just pretend all the debt rolls at once, rather than rolling over some of it each year. 
• Simple math: $36.3 trillion * 2.5% = $907 billion per year in additional interest expense.

A little more math on a “per citizen” level:

• Total debt per citizen: $106,900
• Interest expense at 2% per citizen: $2,138
• Interest expense at 4.5% per citizen: $4,811
• Increase due to Federal Reserve: $2,673

Or on a “per taxpayer” basis:

• Total debt per taxpayer: $323,075
• Interest expense at 2% per taxpayer: $6,462
• Interest expense at 4.5% per taxpayer: $14,538
• Increase due to Federal Reserve: $8,077

Were the actions of the Federal Reserve worth $8,077 per year in perpetuity? That’s not paying down the principal. That’s just paying the interest.

While the 2-year rate increased, the 10-year rate shot higher:

Source: MBSLive

It’s been a pretty tough period for our sectors because of the sensitivity to interest rates.

Portfolio Updates

You can find prior installments of the Portfolio Updates on the Portfolio tab of our website.

Older editions of the Portfolio Update are unlocked for everyone. The newest release reserves the foreshadowing section for paid members (for a couple of weeks).

Trade Alerts

We have a page on our REIT Forum website to link all trade alert articles.

Here are The REIT Forum’s trade alerts.

Layout - Modified Order

To keep things simple for our investors, the rest of the portfolio update is divided into several segments. We run the same segments (with new content) each week. 

We usually maintain the same order from month to month, but I revised the order to work better with free previews. Eventually, the order will be locked in again.

1. Returns on Total Portfolio
2. Sector Allocation
3. Reminder About Cash
4. Housekeeping
5. Recently Closed Positions with Returns
6. Recently Opened Positions with Returns
7. All Open Positions by Sector with Returns
8. Outlook
9. Foreshadowing Potential Trades (paid section)

This layout maximizes transparency while keeping the foreshadowing of our potential trades within the paid section. It also loads the images together at the front, while putting the text-heavy sections together at the end.

Returns on Total Portfolio

The chart below shows our performance since we began preparing for The REIT Forum at the start of 2016 through the end of the latest month:

There are four major index ETFs we use for evaluating performance. They are:

• (MORT) $MORT - Major mortgage REIT ETF
• (PFF) $PFF - The largest preferred share ETF
• (VNQ) $VNQ - The largest equity REIT ETF
• (KBWY) $KBWY - The high-yield equity REIT ETF most retail investors follow

Annual comparison vs. each ETF:

Our performance vs. the average of the ETFs:

We evaluate alpha based on performance against the ETFs because it strips out the general change in our sectors.

The next chart shows the change in the value of our portfolio from month to month. We strip out the impact from contributions made during the month because, obviously, contributions are not returns.

The prior year is included as well to help investors see how the calculations work.

If anyone is confused by these calculations, let me know. I believe this transparency is crucial, so I’ll include an example showing every calculation if I hear that readers have any difficulty following it.

Sector Allocation Chart - 

The sector allocation chart helps to explain how we are thinking about risk and seeking returns:

Reminder About Cash (repeated)

I normally keep at least 6 months or more of living expenses in “cash”.  If you normally keep around $40k to $50k in “cash”, the difference between getting paid 5% and 0.2% is around $2k per year. 

I’m using (SGOV), (SHV), and (BIL) as my cash substitutes. These are short-term Treasury ETFs. Prices are extremely stable. Liquidity is excellent.

I use a Schwab business account that is not part of my portfolio. The only assets it holds are actual cash and cash substitutes (those 3 ETFs). 

Nearly all my expenses go through my credit card already (paid off in full each month).

I still have my checking through USAA because of the long history on those credit cards. If I need cash, I can sell Treasury ETFs and transfer the funds to my USAA account.

It takes a few days, but that’s fine.

This is a pretty nice return for cash I was going to have there anyway. 

Note: Some people think you don’t need a strong credit score after getting a mortgage. I disagree. The long history on those cards is extremely useful if I want to boost someone’s credit score. If I add someone to my card, their next update will show they have a card with 20 years of perfect history.

You can get scammed this way. You are liable for the bill. They can just charge the card and walk away. This doesn’t concern me because I keep a lower limit (such as $10k) on those cards and I’m only doing it for people I trust. If one of those people betrays me, I’ll count myself lucky that I found out for only $10k. For people who can’t afford to risk that money, this would be too dangerous. 

Housekeeping

We used to have a repeated section on strategy, but I wanted to shorten the update. 

I’ll be posting an article that covers our strategy in greater depth and just adding a link to that post.

We have a project underway to update our guides and improve the organization.

Recently Closed Positions with Returns

These are the positions closed during the prior calendar month. If you want to see positions that were closed before that, you can see the prior portfolio updates or use the Google Sheets. 

If we didn’t close any positions for the sector during the month, then the image will be blank. 

Note: By loading the Google Sheets, you can still see all of our closed positions. We only include the recently closed positions to reduce the size of the article:

Recently Opened Positions with Returns

All Open Positions by Sector with Returns

We will start with the open positions as of the end of the month. It often takes a few days to prepare this article, but the screenshots below are from the end of the prior month.

The cell with the ticker is grey if the position is in a taxable account. This was a request by a few members and there was no drawback to adding the information. All of the taxable positions are in equity REITs.

Preferred shares and baby bonds:

Equity REITs in one really tall image:

Equity REITs again, but split up into two images. Equity REITs top half:

Equity REITs bottom half:

Mortgage REITs and BDCs:

Other:

Subsequent Changes

None so far.

Foreshadowing Potential Trades

This section is usually prepared shortly before publishing. The goal is to quickly cover ideas for trades. We aim to foreshadow our trades here, though the market may move in surprising ways. While the article takes days to prepare and documents prices and performance from the end of the month, the potential trades section is written last to provide the most up-to-date pricing.

Based on the change in relative prices as of 01/13/2025 here are some of the trades on my radar. 

Note: This section takes time to prepare. Market prices change. Therefore, the prices below may not be precisely the same as the price at publication, even though they were retrieved on 1/13/2025.

Paid Section Begins

Potential Preferred Share (and Baby Bond) Trades

MFAO (MFAO) $25.46 has my attention. We’re only up about 1% on the trade. Not an amazing return. But interest rates have been increasing. I might close this out. In January we did price target updates for the baby bonds from Gladstone (GAIN) and Ready Capital (RC). I’ll be doing the remaining baby bonds soon. I still want a solid credit spread over Treasury yields for holding onto baby bonds. Since Treasury yields went up, I anticipate reducing targets. Since these are baby bonds and have a defined maturity, a smaller swing in the price creates a material change in the yield. Therefore, the price adjustments won’t be huge. But I felt it was best to disclose the potential trade in advance. I find MFAN (MFAN) $25.21 more attractive than MFAO, but I think I would be more likely to close the position than swap.

The baby bonds that still need target updates are PMTU, MFAN, MFAO, CIMN, and CIMO.

I’ll consider placing targets on NYMTI, MITN, and MITP due to subscriber requests.

RITM-A (RITM-A) at $25.65 or RITM-B (RITM-B) at $25.50 could be interesting. Yield to call isn’t great. Slightly negative for RITM-A. Decent for RITM-B. Call risk is on the table. RITM announced a change in their preferred share ex-dividend dates. Typically their shares went ex-dividend around the 15th of months 1,4,7, and 10 (January, April, July, and October). The dividends were paid out about 30 days later. For Q4 2024, RITM announced the ex-dividend date would be 1/31/2025. The payment date will still be 2/18/2025 (near the 15th), so the difference between the ex-dividend date and payment date is reduced.

PMT-A (PMT-A) at $23.49 and PMT-B (PMT-B) at $22.91 are on my radar again. Shares have declined quite a bit. Their fixed yields are only modestly below PMT-C (PMT-C), which is similar to the times we bought them before. I may post soon to see if we have any experts on retrieving all court records related to the case. It would be nice to have a better view into the courtroom. For members who are not aware, PennyMac (PMT) is the one mortgage REIT that declared their fixed-to-floating shares were actually fixed-to-fixed shares. We’ve traded in these shares previously. We would buy them when they had significant discounts and then sell them near call value.

Potential Common Share Trades

I’m playing it pretty cautiously right now. The main issue is the surging interest rates. As long-term yields keep rising, it’s putting substantial pressure on REIT valuations. Since bond yields have a tendency to “trend”, I’d like to see some stability in the 10-year Treasury before getting aggressive. On the other, we have a bunch of great REITs trading pretty close to their 52-week lows. Consequently, I may still nibble on some positions. It’s hard to pass up on great companies at great prices because they might get even cheaper in the future.

I’ll have some target updates coming soon. The big factor is interest rates, so adjustments will be negative to reflect the higher rates. However, the adjustments won’t be nearly large enough to push most shares out of target ranges. They are still great bargains here, even when we adjust for the impact of rising rates. 

I’m most interested in the tower REITs and industrial REITs, but those are also the segments where I already have the largest allocations. 

I’m punting on further calls because I want to get the target adjustments done first. 

Potential Trade Summary

To summarize:

• I may close out my position in MFAO. Depends on valuation. If it dips (poor liquidity following the article), then I’ll probably just sit in the shares for a while and wait for that to resolve itself. Zero reason to panic. 
• I might make a short-term play with RITM-A and or RITM-B looking to take a dividend or two.
• I’ll be looking into PMT-A and PMT-B. I want to see if we can gain more insight into the court case so we can evaluate how well each side is laying out their arguments.
• I’ll probably wait on common share trades until I can release some new updates to account for elevated interest rates.

Conclusion

Thanks for reading. I hope you find the ideas in this article helpful as you navigate the markets.

I apologize in advance for any typos. With such a large document, having at least one or two is common. If you caught any, let me know in the comments. If you’re reading this more than a day after publication, check the comments section for any corrections. 

We just updated the consensus estimates for NAV and AFFO per share in the Google Sheets.