Real Estate Weekly: REITs Higher On Good Earnings, Lower Yields

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Summary

REITs gained 0.8% this week, aided by declining Treasury yields, which have continued to retreat from the post-election highs. Yield-sensitive REITs outperformed for the second straight week.

As we approach the halfway point of earnings season, REITs have continued to meet or exceed expectations. Residential REITs have led the way, beating modest expectations..

Sentiment and guidance, though, suggests that we are in the later innings of the current real estate cycle. Supply levels have approached equilibrium in most major sectors.

It was a light week for economic data, but we highlight JOLTS, which seems to corroborate our theory that we are seeing hints of a post-election acceleration in private construction.

Weekly Review

The REIT ETF indexes (NYSEARCA:VNQ) and (NYSEARCA:IYR) finished the week higher by 0.8%. The S&P 500 (NYSEARCA:SPY) gained 0.8%. Construction ETFs were higher on the week. The commercial construction ETF (NYSEARCA:PKB) gained 0.2% while the homebuilders ETF (NYSEARCA:XHB) rose 0.8%.

(Hoya Capital Real Estate, Performance as of 12pm Friday)

Across other areas of the real estate sector, mortgage REITs (BATS:REM) finished the week higher by 1.4% and the international real estate ETF (NASDAQ:VNQI) gained 1.3%. Through two weeks of 2017, REITs are higher by 1.1%, slightly underperforming the S&P 500. REITs ended 2016 with a total return of roughly 9%, lower than its 20-year average annual return of 12%.

The 10-Year Treasury yield (NYSEARCA:IEF) finished the week down from last week, but more than 10bps higher than its mid-week low. 10-Year yields are roughly 20 basis points lower than the post-election weekly closing high of 2.6%.

Uncertainty over European elections, less inflationary pressure in the US economic data, and skepticism about the political feasibility of implementation of Trump's pro-growth policies have decreased both real yields and inflation expectations.

The REIT/Rate correlation that has dominated movements in REIT shares over the past several years subsided this past week. Rolling 20-day correlations between REITs and the 10-Year Treasury remain near their lowest level since late last summer. Historically, REITs had been largely uncorrelated with bonds until the Taper Tantrum of 2013. Generally, REIT investors would prefer correlations to be low to increase the diversification effects of real estate equities.

Sector Performance

Residential REITs were among the strongest performers of the week. Despite continued rental growth weakness in the costal markets, Equity Residential (NYSE:EQR) and AvalonBay (NYSE:AVB) were among the strongest performers.

In the student housing space, Education Realty (NYSE:EDR) gained 3% while American Campus (NYSE:ACC) gained 2%. In the manufactured housing space, Equity Lifestyle (NYSE:ELS) and Sun Communities (NYSE:SUI) each gained 2%.

The Yield REIT sectors again outperformed for the second straight week after three straight weeks of underperformance. The net lease sector was led to the upside by Verreit, (NYSE:VER), National Retail (NYSE:NNN), Realty Income (NYSE:O), Store Capital (NYSE:STOR), and Spirit Realty (NYSE:SRC).

We discuss sector earnings results in the Bottom Line section.

Economic Data

(Hoya Capital Real Estate, HousingWire)

Every week, we like to dive deeper into the economic data that directly impacts real estate. We encourage readers to check out "February Construction Report: Early Signs of A Trump Bump" where we discussed recent trends in construction and theorized that we may be seeing hints of a post-election private construction acceleration after a lull in the second half of 2016.

JOLTS and Construction Employment

The December Job Openings and Labor Turnover Survey (JOLTS) showed that total nonfarm hires continue to be soft in recent months. Construction hires, though, saw an unusually sharp bump in December, possibly related to the post-election optimism which has been seen in confidence surveys.

Total job openings have leveled off in the past two years, but remains near healthy levels compared to hires. Too many job openings relative to hires would suggest significant tightness in broad labor markets and imply future inflationary pressure. We are not seeing that yet. The construction labor market, though, continues to look tight. Construction job openings have increased significantly since late 2016 and reached 220,000 this past summer, the highest level since 2007. Tight construction markets has led to significantly increased labor construction costs, which has put a lid on supply growth in most major commercial real estate sectors.

Initial Jobless Claims

Initial jobless claims were better than expected and remain near multi-generational lows, a sign of a very strong and healthy labor market. The four week moving average of initial jobless claims is at 40+ year lows.

Mortgage Rates Lower, But Still Up 60bps From Summer Lows

30-Year Mortgage rates, which tend to track movements in medium and long term Treasury bonds, fell for the third of the past four weeks. The 30-year mortgage rate fell 8 basis points from last week, but remain about 60 basis points above the summer lows.

Bottom Line: Q4 Earnings Continues

Earnings season hit high-gear this week and continues for the next two weeks. Results have generally been in-line or slightly better than expectations, but the sentiment continues to suggest that we are in the later innings of the current real estate cycle as supply-levels have come into equilibrium in most major sectors.

Apartments have generally performed better than expected, led by the non-coastal REITs. Oversupply in coastal markets remains a significant concern for Equity Residential and Avalonbay and should be expected to keep rent growth near cyclical lows. We think the diversified and non-coastal REITs such as Mid-American (NYSE:MAA) and Camden (NYSE:CPT) should be trading at a bigger premiums relative to their coastal peers.

Healthcare REIT performance has been mixed as fundamentals continue to decline, as expected, resulting from higher labor costs and concerns over the future path of healthcare in this country. Significant supply growth has slowed rent growth in the senior housing space, while uncertainly relating to reimbursement policies continues to result in significant discounts applied to the skilled nursing space.

Industrial REITs performed as expected, but that wasn't enough for investors who were expecting another better-than-expected quarter. New concerns over trade policies has resulted in a re-pricing and brought the sector's FCF multiples back in-line with the broader sector.

Office REITs have generally beat expectations and have continued to benefit from the strong jobs market. Office REITs trade at significant premiums to the REIT sector.

Malls and shopping centers have performed better than expected, alleviating much of the very negative sentiment in the brick and mortar space. We've pointed out that, in recent years, consumers have been spending more than usual on big-ticket items: cars, appliances, and home improvement. We have theorized that we will see more spending directed towards apparel and other miscellaneous in-store goods after these lower-level needs are met.

Please add your comments if you have additional insight or opinions. We encourage readers to follow our Seeking Alpha page (click "Follow" at the top) to continue to stay up to date on our REIT rankings, weekly recaps, and analysis on the REIT and broader real estate sector.

Disclosure: I am/we are long ACC, CPT, MAA, EDR, ELS, SUI, SRC, STOR.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: All of our research is for educational purpose only, always provided free of charge exclusively on Seeking Alpha. Recommendations and commentary are purely theoretical and not intended as investment advice. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. For investment advice, consult your financial advisor.