As Fed Blinks, Real Estate Rallies In November

Summary

• With the Fed in focus, US equities finished a volatile November on a high note. The S&P 500 finished the month up 1.8%. REITs climbed 4.6% while Homebuilders jumped 4.4%.
• US interest rates continue to retreat as oil continued its freefall. PCE inflation data was cooler than expected, giving the Fed plenty of wiggle-room to pull back on rate hikes.
• Retailers got off to a strong start this Holiday season. Early spending data suggests that sales could rise another 4-6% this season following last year’s strong 5% surge.
• New home sales dipped to a two-and-a-half year low while pending home sales dipped to a four year low as higher mortgage rates continue to slow the US housing market.
• Home price appreciation continues to moderate following a half-decade of strong growth. Market fundamentals, however, are vastly different than the pre-crisis period in the mid-2000s.

Real Estate Weekly Review

On a busy week jam-packed with economic data, trade talks, and Fed-watching, US equities delivered a strong week despite the continued pull-back in oil prices. The S&P 500 (SPY) jumped nearly 4%, boosted by a cooler-than-expected reading on PCE inflation data and signs that the Federal Reserve may be pumping the breaks on rate hike plan. The G20 summit, which began on Friday, will be the central focus of investors throughout the weekend with the China-US trade talks taking center stage.

Plunging oil prices, along with signs of cooling economic growth in international markets, continues to drag down US interest rates and brighten the outlook for the rate-sensitive segments of the US market, including housing. WTI oil prices briefly dipped by $50 per barrel in trading this week, a level that would be unbelievable just six weeks ago. REITs (VNQ and IYR) climbed 2.5% on the week, while Homebuilders (XHB and ITB) rose 1%, each capping off a strong November in which both sectors gained nearly 5%.

(Hoya Capital Real Estate, Performance as of 4pm Friday)

The Housing 100, an index that tracks the performance of the US housing industry, finished the week higher by 3%, led by strength in the home improvement and brokerage and technology industry sectors despite mixed housing data. In the home improvement category, Lowe's (LOW) and Home Depot (HD) each jumped more than 6% on the week. In the brokerage and technology sector, Zillow (Z) surged 24%, Redfin (RDFN) jumped 15% and RealPage (RP) climbed 8%. Online furniture retailer Wayfair (W), meanwhile, jumped 20% on the week.

Real Estate Economic Data

(Hoya Capital Real Estate, HousingWire)

Another Weak Month for Home Sales

A decade after the financial crisis, the US housing markets are again the central focus of global investors. A stretch of weak home sales data that began in late-spring has continued into the fall and now into the early winter months as the effects of higher mortgage rates have weighed on demand for single family housing. New Home Sales released this week dipped to a two-and-a-half year low on a SAAR-basis while Pending Home Sales dipped to a four-year low. On a trailing-twelve-month basis, new home sales are still higher by 5% while pending sales are lower by 2%.

A combination of factors has contributed to weakness in the single family markets throughout 2018, all centering around the central issue of affordability, or lack thereof. With the strongest labor market in a generation, wages rising at the fastest rate since the recession, along with a demographic boom that is entering prime home-buying years, this should be the time to see accelerating demand for single family homes. Instead, the combination of rising mortgage rates, the reduction in the homeownership incentive in the tax code, and the rise in home values have prompted many potential buyers to remain in the rental markets.

In our recently published report, Homebuilders: Relief In Sight, we discussed how the outlook has brightened in recent weeks in for homebuilders. Lumber prices have retreated 50% from 2018-highs. The decline in oil prices should soon filter through into lower mortgage rates in the coming weeks and months. Along with declining lumber prices, lower mortgage rates remove two of the key headwinds pressuring homebuilders. For the reasons that we discussed in our new update, we now have a more favorable outlook than consensus on the homebuilding sector but note that the recovery will remain choppy and could indeed be derailed by an overly-aggressive Federal Reserve or an unexpected surge in inflation expectations.

Home Prices Appreciation Moderates

Consistent with the softening trends seen in home sales data, home price appreciation has slowed considerably in recent months. The Case Shiller National Home Price Index recorded a 5.4% YoY rise in home values, the slowest rate of home price appreciation in nearly two years. Home prices peaked in July of 2006 and bottomed in February 2011 after dipping more than 25%. National home prices have risen more than 40% from the 2011 lows and are now 14% higher from the prior peak on a nominal basis, but still 5% below prior peaks after adjusting for inflation.

Sine 2012, home prices have risen at a strong and steady 5-7% YoY rate of appreciation. The streak of more than six years of 5% growth is poised to come to an end by early 2019 absent a significant reversal in mortgage rates over the next several months. In the three months of home price data since June the seasonally-adjusted Case Shiller National Index has climbed a mere 0.6%, an annualized rate of barely 2%.

Market fundamentals, however, are vastly different than the pre-crisis period in the mid-2000s. Home price appreciation has been driven primarily by rising replacement costs to build rather than pure speculation and credit-fueled demand. Rising construction costs and their impact on rising home prices have had the effect of keeping new home development and supply growth far below the levels normally associated with this level of recent economic growth.

Amid the lingering housing shortage, long-term rental fundamentals remain highly favorable. Since 1995, shelter inflation has outpaced the broader rate of inflation by more than 1% per year, fueled by a persistent supply shortage in the US housing markets. Over the last three decades, structural impediments to supply growth, aggravated by the dramatic dislocations during the housing crisis, have dramatically slowed the rate of housing starts per capita. The implications of this housing shortage, we believe, will be a continued persistence of “real” housing cost inflation (rent growth) and a long runway for growth in residential housing construction.

Earnings Season Recap

This week, we published Mall REITs: Strong Start To Holiday Season. Following a record year in 2017, this holiday season has gotten off to a very strong start, according to most early metrics. Simon reported a solid 2% rise in foot traffic over the Black Friday weekend, while ShopperTrack noted that overall foot traffic across both high- and low-productivity retailers was down -1.7%, consistent with last year's decline. FirstData recorded 6.1% growth over the Black Friday weekend, while Mastercard recorded a 9% jump on Black Friday. Econoday's Redbook same-store retail sales showed a 7.9% surge last week, the strongest rate of growth in twelve years. Mall REITs have been among the better performers this year, but the bifurcation between top-tier and lower-tier mall REITs continues to widen. Store closings remain elevated in low-productivity properties.

Retail REIT fundamentals have stabilized in 2018 despite still-elevated levels of store closings. Top-tier malls continue to find success in repurposing vacated department store space into higher uses. High-productivity mall REITs reported an average 5.8% rise in tenant same-store sales in 3Q18, powering a 5.1% rise in REIT same-store NOI. Low-productivity malls achieved just 1.4% and -2.7%, respectively.

Last week, we published our third quarter REIT Earnings Recap: Solid Quarter Powers Outperformance. Beneath the interest-rate-driven market swings, REITs have quietly delivered a solid year in 2018 as fundamental metrics have inflected higher after bottoming at the end of last year. REITs delivered strong third quarter as, for the first time since mid-2016, dividends per share and FFO per share were both positive on a trailing twelve-month basis. Same-store NOI ticked higher to 2.82%, the third straight quarter.

While the NAV discount has shrunk in recent months, the persistent NAV discount has forced many REITs to scale back their acquisition plans and many REITs have sold assets in an attempt to close the valuation mismatch. REITs have acquired just $5 billion in net assets over the last year, far below the $60 billion peak pace of 2016.

REITs are no longer simply buy-and-hold real estate holding companies, however. The development pipeline remains near a record-high at $43 billion, exceeding the 2008 peak of $38 billion.

2018 Performance

REITs are now lower by just 1% YTD on a price-basis and are higher by 1-2% on a total return basis. Despite their recent outperformance, REITs are still underperforming the 3% price-return on the S&P 500. Homebuilders are off by more than 26% after rising more than 50% last year. The 10-Year yield has retreated more than 25 basis points from 2018 highs but remains higher by 61 basis points since the start of the year.

REITs and housing-related equities have outperformed the broader US stock market over the last 25 years. The NAREIT All-Equity REIT Index has delivered a 12.1% average annual return while the Fidelity Construction & Housing Fund (FSHOX) has delivered a 10.8% annual return since 1994. The S&P 500, meanwhile, delivered a 9.9% annualized rate of return during this period.

Bottom Line: Strong Week for Real Estate Equities

With trade talks in focus, US equities finished a volatile month on a high note. The S&P 500 finished the month up 1.8%. REITs climbed 4.6% while Homebuilders jumped 4.4%. US interest rates continue to retreat as oil continued its freefall. PCE inflation data was cooler than expected, giving the Fed plenty of wiggle-room to pull back on rate hikes.

Retailers got off to a strong start this Holiday season. Early spending data suggests that sales could rise another 4-6% this season following last year’s strong 5% surge. New home sales dipped to a two-and-a-half year low while pending home sales dipped to a four year low as higher mortgage rates continue to slow the US housing market. Home price appreciation continues to moderate following a half-decade of strong growth. Market fundamentals, however, are vastly different than the pre-crisis period in the mid-2000s.

For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Net Lease, Data Center, Manufactured Housing, Student Housing, Single-Family Rentals, Apartments, Cell Towers, Manufactured Housing, Malls, Shopping Centers, Hotels, Office, Healthcare, Industrial, Storage, and Homebuilders.

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Disclaimer: All of our research is for informational purposes 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.

Analyst’s Disclosure: I am/we are long VNQ, XHB, HD. 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.

Comments

[StevenK1]

great article. long FREL.

[jansdirk]

Yes of course but stock prices are exxagerated punished even in case Brexit will end as a disaster.
It reminds me of An Italian Reit which I have bought at the time for 0,32 and sold a while later for 0,75 which appeared to be a fair price during a number of years now: Beni Stabili Spa
Thanks Good luck in UK!

[Duc1198]

@jansdirk. Nio fear or Britexit?

[jansdirk]

Thanks as usual.
What a difference between malls/shopping centers in US and Continental Europe: in Europe for cheap despite oversupply of square meters per capita in US.
In UK most extreme due to Brexit: high quality retail Reits for sale at approximately 30 to 50 % of net asset value.
INTU right now is a bargain, also British Land and Capital &Counties and Hammerson with big discounts.
On mainland some 40 % discount for Unibail and Klepierre and others as well. Patience will be rewarded while receiving juicy dividends in 6 to even more % dividends.
Regards from Netherlands