Real Estate Weekly Review
Goldilocks is alive and well, and that's been a boon for the US real estate sector in 2019. Mounting signs of slowing global growth and receding inflationary pressure in the US have kept the Fed on pause this year, sending the 10-year Treasury yield and the 30-year mortgage rate to their lowest levels in more than a year, boosting optimism across the commercial and residential real estate sectors.
The REIT indexes resumed their 2019 rally, climbing an average of 0.5% on the week, led by the more yield-sensitive segments of the commercial real estate market, including data centers, net lease, and storage REITs. The S&P 500 retreated more than 1% on the week while the small-cap Russell 2000 dipped more than 3% seemingly in a return of the risk-on/risk-off trading pattern seen earlier in the cycle. REITs pushed their YTD gains in 2019 above 15% following the worst year for real estate since the recession.
(REIT & Housing Index Definitions Available at HoyaCapital.com)
Housing data has painted a mixed but improving picture for the US housing market in 2019. Forward-looking metrics signal a pending recovery as the sharp pullback in mortgage rates since November has done wonders to ease affordability issues. Apartment demand remains unwavering, according to a report from Yardi this week, which showed that rents rose 3.6% in February, the fastest rate of growth since late 2016. This week, the Hoya Capital US Housing Index pulled back roughly 1% on the week, led on the upside by the Home Improvement sector, but dragged down by the Mortgage Lending sector. Redfin (RDFN), Lowe's (LOW), Armstrong (AWI), Fidelity National (FNF), and Home Depot (HD) were the top performers in the housing sector.
Real Estate Economic Data
Mixed Signals in Home Sales Data
The outlook for the single family housing marked looked pretty bleak last November, with mortgage rates at post-recession highs and housing data showing a sharp pullback in both demand and appetite for new construction. The sun appears to be reemerging for the sector, prompted by the sharp pullback in interest rates over the last four months as the 30-year mortgage rate dipped to the lowest level since last February. Forward-looking metrics, including mortgage applications, have shown a brisk reacceleration this year.
As we pointed out earlier this year, 2018 is looking increasingly more like 2013 than 2007. In the wake of the "taper tantrum," the 30-year mortgage rate shot higher by 120 basis points, prompting a significant slowdown in single family housing data over the next year before bouncing back strongly in 2015 as rates again pulled back. New home sales rose just 2% in 2014 before reaccelerating to 15% growth in 2015. Lingering affordability issues across the single family ownership markets are likely a primary source of the increased degree of mortgage rate sensitivity we've noted in the post-recession period.
Backward-looking housing data remains soft but stabilizing. New home sales data for January missed estimates last week, but existing home sales beat estimates this week. On a trailing twelve-month basis, new home sales have risen just 2.0%, the lowest rate of growth since early 2015. Existing home sales have declined by 3.8% over the last twelve months. Considering the rate at which sentiment has shifted over the last three months, investors have so far discounted much of this backward-looking data. Home sales data for February comes out next Friday while pending home sales data is released on Thursday.
As we pointed out in Homebuilders: Relief Has Arrived, the "Four L's" of homebuilding bedeviled homebuilders in 2018: lumber, labor, lending, and land. While land prices and labor costs continue to rise above the rate of inflation, two of the four constraints - lending and lumber - have eased considerably over the last two quarters. Improving homebuilder sentiment in recent months has reflected growing optimism. Three of the four regions in the Housing Market Index accelerated in March, while two of the three index sub-components rose from last month.
Inflation Remains Tame But Housing Costs Rise
Runaway inflation was - and remains - the key threat to potentially ending the nearly decade-long economic recovery. Rising oil prices, along with rising costs from tariffs and trade disputes, had put upward pressure on inflation throughout 2018, but the recent dip in oil prices, along with moderating global growth, has quelled much or all of that inflationary pressure. Core CPI declined to 2.1% in last week's release while Core PCE, the Fed's preferred metric, remains at 1.9%.
Housing (CPI:Shelter) accounts for more than a third of the total CPI weight (42% including housing-related services), and since 2013, housing inflation has been significantly above the overall inflation rate. From 2015 through late 2016, housing inflation was one of the only components keeping Core CPI out of deflationary territory. Housing inflation has reaccelerated over the last several months after moderating slightly in 2018. Consistent with data from Yardi, primary rent growth has picked back up to 3.5% YoY, significantly above the broader inflation rate of 0.6%.
The importance of housing costs on the overall price index cannot be overstated. 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. On a rolling ten-year average, residential fixed investment as a share of GDP is the lowest since the end of WW2. The implications of this housing shortage, we believe, will be a continued persistence of “real” housing cost inflation and a long runway for growth in residential housing construction in order to equalize the supply/demand imbalance.
So far in 2019, REITs have climbed more than 15%, led by the cell tower, data center, industrial, and single family rental REIT sectors. The US Housing Industry has surged more than 13% led by the Home Furnishings sector. The S&P 500, meanwhile, has climbed roughly 12% on the year while the small-cap Russell 2000 has gained nearly 12%. At 2.46%, the 10-year yield has retreated by 23 basis points since the start of the year and is roughly 80 basis points lower than the peak levels of last November.
Bottom Line: Fed Pauses, REITs Rally
The REIT rejuvenation continued this week after the Federal Reserve signaled a continued pause in monetary policy. REITs pushed their 2019 gains above 15%. Moderating inflation and slowing global growth has pushed the 10-year yield to the lowest level in 14 months. The 30-year mortgage rate, meanwhile, dipped to the lowest since February 2018.
Home sales data remains choppy, but existing home sales data beat estimates in February. Forward-looking metrics continue to point to a reacceleration this year. Lower oil prices and easing trade tensions have relieved the broader inflationary pressure felt in 2018, but housing inflation remains unyielding and has picked up since late last year. Rent growth accelerated to the fastest rate since 2016, according to Yardi. Demand for apartments remains unwavering while supply across the broader US housing sector cooled in 2018.
It’s a busy week ahead of housing data now that we’re finally back on schedule following the disruptions of the government shutdown. Starts and permits data for February are released on Tuesday, as is the Case Shiller and FHFA home price indexes. Pending home sales come out on Thursday, while new home sales for February come out on Friday.
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Disclosure: I am/we are long VNQ, RDFN, LOW, AWI, FNF, HD, AMZN, LII, VTR, CUBE, TGT. 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: It is not possible to invest directly in an index. Index performance cited in this commentary does not reflect the performance of any fund or other account managed or serviced by Hoya Capital Real Estate. All commentary published by Hoya Capital Real Estate is available free of charge and is for informational purposes only and is not intended as investment advice. Data quoted represents past performance, which is no guarantee of future results. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy.
Real Estate and Housing Index definitions are available at HoyaCapital.com.