Real Estate Weekly Review
Real estate equities helped to power the US stock market to its best quarter in nearly a decade. The S&P 500 (SPY) surged nearly 13% for the quarter, the best quarterly gain since 2009, driven by the rejuvenation in the REIT and broader housing sectors. The revival has been spurred by receding interest rates and signs of solid macroeconomic and improving housing-related data. REITs and homebuilders each ended the quarter up by more than 15%.
The rally continued this week as the Vanguard REIT ETF (VNQ) climbed for the 11th week out of the past 12, a remarkable run of performance for the broader REIT sector following the worst year since the recession. The S&P 500 added more than 1% while the small-cap Russell 2000 jumped more than 2%. These strong gains come even after the yield curve inverted last Friday for the first time since 2007, which many market participants interpret as a sign of a looming recession. Receding yields, however, have been driven primarily by a moderation in energy prices and slowing global economic conditions in the face of otherwise solid economic data in the US, setting the stage for the "Goldilocks" economic conditions in the US that tend to be ideal conditions for real estate-related equities.
(REIT & Housing Index Definitions Available at HoyaCapital.com)
The US Housing sector has been at the forefront of the broader stock market gains in 2019. The Hoya Capital Housing Index, an index that tracks the performance of the US housing industry, climbed 1.5% on the week, led by a nearly 4% jump in the Homebuilding Products sector and 3% gains in the Homebuilding and Home Improvement Retail sectors. Solid results and positive commentary from Lennar (LEN) and KB Home (KBH) confirmed recent optimism around the housing market even as housing data remains mixed.
The Home Furnishings sector was the lone housing sector in negative territory for the week after disappointing results from Restoration Hardware (RH) and At Home (HOME). News of activist investor interest boosted the shares of both Bed Bath & Beyond (BBBY), which jumped nearly 25% on the week, and Eagle Materials (EXP), which climbed nearly 20%. Despite this week's relative underperformance, the Home Furnishings sector remains higher by nearly 23% since the start of the year.
New Home Sales Crush Estimates, Pending Sales Soft
Last week, we discussed how the sharp pullback in mortgage rates over the last four months to the lowest level in more than 14 months has already done wonders to stabilize the sputtering single-family housing market so far in 2019. We discussed how forward-looking metrics, including mortgage applications, have shown a brisk reacceleration this year, but noted that the major housing data releases - home sales and housing starts - would likely not start to reflect these improving conditions until the March or April data.
This week, we did start to see the early signs of stabilization in new home sales data, which smashed through expectations in February following a brutal end to 2018. New home sales jumped to a seasonally-adjusted annualized rate of 667k, the strongest since March 2018. On a trailing 12-month basis, however, new home sales have risen a mere 1%, the slowest rate of growth since early 2012. While conditions do appear to be improving in the new home sales category, existing homes have yet to feel the tailwind of receding mortgage rates. Pending home sales, which are a forward indicator of existing sales, came in shy of expectations in February.
The continuing theme of the post-recession period has been the lingering underinvestment in new home construction. New home sales peaked in 2015 at an annualized rate just shy of 1.3 million and bottomed in 2011 at a rate off 300k. While existing home sales quickly recovered most of the lost ground after the housing crisis, new home sales remain far below even 1990s' levels. Besides continued tight supply in the single-family markets, a secondary effect of the relative underinvestment in new single-family homes is the aging of the housing stock. The median age of a single-family home in the US is nearly 40 years old according to the American Community Survey, the oldest on record.
Housing Starts Disappoint But Permits Perk-Up
While the effects of lower mortgage rates are beginning to be felt in the new home sales data, the slower-reacting housing starts data remains soft. Housing starts missed estimates in February, dragged down by considerable weakness in single-family category, which dipped to the lowest seasonally-adjusted rate in roughly four years. Unfavorable weather conditions in February throughout much of the country may have pushed some starts into March. On a trailing 12-month basis, total starts are higher by less than 2%, the weakest rate of growth since 2011.
While housing starts data may not be reflecting the improving conditions, permitting data has begun to inflect higher over the last three months, led by a sharp recovery in the volatile multifamily sector. Last week, we noted that 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. Developers have quickly responded to improving rental conditions, helping to pull the average three-month permit growth to the highest level since late 2016.
Home Prices Soften, But For How Long?
Rounding out the trifecta of housing data, the Case Shiller Home Price index was released this week. At 4.3%, national home prices rose at the slowest rate of annual growth in four years in January, and the effects of higher mortgage rates in late 2018 will likely continue to weigh on this particular index well into this year. New home prices have been even softer, dipping 1.8% on a trailing 12-month basis. With mortgage rates now lower on a year-over-year basis, home price indices are likely to stabilize or even inflect higher again by mid-year based on recent correlations between rates and home values.
While home price appreciation has moderated in recent months, rent growth has reaccelerated. Likely boosted in part by marginal homebuyers that decided to remain in the rental markets late last year, but driven more significantly by the broader demographic tailwinds that continue to power new household formations, rents appear poised to outpace wage growth yet again in 2019 after a brief reprieve last year. According to Zillow ZRI data, both single-family rental and multi-family rental rents have risen by nearly 3% year-over-year, the strongest rate of growth for each category since 2016. This is consistent with data last week from Yardi which showed that rents rose 3.6% and data this week from HotPads which showed rents up 3.1%.
As we discussed last week, the combination of rising land, materials, and labor costs have compressed homebuilding margins to near-zero for all but the largest national homebuilders. It's a very different scenario than the pre-recession period as 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 raising 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.
So far in 2019, both REITs and homebuilders have climbed more than 15%, bouncing back after their worst year since 2008 for each sector. The S&P 500, meanwhile, has climbed 13% on the year while the small-cap Russell 2000 has jumped 14%. At 2.41%, the 10-year yield has retreated by 27 basis points since the start of the year, and is more than 80 basis points lower than the peak levels of last November. Energy prices including crude oil and gasoline have recovered this year after a sharp decline in late 2018.
Bottom Line: Real Estate Powers Robust Quarter
Real estate equities helped to power the US stock market to its best quarter in nearly a decade. REITs and homebuilders each ended the quarter up by more than 15%. The revival has been driven by receding interest rates and signs of solid macroeconomic and improving housing-related data. Both the 10-year yield and 30-year mortgage rate remain near 14-month lows.
The rally continued this week with REITs adding 1% and homebuilders jumping nearly 3%. Solid results from Lennar and KB Home confirmed recent optimism around the housing market. The trifecta of housing data - new home sales, housing starts, and home prices - was released this week. New home sales smashed through expectations, but starts and home prices remain soft. For the single-family housing market, so far 2019 is looking a lot like 2015, when a sustained pullback in mortgage rates reignited the previously stumbling sector.
Next week is payrolls week with ADP releasing its nonfarm employment report on Wednesday and the Bureau of Labor Statistics releasing the nonfarm payrolls report on Friday. Analysts are expecting 170k jobs to be added in March following the disappointing 20k jobs added in February, which came dangerously close to breaking the streak of 101 straight months of job growth. While it will be a quiet week for housing data, REIT investors will be watching retail sales and construction spending data, which will be released on Monday.
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Disclosure: I am/we are long VNQ, BBBY, EXP, AMWD, KBH, PPG, PBHS, AWI, PHM, SSD, AAN, HOME, RH, LEN, KBH. 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.
Hoya Capital Real Estate advises an ETF. Real Estate and Housing Index definitions are available at HoyaCapital.com.