Real Estate Weekly Review
Bouncing back from their worst week of 2019, REITs (VNQ and IYR) resumed their rally, now having produced positive returns in all but three weeks of 2019. Led by the yield-sensitive segments of the real estate market, REITs climbed 1.5% as the 10-year yield pulled back from four-week highs following the release of economic data that signaled a continuation of ‘Goldilocks’ economic conditions that have been so favorable for REITs and Homebuilders so far this year. Both the S&P 500 (SPY) and Nasdaq (QQQ) climbed to new closing highs following the better-than-expected GDP report on Friday.
Receding mortgage rates have jolted some life back into the housing sector after a dismal end to 2018 as forward-looking housing metrics have inflected notably higher over the past quarter. However, after jumping nearly 3% last week, Homebuilders (XHB and ITB) stumbled this week as earnings results so far this quarter have been mixed. PulteGroup (PHM) and NVR (NVR) reported strong results early in the week, but weak guidance from D.R. Horton (DHI) and TRI Pointe (TPH) dragged the sector lower by 2% on the week. Despite this week’s losses, homebuilders remain higher by nearly 25% so far in 2019, leading the broader equity market.
Despite a soft week from the Homebuilding sector, the Hoya Capital US Housing Index, an index that tracks the performance of the broader US housing industry, gained 0.3% on the week, led by the Real Estate Insurance and Residential REIT sectors. Besides Homebuilders, the Home Furnishings and Home Improvement sectors were lower for the week. All 20 residential REITs in the index finished higher, led by American Homes 4 Rent (AMH), Invitation Homes (INVH), and Sun Communities (SUI). Zillow (Z), Sleep Number (SNBR), Owens Corning (OC), and Masco (MAS) were among the laggards.
Earnings season kicked into high-gear this week in the REIT and Housing sectors which will continue for the next four weeks. Highlights this week included solid results from apartment REITs AvalonBay (AVB) and Essex (ESS) and in-line results from data center REITs Digital Realty (DLR) and CoreSite (COR). The data center REIT was the lone sector in negative territory on the week, however, after weak commentary on data center trends from Intel (INTC). As discussed in our REIT Outlook, the REIT rejuvenation appears to be on solid footing from a fundamental perspective, as long as interest rates cooperate. On a fundamental level, REITs should deliver a fairly strong year of reacceleration across many property sectors, particularly the residential and office sectors, which continue to be powered by strong job growth.
Real Estate Economic Data
New Home Sales Crush Estimates, Existing Sales Soft
As we've been discussing since late last year in our report, Homebuilders: Relief in Slight, forward-looking metrics have pointed to a recovery in single family housing market data following the rather dramatic slowdown in 2018. This week, New Home Sales data beat estimates as the seasonally-adjusted rate climbed to a sixteen-month high. On a trailing 12-month basis, however, new home sales have risen a mere 0.2%, 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. Existing home sales for March, which generally reflected sales activity in December and January, continue to be soft, but we expect this to recover by mid-summer.
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 of 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.
US Economic Expansion Continues
After delivering its best year since 2005 last year, the US economy started 2019 on the right foot with GDP growth smashing through estimates. Internal metrics, however, were not as strong as the 3.2% headline would suggest, as final domestic demand - the most important spending category - was higher by a more modest 1.5%, the weakest since 2015. An uptick in government spending and rising inventory levels offset otherwise weak consumer spending. Inflationary pressures, however, remained muted with PCE coming in below estimates, an affirmation that 'Goldilocks' economic conditions which have powered real estate outperformance this year may be sticking around.
Recent economic growth has been even more impressive considering the negligible impact of real estate development. Growth in residential fixed investment and business investment in structures has been a drag on growth over the past three quarters, subtracting a combined 0.13% from the GDP growth figure. For context, these two categories boosted GDP by 1.3% at the peak in 2002 and dragged down GDP growth by 1.1% at the bottom in 2008. Residential construction was a drag on GDP growth for the fifth straight quarter while non-residential investment in structures was negative for the third straight quarter. A tailwind for REITs and asset owners, supply growth has cooled even as demand remains robust.
Looking at this data through another lens, we see that real estate construction’s share of GDP remains well below the pre-recession period. The surge in residential investment fueled the housing bubble in the mid-2000s and was responsible for 6.6% of GDP in 2005. Residential fixed investment now makes up just 3.8% of GDP while business non-residential investment in structures makes up 3.1% of GDP. This period of moderate supply growth across the residential and non-residential sectors continues to support valuations of housing and commercial real estate assets.
Homeownership Rate & Household Formations
This week, the US Census released the quarterly Residential Vacancy and Homeownership report, which showed that growth in household formations remains robust, powered by rising real wages and strong job growth. Once thought to be a "new normal" of lower labor force participation, the strong US economy has pulled workers from off of the sidelines, and as a result, out of the parent's basements and friend's couches. Over the past year, total household formations in the US have risen by 1.9%, the strongest rate of growth since 1985 and the data indicates that there potentially remain millions of "deferred" household formations that may be realized in the coming years if the economy remains strong.
More households are renting, however, as the homeownership rate stalled-out in Q1 after climbing to the highest level in four years last quarter. Leading the gradual recovery has been a climb in the homeownership rates in the younger segments, particularly the <35 and 35-44 categories, which were hit the hardest from the housing recession. At 64.2%, the overall homeownership rate remains well below peak levels of 69.2% in 2004. Given the abnormally large 4-year cohort of 25-29 year-olds, we think that the homeownership rate will see continued gradual increases over the next five years as this "mini-generation" enters prime first-time homebuying age.
Housing markets remain historically tight as the vacancy rate for both rental and owner-occupied units remains at or near historic lows. The rental vacancy rate trended sideways from this time last year at 7.0% while the homeowner vacancy rate retreated to just 1.4%, the lowest level in nearly 20 years. Including all vacant units (second-homes, etc.), the total vacancy rate finished 2018 at the lowest level since 2002 prior to the "housing boom" in single family construction.
To bring it all together, the effects of these trends has been a persistent rise in overall housing costs, manifesting in rising rents and higher home values. Housing inflation has outpaced the broader inflation rate on a year-over-year basis in 90% of months since 1995 and does not show signs of receding anytime soon. Housing accounts for a third of average consumer spending and the "wallet share" of housing and housing-related services have increased significantly over the last decade. Given the recent slowdown in housing starts, combined with favorable demographics for household formation growth, it appears that that rising housing costs will continue to be a theme well into the next decade.
So far in 2019, REITs have climbed more than 16% while Homebuilders have jumped roughly 24%, bouncing back after their worst year since 2008 for each sector. The S&P 500, meanwhile, has climbed 17% on the year while the tech-focused Nasdaq has jumped 24%. At 2.51%, the 10-year yield has retreated by 18 basis points since the start of the year and is roughly 75 basis points below peak levels of 2018 around 3.25%. Energy prices, including crude oil and gasoline, have recovered strongly this year after a sharp decline in late 2018.
This week, we published Cell Tower REITs: 5G’s True Killer App. With 5G on the horizon, Cell Tower REITs have outperformed the broader real estate sector in each of the past four years. 5G technology will fundamentally disrupt the communications sector. The true “killer app” for 5G will be fixed wireless broadband internet. Dense small cell networks will allow carriers to deliver fiber-like speeds without the last-mile wires into each home. The Sprint (NYSE:S)/T-Mobile (NASDAQ:TMUS) merger saga continues. Just when a deal appeared imminent, a new curveball emerges. We think that Sprint’s troubles are overstated and that a no-deal outcome would benefit tower REITs.
We also published Manufactured Housing: The Answer to the Affordable Housing Crisis? The lingering underinvestment in residential housing continues to put upward pressure on housing costs. Manufactured Housing fundamentals reflect a significant shortage of affordable housing. Manufactured Housing REITs have outperformed the broader REIT index for six straight years, and are on pace to push it to seven. Same-Store NOI growth topped 7% in 2018. Rising construction costs, not speculation, have been responsible for much of the post-recession rise in home values and rents. Manufactured housing remains cheap largely because of lower construction costs.
Bottom Line: REIT Rally Resumes After Housing Data
Following the worst week of the year for REITs, the real estate sector bounced-back on a busy week of economic data. REITs have climbed in fourteen of seventeen weeks of 2019. GDP data smashed through estimates in the first quarter, silencing concerns that economic growth may be stalling out following the 2018 reacceleration. A true “Goldilocks” report, inflation pressures remained muted.
GDP growth is even more impressive considering the recent drag from residential fixed investment and non-residential construction. A positive for REITs, supply growth has cooled even as demand remains robust. New Home Sales topped estimates, climbing to a sixteen-month high as lower mortgage rates are translating into stronger demand. Homebuilder earnings, however, have been mixed so far this quarter. Household formations are growing at the strongest rate since 1985, powered by rising wages and solid job growth. More households are renting, however, as the homeownership rate stalled-out in Q1.
It'll be another busy week for housing and economic data, highlighted by Core PCE inflation data on Monday, Case-Shiller Home Prices and Pending Home Sales on Tuesday, ADP jobs data and Construction Spending on Wednesday, and the monthly non-farm payrolls report on Friday.
If you enjoyed this report, be sure to "Follow" our page to stay up-to-date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Manufactured Housing, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Student Housing, Single-Family Rentals, Apartments,Shopping Centers, Hotels, Office, Storage, and Homebuilders.
Disclosure: I am/we are long MTH, PHM, NVR, KBH, LEN, MDC, TMHC, TOL, DHI, AAN, FBHS, W, RMAX, MTG, WSO, USG, ORI, AMZN, Z, OC, SNBR, MAS, VNQ, DLR, COR, AVB, ESS, AMH, INVH. 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.
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