Real Estate Weekly Review
Pushing their 2019 total returns back near 20%, REITs (VNQ and IYR) continued their strong performance, climbing for the 15th of the past 17 weeks. Helping to power this remarkable run of performance has been the ‘Goldilocks’ economic backdrop of low inflation and solid growth which has been ideal for real estate outperformance in the post-recession period. Economic data this week highlighted by Monday’s cooler-than-expected PCE inflation report and Friday’s stronger-than-expected jobs report provided an extra boost of performance on top of a solid earnings season for REITs. The S&P 500 (SPY) and Nasdaq (QQQ) each climbed 0.2% on the week while yields across the curve climbed modestly higher with the 10-year rising 2 basis points.
On the week, the Hoya Capital US Housing Index, an index that tracks the performance of the broader US housing industry, gained 1.0% and closed at new 2019 highs. Homebuilders (XHB and ITB) powered the gains in the housing sector following strong earnings results and optimistic commentary from Taylor Morrison (TMHC) and M.D.C. Holdings (MDC). The homebuilding products and materials and home furnishings sectors also continued their strong 2019 with strong gains from Tempur Sealy (TPX) and At Home (HOME). Disappointing commentary from Realogy (RLGY) and RE/MAX (RMAX) on the single family home sales market, however, dragged on the high-flying real estate technology and brokerage sector.
Earnings season generally topped estimates across the REIT sector with roughly 60% of companies beating projections and a third raising full-year 2019 guidance. The residential (REZ), industrial (INDS) and data center (SRVR) REIT sectors have been the stand-outs since the start of earnings season. 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 and modest supply growth.
Real Estate Economic Data
Job Growth Beat Expectations in April
For the second straight month, the US economy added more jobs than expected as the unemployment rate dipped to the lowest level in 50 years. Nonfarm payrolls totaled 264k, beating consensus expectations of around 180k jobs added. Earlier in the week, ADP reported a 275k rise in payrolls in April, also above estimates. The combination of tax reform, trade policy, and deregulation have contributed to a reacceleration in US job growth since 2016 that has pushed wage growth to the strongest level since the pre-recession period.
Average hourly earnings rose 3.2% in March, slowing modestly after recording the fastest rate of growth since 2009 earlier this year. Core PCE inflation data released on Monday showed that inflation rose just 1.6% in March, below estimates, as inflationary pressures remain muted after a brief scare in 2018. Real wage growth topped 1.6% in March, the strongest rate of growth since 2009. At 1.8%, productivity (Real Output Per Hour of All Persons) last year grew at the fastest rate since 2009. Along with a growing labor force, productivity growth is the key component to real economic growth on a per-capita basis.
The jobs market is powering the best growth in household formations in a generation, setting the stage for a housing market recovery in 2019, but also rising rents and likely home values. Last week, the US Census released data which showed that growth in household formations are growing at the strongest rate since 1985. 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 into the housing markets.
The story of the post-tax reform economic reacceleration has been a resurgence in the long-dormant goods-producing sectors. Manufacturing jobs, which had entered a mild recession in 2016, saw significant growth in 2018 but have slowed over the past quarter. Job growth in the goods-producing sectors grew at a seasonally-adjusted rate of 2.38%, slowing from the high of 3.3% growth recorded in mid-2018, which was the strongest rate of goods-producing job growth since January 1985.
Job growth in the services sectors, which accounts for roughly 85% of total jobs in the US, has trended sideways since early 2017, but has seen several solid months of growth since late 2018. The largest single job category, retail, has been among the weakest job categories and is showing signs of a "double-dip" following a brief recovery after the "retail apocalypse" of 2016-2017. Hiring in the professional services and healthcare categories has seen solid and accelerating growth since late 2016.
The traditional measure of unemployment, the U3 unemployment rate, ticked down to 3.6% in April while the labor force participation rate ticked down slightly to 62.8%. As we have discussed for the last three years, we continue to believe that there is significantly more labor market slack remaining in the labor market than traditional metrics would imply, slack that could be unleashed by continued wage growth and perhaps also policy changes that reduce disincentives to employment. The prime-age labor force participation rate remains nearly 100 basis points below the lows of the mid-2000s recession, suggesting that the recovery could very well endure for another half-decade, or at very least shouldn't be hampered by the lack of labor market slack.
Construction Spending Sees Moderating Growth
Private construction spending growth has slowed since peaking in 2015 as rising construction costs and moderating real estate fundamentals have dampened the appetite for new development. As private spending has pulled back, however, infrastructure spending has seen a sudden resurgence. Public construction spending is higher by 7.7% over the last year, the strongest rate of growth since 2009, powered by robust spending at the state and local levels on infrastructure.
Rising construction costs can have a tightening effect on supply growth in the commercial real estate market. Construction costs rose considerably throughout 2018, primarily a result of tariffs and other trade-related issues. As construction spending has moderated, construction costs have started to pull back, led lower by a sharp dip in lumber prices which had surged in the first half of 2018. As we discussed in our recent homebuilding report, the combination of rising land, materials, and labor costs has compressed homebuilding margins to near-zero for all but the largest national homebuilders, but the outlook has brightened in 2019 as cost pressure has moderated.
This week, the Case Shiller Index showed that home prices rose in February by 3.0%, the slowest rate of growth since 2012, and was weaker sequentially for the 11th consecutive month. This index tends to reflect housing market conditions 3-6 months prior, and more forward-looking housing market metrics continue to show a stabilization or reacceleration in the single family market heading into the Spring selling season. Regardless, it's a very different scenario than the pre-recession period as home price appreciation has been driven primarily by rising replacement costs and lack of supply 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.
So far in 2019, REITs have climbed by more than 17% while Homebuilders have surged nearly 30%, each coming off their worst year since 2008. The S&P 500, meanwhile, has climbed roughly 18% on the year while the small-cap Russell 2000 has jumped 20%. At 2.53%, the 10-year yield has retreated by 16 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.
Next week, we will publish our quarterly updates on the single family rental and homebuilding sectors. Last 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 no-deal outcome would benefit tower REITs.
Bottom Line: Real Estate Loves Goldilocks
REITs and Homebuilders continued their 2019 rally on a busy week of earnings and economic data. Low inflation and solid growth continue to provide an ideal ‘Goldilocks’ economic backdrop. Optimism is high as REITs climbed for the 15th week out of the past 17, a remarkable run of performance that has been aided by stronger-than-expected earnings results this quarter.
Job growth surprised to the upside in April as the jobless rate fell to the lowest level in 50 years. Real wages are rising at the strongest rate since 2015. The jobs market is powering the best growth in household formations in a generation, setting the stage for a housing market recovery, but also rising rents and home values. Construction spending continued to moderate in March as supply growth in the residential and non-residential real estate sectors has cooled, helping to solidify real estate fundamentals across major sectors.
After a few busy weeks of housing-related data, it’ll be a relatively light week for economic data next week, highlighted by PPI and CPI inflation data on Thursday and Friday, respectively. Peak earnings season for the real estate and housing sectors wraps up next week with a handful of company reports.
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Disclosure: I am/we are long MHK, TMHC, SSD, MDC, LZB, HOME, TPX, FBHS, MTH, MAS. 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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