Real Estate Weekly Review
Following the worst week of 2019 for the major equity indexes, the S&P 500 (SPY) finished the week lower by another 0.7% as trade talks have reportedly broken down between the US and China. Progress on North American trade relations and a delay of the European auto tariffs were welcome news for investors, who have flocked to bonds and domestic-focused equity sectors in recent weeks, taking the 10-year yield down near 18-month lows. REITs (VNQ and IYR) continue to be among the stronger-performing equity sectors of 2019, climbing more than 1% this week led by the more yield-sensitive segments of the real estate sector.
On the week, the Hoya Capital US Housing Index, an index that tracks the performance of the broader US housing industry, declined 0.4% after closing at new 2019 highs earlier this month as housing data continues to point to a solid recovery this year. The exclusively-domestic Residential REITs (REZ) and Homebuilders (ITB) were the relative outperformers, but trade tensions continue to weigh on the sectors more reliant on imported goods: Homebuilding Products and Home Furnishings. Zillow (Z) jumped more than 12% on the week, continuing its post-earnings momentum while Progressive (PGR), HCP (HCP), Ventas (VTR), and Mid-America Apartment (MAA) each delivered strong weeks in the housing sector as well.
Real Estate Economic Data
Housing Data Strengthens Into Peak Season
The resurgence of housing-related stocks in 2019 has been largely driven by the pullback in the 30-year mortgage rate, which had climbed through 2018 and reached six-year highs around 5.0% in November. At their peak last year, rates were higher by roughly 150 basis points on a year-over-year basis, the most significant climb in mortgage rates in decades. Since then, rates have pulled back by roughly 90 basis points and there are indications that buyers may be coming back from the sidelines. The MBA Purchase Index, a useful leading indicator of new and existing home sales, continues to show strong growth while the MBA Refinance Index has jumped roughly 40% on a quarter-over-quarter basis.
As rates have pulled back, homebuilder sentiment has improved, climbing to seven-month highs in May. Homebuilder sentiment dipped late last year to the lowest level since 2015, but lower mortgage rates continued strength in the labor markets and moderating construction costs have brightened the outlook for single-family construction this year. All three index subcomponents improved from last month with buyer traffic matching the highest level since last July at 49. On the regional level, the Northeast led the gains, jumping 10 points to 65. The South and West, however, remain the strongest regions. Rising homebuilder sentiment data suggest that single family housing starts should recover in 2019 based on past correlations between the data sets.
While the effects of lower mortgage rates are beginning to be felt in many of the forward-looking housing market data, the slower-reacting housing starts data remains fairly soft. Housing starts and permits beat estimates in April, both are still lower on a year-over-year basis. Total housing starts are lower by 1.3% over the last year, the first time this metric has seen negative growth since 2011. At this point, weakness in housing starts data is likely still reflecting soft conditions in late 2018, considering the lag between project conception and ground-breaking.
By nearly every metric, single-family housing markets remain significantly undersupplied. Household formations outpaced new housing starts by more than 100k in 2018 as the vacancy rate for both owner-occupied and renter-occupied homes reached multi-decade lows in the fourth quarter. The United States has been under-building homes since the early 1990s, and that trend of underbuilding has intensified dramatically since the housing bubble burst in 2008. A shortage rooted in sub-optimal public policy at the local, regional, and national levels, the US is building homes at a rate that is less than 50% of the post-1960 average after adjusting for population growth.
The secondary effect of this underinvestment in new home construction is that the average age of existing homes keeps getting older. The average physical age of an owner-occupied home in the US is nearly 40 years old, according to US Census data. Combined with significant deferred home improvement spending in the post-recession period, we think that these factors create very favorable demand tailwinds lifting the home improvement, homebuilding products, and home furnishings categories over the next decade.
Retail Sales Missed Estimates in April
After reaching the fastest rate of growth since 2012 in the middle of last year, retail sales growth has generally moderated over the past several months, and data was weaker than expected in April following a strong prior month. On a trailing twelve-month basis, total retail sales climbed to 4.3%, powered largely by a jump in spending at gasoline stations, but also by a mild acceleration in the brick-and-mortar categories. Non-store (e-commerce) retail sales have moderated to sub-10%-growth levels for the first time since 2016. Even with the weak end to 2018, the brick-and-mortar retail category grew at the strongest full-year rate since 2015.
Particularly relevant to the housing markets are the hardline retail categories which include building and home improvement as well as furniture sales. These two categories accelerated from early 2017 through mid-2018 but have moderated considerably since last summer, corresponding to the broader slowdown in the US single-family housing markets. Indicated by strong price performance from the Home Furnishings and Home Improvement sectors this year, however, optimism is high that sales in these sectors will recover alongside a potential recovery in housing data.
While hardline and food retailers tend to be somewhat immune from e-commerce related disruption, softline and specialty retail categories are generally more at-risk. During the so-called "retail apocalypse" of 2016-2017, these categories were particularly weak but recovered nicely in 2018. Growth has generally moderated so far in 2019, particularly in the primarily mall-based categories including department stores, sporting goods/hobby, and electronics. Clothing continues to see solid but moderating growth. Strong earnings results from Walmart (WMT) and Macy's (M) kicked off an important earnings season for retailers.
Interestingly, data from Thasos Group has indicated that foot traffic at mall REITs, derived from mobile phone location data at all REIT properties, have notably improved over the last year, and particularly over the last several months. We recently published Mall REITs: Catch A Falling Knife. The bifurcation between top-tier and lower-tier mall REITs continues to widen. For high-productivity malls, however, the metrics are stronger than the stock performance suggests. Occupancy remains around 95% and leasing spreads averaged 10% in 2018 as the long-term outlook remains solid.
The rate of e-commerce market share growth is particularly relevant to the retail REIT sectors, as well as the flip-side of the coin, the logistics and distribution-focused industrial REIT sectors which stand to benefit from growth in e-commerce. E-commerce remains a relatively small slice of total retail sales at roughly 10% but represents nearly 20% of at-risk categories which exclude automotive, gas, and food. The relevant statistic to watch, in our view, is the rate of e-commerce market share gains. From 2013 to 2016, e-commerce market share gains were accelerating, corresponding with calls for the retail apocalypse, but have moderated over the last two years as brick-and-mortar retailers found relatively more success in attracting customers through the doors.
So far in 2019, REITs are now higher by nearly 18% on a price-return basis while Homebuilders are higher by nearly 30%, bouncing back after their worst year since 2008 for each sector. The S&P 500 and small-cap Russell 2000, meanwhile, have each climbed 14% on the year. At 2.39%, the 10-year yield has retreated by 29 basis points since the start of the year and is roughly 85 basis points below peak levels of 2018 around 3.25%. Energy prices including crude oil and gasoline have recovered strongly this year after sharp declines in late 2018.
This week, we published Storage REITs: When Business Is Too Good It Becomes A Problem. The operating efficiency and relative simplicity of the self-storage business is second to none in the real estate sector, where properties can break even at sub-50% occupancy rates with sub-par management. For self-storage REITs, the business is almost too good. Developers and new operators have flocked to the sector in recent years, adding new supply at a furious rate, weakening fundamentals.
Last week, we published Single-Family Rentals: REITs Flex Their Muscle. Single-family renting is a tough, capital-intensive, and low-yield business. Through market-level scale and operating efficiency, however, single-family rental REITs have cracked the code to profitably manage rental homes. The institutionalization of the single-family housing market is a trend in the early innings. The home buying, selling, and renting business is being fundamentally disrupted by technology and Big Data. A growing share of new single family housing starts are being built specifically for renting.
Bottom Line: REITs Climb In Risk-Off Rally
REITs climbed more than 1% this week, extending their 2019 outperformance over the major indexes. Ongoing trade tensions and geopolitical uncertainty have strengthened investor demand for the domestic-focused REIT sector. Lower benchmark yields continue to provide a strong economic backdrop for real estate outperformance. The 10-year yield and 30-year mortgage rate are each flirting with nearly 18-month lows.
Housing Starts and Homebuilder Sentiment data beat expectations this week as lower yields and strong recent growth in household formations point to a solid recovery in 2019. Homebuilders jumped nearly 2%, but Homebuilding Products and Home Furnishings firms were hit by fears over rising input costs from tariffs even after news of progress on the USMCA.
Retail sales stumbled in April, but have held-up rather well in 2019 following a slowdown in late 2018. Strong results from Walmart and Macy’s kicked-off earnings season for retailers. Next week will be an important week of housing data with Existing Sales data released on Tuesday and New Home Sales data released on Thursday.
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Disclosure: I am/we are long Z, PGR, HCP, VTR, MAA, W, WELL, KBH, TPH, PHM, VNQ, WMT. 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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