Real Estate Weekly Review
Bouncing back from four straight weeks of declines, the major US equity indexes (SPY) (QQQ) each jumped more than 4% this week as softer-than-expected economic data increased the likelihood of Federal Reserve rate cuts by the end of the year. The seemingly unflappable US labor markets revealed early signs of stress with both major jobs reports missing estimates by a wide margin, sending the benchmark 10-year yield to nearly two-year lows.
For now, the economic momentum from last year’s reacceleration appears to be enough to keep the machine chugging if trade tensions thaw and the late-Friday deal with Mexico to avoid tariffs lifted hopes that this will indeed be the case. If so, these potential ‘Goldilocks’ conditions of lower domestic interest rates coupled with slowing but still-solid economic growth have provided a favorable macroeconomic backdrop for domestic-focused REITs and the US Housing industry. 30-year mortgage rates have plunged so far this year, completely changing the affordability dynamics relative to this time last year. REITs (VNQ) and (IYR) underperformed on the week, climbing 2.5%, but remain the leaders in the clubhouse with roughly 20% gains so far this year.
On the week, the Hoya Capital US Housing Index, an index that tracks the performance of the broader US housing industry, jumped more than 3%, led by a surge in the Homebuilding, Homebuilding Products, and Real Estate Technology and Brokerage sectors. Home Furnishings retailers were the relative laggards on the week, continuing to face margin pressures from tariff concerns and the lingering effects off last year’s housing market slowdown. At Home Group (HOME) dived after reporting disappointing earnings, along with furniture maker La-Z-Boy (LZB). Double-digit weekly gains from Trex (TREX), Sherwin-Williams (SHW), and Whirpool (WHR) led the way on a strong week across most of the housing sector.
NAREIT, the REIT industry trade group, held their annual REITweek convention in New York City this week, a gathering of more than 100 REITs and several thousand analysts and investors. The general tone of conversations from both investors and REIT executives was noticeably more upbeat this year as the REIT Rejuvenation of 2019 has injected life back into the stumbling sector. Strong share price performance has restored the coveted NAV premium, giving these REITs the currency to re-open the acquisition pipeline which had essentially shut down since 2017, allowing REITs to maximize the advantages of their equity-raising structure. While news-making comments were in relatively short-supply, remarks from Mid-America (MAA) on robust rent growth trends post-Q1 earnings confirmed our view that momentum in the rental markets remains highly favorable. We recently published our Real Estate Earnings Recap: Housing REITs Lead Recovery. Following several years of floundering stock price performance, REITs have outperformed in 2019, boosted by receding interest rates and strengthening property-level fundamentals.
Real Estate Economic Data
Job Growth Beat Missed Estimates in March
A sign that trade tensions are indeed beginning to be felt outside of Wall Street and weigh on the real economy, jobs data missed estimates across both major releases this week, a rare hiccup for the otherwise relentless labor markets. Following two straight months of better-than-expected data, BLS nonfarm payrolls totaled just 75k in May, missing estimates of 185k while revisions to the prior two months subtracted another 75k. This weak print comes two days after ADP data showed that companies added the fewest jobs since 2010 as private payrolls climbed just 27k, well short of estimates of 180k.
Average hourly earnings ticked lower to 3.1% in May, slowing modestly after recording the fastest rate of growth since 2009 earlier this year. Core PCE inflation data released last week showed that inflation rose just 1.6% in April, as inflationary pressures remain muted after a brief scare in 2018. Real wage growth grew 1.5% in May, retreating slightly after hitting the strongest rate of growth since 2009 last month at 1.7%. 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 story of the last year's economic reacceleration was 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 two quarters. Job growth in the goods-producing sectors grew at a seasonally-adjusted rate of 2.1%, 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. Construction added 4,000 jobs last month while manufacturing added 3,000.
Job growth in the services sectors, which accounts for roughly 85% of total jobs in the US, has trended sideways since early 2017, but had seen several solid months of growth since late 2018. Continued weakness in the retail category, which lost 7,600 jobs last month, have reversed the recent positive momentum as analysts are fearing that the sector is showing signs of a "double-dip" following a brief recovery after the so-called "retail apocalypse" of 2016-2017. Hiring in the professional services and healthcare categories has seen solid and accelerating growth since late 2016, which added 33,000 and 16,000 jobs last month, respectively.
The traditional measure of unemployment, the U3 unemployment rate, remained steady at 3.6% in May while the labor force participation rate also remained at 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 begun to be unleashed by continued wage growth and 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. Residential construction spending is now lower by 1.7% on a TTM basis but private nonresidential spending has picked up since late 2018. As private spending has pulled back, however, infrastructure spending has seen a sudden resurgence. Public construction spending is higher by 8.6% 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.
So far in 2019, REITs are now higher by more than 19% on a price-return basis while Homebuilders are higher by more than 29%, bouncing back after their worst year since 2008 for each sector. The S&P 500 has gained just shy of 15% while the small-cap Russell 2000 has climbed 13% on the year. At 2.08%, the 10-year yield has retreated by 60 basis points since the start of the year and is roughly 1200 basis points below peak levels of 2018 around 3.25%. Energy prices including crude oil and gasoline, which jumped through the first five months of 2018, have given back roughly half of their YTD gains over the last month.
This week, we published Crowdfunding Real Estate vs. Real Estate ETFs. Promising efficient and low-cost access to private market real estate, more than 100 online real estate crowdfunding platforms have emerged over the last decade, raising billions of dollars from investors. While a handful of platforms represent meaningful innovation for a certain type of speculative and sophisticated real estate investor in one-off private market transactions, crowdfunding platforms have increasingly marketed their products to less sophisticated investors, utilizing the notoriously investor-unfriendly nontraded REIT model.
While we love the concept of making private real estate more accessible to more investors, and we think that the platforms offering deal-by-deal projects make sense for a relatively small class of sophisticated risk-seeking self-directed real estate investors, these firms make a series of misleading claims when comparing their inefficient and high-fee nontraded REITs to low-cost real estate ETFs. We analyzed the firm’s most recent annual report on their two largest nontraded REITs, the Income eREIT and the Growth eREIT and properly adjusted the estimated fees annual on a like-for-like basis.
For the vast majority of investors, publicly traded REITs and real estate ETFs represent the far more efficient investment vehicle. Publicly-traded REITs and ETFs each represent some of the most significant investor-friendly innovations of the past century.
Bottom Line: Fed Back in Play After Weak Jobs Data
Following four straight weeks of losses on the S&P 500, the major equity indexes rallied more than 4% this week as disappointing economic data increased the odds of rate cuts. Jobs data missed estimates across both major releases this week, a rare hiccup for the relentless labor markets. Trade tensions with China appear to be weighing on hiring.
With at least two rate cuts potentially in play this year, trade-related recession fears should be temporarily allayed by a deal with Mexico late-afternoon Friday to avoid tariffs. Homebuilders jumped more than 5% on the week as mortgage rates continue their retreat. The 10-year yield and 30-year fixed mortgage rate each dipped to nearly two-year lows. Still the leaders in the clubhouse so far in 2019, REITs underperformed the major indexes this week as the industry held their annual REITweek conference, which was positive but uneventful.
With jobs week wrapping up, the economic calendar turns to inflation and retail data next week. Inflationary pressure has remained muted since late 2018 but has begun to creep higher in recent months as oil prices rebounded from their lows last December. PPI is released on Tuesday while CPI comes out on Wednesday. Retail data, released on Friday, has softened in recent months after a relative resurgence throughout 2018. JOLTs data on Monday will round out next week’s major economic releases.
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Disclosure: I am/we are long TREX, SHW, WHR, CLGX, PPG, MAS, RMAX, OC, MHK, AOS, VNQ. 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.