Another week, another record high. Each of the three major US equity indexes climbed to new record highs on the week, with the S&P 500 (SPY) breaching 3,000 for the first time ever on a busy week of inflation data and Fed Chair Powell's testimony to Congress. Despite slightly warmer-than-expected inflation data, the Fed Chair reiterated that easier monetary policy was needed to address signs of cracks in the global economic recovery and stimulate inflation back towards their 2% target. Outside of rising housing costs, which was largely responsible for this month's slight pickup in inflation, CPI excluding Shelter has averaged less than 1% over the past half-decade.
After rallying more than 2.5% last week, the broad-based REIT ETFs (VNQ and IYR) traded sideways on the week, ending the week lower by 0.1%. Somewhat remarkably, it was just the 7th down-week for REITs out 28 weeks so far in 2019, highlighting the consistent strength exhibited by the REIT sector this year. The residential REIT sectors led the way, with the student housing, single-family rental, and storage REIT sectors each climbing more than 1.5%. The industrial, hotel, and timber REIT sectors were the relative laggards on the week. After dipping below 2% earlier this month, the 10-year yield (IEF) has climbed in each of the past two weeks, ending the week higher by 6 basis points as oil prices surged another 5% on the week as the roller-coaster ride for commodity investors this year continues.
On the week, the Hoya Capital US Housing Index, which tracks the performance of the US housing industry, finished the week higher by 1.1%, jumping to another new record high. The housing sector was led by a nearly 4% surge in the Homebuilding (XHB and ITB) sector and strong gains in the Home Improvement Retail sector. This week, homebuilder M.D.C. Holdings (MDC) reported preliminary Q1 results that smashed estimates, reporting that net new home orders increased 32% to 2,273, largest quarterly percentage increase since 2012. Analyst sentiment has been shifting positively on the homebuilding and broader housing sector as expectations rise for a reacceleration in home sales and home construction activity into year-end following a weak 2018 and early 2019, powered by the retreat in mortgage rates.
Earnings season kicks off next week across the real estate and housing sectors with reports from Prologis (PLD), Crown Castle (CCI), NVR (NVR), PPG (PPG), and a bevy of regional and global banks. As we discussed in our Real Estate Earnings Recap from last quarter, the 'REIT Rejuvenation' has restored the coveted NAV premium for REITs, giving these companies the currency to re-open the acquisition pipeline which had essentially shut down since 2017. First-quarter earnings results were generally better-than-expected across most real estate sectors. Growth metrics inflected higher and generally rose throughout 2018 after bottoming at the end of 2017.
The highlight of the past quarter was a reacceleration in property-level same-store NOI metrics, which jumped to 2.72% from an eight-year low of 2.16% last quarter. Despite continuing to battle a somewhat crippling cost-of-capital disadvantage for most of the past two years, REITs recorded FFO/share growth of 2.9% on a TTM-basis after declining by as much as 4% in 2017. With an improved cost of capital, we expect to see improving growth metrics across the REIT sector in 2019.
Inflation was - and remains - the key threat to potentially ending the nearly decade-long economic recovery. Rising oil prices, along with rising costs from tariffs and trade disputes, had put upward pressure on inflation throughout 2018, pushing both the 10-year yield and 30-year mortgage rates to post-recession highs. The plunge in oil prices in late 2018, along with moderating global growth - perhaps in part related to the Fed's controversial rate hike at the end of 2018 - has quelled much or all of that inflationary pressure. Following several months of cooling, both core CPI and PPI data released this week were slightly warmer-than-expected. However, the Fed's most closely-watched inflation gauge, Core PCE, ticked lower last week to just 1.6%, far below the Fed's 2% inflation target.
As we noted in the introduction, behind this month's unexpected tick higher in Core CPI was a jump in housing costs. Housing (CPI: Shelter) accounts for more than a third of the total CPI weight (42% including housing-related services), and since 2013, housing inflation has been significantly above the overall inflation rate. From 2015 through late 2016, housing inflation was one of the only components keeping Core CPI out of deflationary territory, and since 2013, core inflation excluding housing has averaged less than 1%. Housing inflation has reaccelerated over the last several months after moderating slightly in 2018. Consistent with recent private-market rent growth data showing a reacceleration in rents since late 2018, at 3.9%, Primary Rents climbed to the highest rate of growth since August 2017.
The importance of housing costs on the overall price index cannot be overstated. Since 1995, shelter inflation has outpaced the broader rate of inflation by more than 1% per year, fueled by a persistent supply shortage in the most in-demand US housing markets. Over the last three decades, structural impediments to supply growth, aggravated by the dramatic dislocations during the housing crisis, have dramatically slowed the rate of housing starts per capita. On a rolling 10-year average, residential fixed investment as a share of GDP is the lowest since the end of WW2. The implications of this housing shortage, we believe, will be a continued persistence of "real" housing cost inflation and a long runway for growth in residential housing construction in order to equalize the supply/demand imbalance.
JOLTs data fell slightly short of estimates in May at 7.32 million job openings compared to the 7.47 million expected. Confirming recent payrolls data from the BLS and ADP, the rate of job creation has undoubtedly slowed in 2019 following a period of reacceleration last year. Hires are higher by 3.7% over the last year, as the number of job openings continues to outnumber the total amount of unemployed Americans in the labor force by more than a million. The spread between the rate of job openings growth and hires has widened since early 2018, however, a sign that labor shortages may be developing.
On that point, confirming anecdotal evidence and commentary from homebuilders, JOLTs data suggests that the construction industry is having an increasingly difficult time sourcing skilled labor, a continuing headwind for the industry. Construction job openings have surged more than 44% while construction hiring has risen a more modest 3.3% over the past year. The surge in job openings, however, has historically been a good leading indicator of construction spending and home building activity.
The rate of voluntary quits continues to rise, matching the highest level of this economic expansion, a sign of increased labor market dynamism and an indication that workers are feeling more confident about their financial situation. The lack of labor market dynamism in the post-recession period has been blamed for weak productivity growth and there is hope that the uptick in the quit rate may foreshadow future productivity gains as workers pursue jobs that better maximize their skills.
After surging through the first few months of this year, the gains have been harder to come by for the REIT sector. REITs have given up their relative outperformance compared to the broader indexes, but REITs remain higher by nearly 20% YTD on a price basis and more than 22% on a total return basis. The S&P 500, meanwhile, is higher by 20% and the Nasdaq is higher by 25%. The US Housing sector has climbed 23% this year led by the 31% surge in Homebuilder stocks. At 2.11%, the 10-year yield has retreated by 58 basis points since the start of the year and is roughly 110 basis points below peak levels of 2018 around 3.25%.
This week, we published Data Center REITs: It’s Getting Cloudier. The home of the "cloud," Data Center REITs are the physical epicenter of the continued boom in outsourced IT spending, a long-term secular growth story with years to run. 5G will only accelerate the offloading of computing power from physical devices to "insanely efficient" data centers, allowing devices to be smaller, less powerful, and be less prone to obsolesce. On the back of a record-setting 2018, however, global IT spending has slowed in 2019 as businesses temper growth plans, citing macroeconomic uncertainty. We discussed and analyzed the five largest data center REITs: Equinix (EQIX), Digital Realty (DLR), CyrusOne (CONE), CoreSite (COR), and QTS Realty (QTS).
We also published Timber REITs: Can’t Ignore This Growth Sector. Timber REITs are the newest addition to our coverage universe. Timber REITs own 20 million acres of timberlands, more land than the five smallest states in the US combined. Timber REITs are the link connecting the commercial real estate sector to the residential homebuilding sector. Residential construction is responsible for roughly half of wood product consumption in the US. We discussed and analyzed the four timber REITs: Weyerhaeuser (WY), Rayonier (RYN), PotlatchDeltic (PCH), and CatchMark Timber (CTT).
Lumber prices peaked in May 2018 on supply shortages in the Pacific Northwest and the ongoing softwood lumber dispute with Canada. Prices have plunged 40% since last Spring. Long-term fundamentals look strong for the timber REIT and broader housing sectors, powered by demographic trends that suggest a revival of the suburbs and single-family housing in the 2020s and the aging of the US housing stock, which we expect to be a multi-decade secular tailwind for the home building products and materials sector.
Led by strength in the US housing sector, it was another record week for US equities as the S&P 500, Nasdaq, and Dow each climbed to new record highs. Homebuilders jumped nearly 4% on the week, pushing their YTD gains back above 30%. Boosted by lower mortgage rates, forward-looking metrics indicate that the housing market is heating back up.
Confirming anecdotal evidence and commentary from homebuilders, JOLTs data suggests that the construction industry is having an increasingly difficult time sourcing skilled labor, a continuing headwind for the industry. REITs traded sideways on the week with residential REITs leading the way after inflation data showed that rents are climbing at the fastest rate since 2017. Outside of rising housing costs, inflation data remains benign. After months of cooling, CPI data was slightly warmer than expected due largely to an acceleration in shelter inflation.
Housing Starts and Permits data on Wednesday highlights next week’s economic calendar. Housing starts data beat estimates last month, led by a jump in multifamily starts to the highest monthly rate since 2016. Interestingly, while home sales data and mortgage demand data have accelerated over the past quarter, single-family starts and permitting data has been comparatively soft to this point. Other notable economic data points next week include Homebuilder Sentiment and Retail Sales data on Tuesday.
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