Real Estate Weekly Review
Citing indications of slowing global economic growth and still-nonexistent inflation, the Federal Reserve cut short-term interest rates for the first time since 2008. Perhaps the most closely-watched Fed meeting since "lift-off" in December 2015, the 25 basis point cut was well choreographed by the committee but commentary during the subsequent press conference was seen by most as less "dovish" than expected. Compounded on Friday by threats of additional tariffs on China, US equities delivered their worst week of 2019 with the S&P 500 (SPY) dipping more than 3% and the Nasdaq (QQQ) dropping more than 4%. Interestingly, despite the "hawkish" stance by the Fed, long-term bond yields in the US and globally plunged with the 10-year yield dropping the most in seven years.
The domestic, defensively-oriented REIT sector was among the few gainers on the week with the broad-based REIT ETFs (VNQ and IYR) gaining more than 1% led by a jump in the data center, cell tower, and storage REIT sectors. Earnings season for the REIT sector has generally been better-than-expected with nearly two-thirds of the sector beating estimates with an impressive 50% of names raising full-year guidance.
On the week, the Hoya Capital US Housing Index, which tracks the GDP-weighted performance of the US Housing Industry, finished the week lower by 1.3%, led to the upside by the residential REIT and homebuilding sectors. Like the commercial REIT sector, earnings season has been strong for the housing sector as the industry continues to recover from a "mini-housing recession" in 2018. Homebuilder DR Horton (DHI) continued the streak of better-than-expected earnings from the nation's largest single-family builders with order growth increasing 6%. Redfin (RDFN), Restoration Hardware (RH) and Trex (TREX) were each higher by at least 4% on the week following Q2 results. Tariff concerns, however, weighted on the home building products, home improvement, and home furnishings sectors. This past week's pending home sales and home price data, which we discuss below, was better-than-expected as the positive effects of lower mortgage rates are finally beginning to show up in the most closely-watched data sets.
On the commercial REIT side, strong earnings propelled the data center and storage REIT sectors. Following weak results from CoreSite (COR) last week, data centers were powered higher this week by beats and solid leasing results from Digital Realty (DLR), Equinix (EQIX), and QTS (QTS). Storage REITs, which have struggled over the past two years on oversupply concerns, were buoyed this week by strong results from ExtraSpace (EXR) and Public Storage (PSA). As we discussed in our Cell Tower REIT report this week, "For 5G, 4 Is Better Than 3", American Tower (AMT), Crown Castle (CCI), and SBA Communications (SBAC) delivered another stellar quarter and investors are hopeful that already strong fundamentals may improve further by developments in the T-Mobile and Sprint merger, which requires the creation of a fourth competitor, Dish Network (DISH).
Peak earnings season for the real estate and the housing sector continues for the next two weeks Earnings season continues for the next two weeks with next week's slate highlighted by Realty Income (O), Omega Healthcare (OHI), Host Hotels (HST), Realogy (RLGY) and Beacon Roofing (BECN).
Real Estate Economic Data
Job Growth Beat Estimates in June
With all eyes on the Fed, jobs data was generally in-line or slightly better than forecast. Following a strong June for jobs growth, the BLS reported that total nonfarm payrolls rose 164k in July, precisely in line with consensus estimates. Earlier in the week, the ADP reported a 156k rise in private payrolls, slightly ahead of estimates. Overall, the pace of job creation has slowed following a mid-cycle reacceleration in 2018, which was led by the goods-producing sectors including manufacturing and construction. Nonfarm payrolls have risen by just over 1.5% over the past year after flirting with 2% growth in mid-2018, a slowdown that, in our view, can be partially ascribed to overly restrictive monetary policy guidance in late 2018 and into early 2019 as well as trade-related uncertainty.
While job growth has moderated since the reacceleration in 2018, growth in average hourly earnings has continued to accelerate since early 2018, rising 3.2% in July. Contrary to the popular political narrative, lower-income wage brackets have actually seen the strongest wage growth over the past two years. Core PCE inflation data released earlier in the week showed that inflation rose just 1.6% in June as inflationary pressures remain muted following a brief inflation scare in early-to-mid 2018. The BEA's measure of incomes also beat expectations this past week with nominal personal incomes rising just shy of 5% over the past year. Real wage growth, as measured by real average hourly earnings or real disposable personal income per capita, remain near cycle-highs.
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 1.8%, 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 16,000. The mining and logging industry lost a combined 4,000 jobs in June. Goods-producing sectors contributed 15k jobs to the 164k total jobs added in June.
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 another 3,600 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 38,000 and 30,000 jobs last month, respectively.
For retailers, the more significant issue over the last two years has not been on the demand side, but rather on the expense side. Before even considering the margin hit from tariffs and excess inventory, labor costs have risen considerably over the last two years as eighteen states raised their minimum wage in 2018 and many cities (largely in already high-cost markets) have raised minimum wages over the last two years, oftentimes far above market rate, which has begun to result in retail job cuts and store closures. Hourly earnings surged to 5% in early 2019, outpacing the roughly 3% growth in retail sales, while retail has been negative on a year-over-year basis for all of 2019.
Home Prices Rising, But Not Quite As Fast
Home price appreciation moderated meaningfully from mid-2018 through early 2019, but has shown early signs of stabilization and even reacceleration in recent months amid a favorable backdrop of lower mortgage rates. The Case Shiller National Home Price Index showed a 3.4% year-over-year gain in May, the lowest rate of growth since 2012, but the pace of slowdown has all-but-stopped in recent months. Faster-responding home price data series have started to reflect stronger conditions in recent months. As we discussed last month, we think that homebuyers appear to have a short window of opportunity where sellers' pricing expectations have trended lower as headlines reflect this "stale" home price data, as we expect pricing to stabilize and perhaps reaccelerate by late 2019 given recent mortgage market conditions.
As discussed previously, personal income data was also released this week, which came in better-than-expected at nearly 5% growth on a year-over-year basis. Unlike average hourly earnings data which includes only wages, the personal income measure also includes non-wage benefits such as proprietors' income, dividends, interest, and government benefits. As shown below, home price appreciation has generally tracked disposable personal income per capita growth over the past three decades, but prices have outpaced income growth in the post-recession period amid a lingering undersupply of housing in many major markets. Housing costs - already the single largest spending category for the average American - have accounted for a growing share of total household spending over the past several decades, amplified by the growing housing shortage affecting many major metropolitan markets. That said, unlike in the "housing bubble" period, home prices are not significantly out-of-line with total income growth (indexed to 1995) following the steep post-recession correction in home values. This suggests that upward pressure on home price could very well continue well into the next decade, particularly given the very favorable demographic wave of millennials entering the housing markets in full-force during the 2020s.
Since mid-2018, relative softness in the single-family housing markets has been largely offset by strength in the rental markets, powered by 2.2 million new household formations in 2018, the strongest rate of household formation growth since 1982. Data from Zillow Research showed that multifamily and single family rent growth accelerated in June to the highest year-over-year rate since 2016. According to NAREIT, same-store net operating income (NOI) growth for Residential REITs climbed to 4.4% in 1Q19 on a trailing twelve-month basis, the highest rate of NOI growth since 2016.
As expected, the relatively high-tax coastal markets have been among the weakest performing housing markets following the 2017 tax reform which capped state and local tax deductions, significantly raising the total cost of ownership for high-priced homes in these markets. Among the top-65 housing markets according to Zillow Data, ten of the eleven worst-performing housing markets are in states that rank within the top-10 in WalletHub's ranking of states with the highest total tax burden.
After surging through the first few months of this year, the gains have been harder to come by for the REIT sector over the last quarter. Following a strong week of relative performance, however, REITs have regained their YTD outperformance over the S&P 500. The broad-based REIT indexes are up by roughly 20% YTD while the S&P 500 has climbed 17%. The US Housing sector has climbed 21% this year led by the 33% surge in Homebuilder stocks. At 2.86%, the 10-year yield has retreated by 83 basis points since the start of the year.
This week, we published Cell Tower REITs: For 5G, 4 Beats 3. The long-anticipated marriage between T-Mobile (TMUS) and Sprint (S) appears more certain than ever after clearing regulatory hurdles from DOJ and FCC, setting-up a final battle with state attorney generals. An unexpected coup for cell tower REITs, the approval is conditional on the facilitated creation of a fourth competitor. Dish’s (DISH) viability as a national carrier, however, is an unknown wildcard. For cell tower REITs, four competitors are better than three, and three beats two. Even if Dish’s ambitious plans fail to materialize, a strong combined T-Mobile avoids a possible duopoly. Dish needs a well-capitalized partner or acquirer to have any real shot at success, something that T-Mobile negotiators have walked a tight-rope with regulators to try to prevent.
We also published Manufactured Housing REITs: Beat, Raise, Repeat. Perhaps the biggest beneficiaries of the mounting housing shortage, the Manufactured Housing REIT sector, which includes Equity Lifestyle (ELS), Sun Communities (SUI), and UMH Properties (UMH) has continued their stellar run into 2019. The already sector-leading fundamentals have improved further this year. Surging nearly 30% so far this year, the manufactured housing REIT sector is on pace to outperform the REIT index for a remarkable seventh straight year. As the most affordable non-subsidized housing option in most markets manufactured housing demand has benefited from the long-awaited acceleration in wage growth among blue-collar workers. Home sales of manufactured housing and RV units, however, were not immune to the housing market slowdown last year.
On the most closely-watched Federal Reserve interest rate decision since “lift-off” in December 2015, US stocks delivered their worst week of the year. The S&P 500 dipped more than 3%. Seen by investors as a “hawkish” cut, commentary on the decision suggested that monetary policy would less accommodative than hoped. Global bond yields plunged on fears of further economic slowing.
While global economic indicators continue to show signs of meaningful slowing, solid payrolls and income data suggest that US will again have to be the engine of global growth. Following an otherwise firm week of US economic data and earnings, hopes of a trade truce with China were dashed on Friday as the US threatened additional tariffs. The domestic, defensively-oriented REIT sector was among the few gainers on the week. REITs rallied on strong earnings and on the biggest plunge on the 10-year yield in seven years.
Following a furious few weeks of economic data, the economic calendar goes on it's "August vacation" so-to-speak next week with a slow week of notable news. JOLTs data is released on Tuesday while PPI data is released on Friday.
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Disclosure: I am/we are long VNQ, AMT, COR, DHI, DLR, ELS, EQIX, EXR, HST, KBH, LEN, OHI, PSA, QTS, RDFN, RH, RLGY, SPY, SUI. 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.
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