Real Estate Weekly Outlook
The turbulence continues. US equity markets finished lower for the third straight week as the remarkable plunge in global bond yields continued with the 30-year yield retreating to new all-time lows. The rather modest 0.9% decline in the S&P 500 (SPY) masked the intra-week volatility that saw the Dow Jones Industrial Average (DIA) record its fourth-largest one-day point drop of all time on Wednesday. With much of Europe and Asia appearing to be on the brink of a recession, the weight of the world is seemingly on the still-strong US consumer. Strong retail sales data, a solid earnings season for domestic-focused companies, and improving housing market data boosted investor confidence that the US economy can withstand global weakness and perhaps come ahead in the recent spate of trade wars.
The domestic-focused and rate-sensitive equity sectors, particularly real estate and utilities, extended their 2019 outperformance this week as the 10-year yield continued its free fall. The broad-based REIT ETFs (VNQ and IYR) finished slightly higher on the week, pushing their outperformance relative to the S&P 500 to nearly 6% over the past four weeks and pushed their total return on the year to roughly 25%. The gains would be even higher absent the continued weak performance from the mall REIT sector, which dove another 4% on the week following soft earnings from department store giant Macy's (M) despite otherwise solid retail sales data. The residential and technology-focused real estate sectors led the gains this week.
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 1.0% led to the upside by the residential REIT sector, but dragged down by the home improvement retail and real estate technology and brokerage categories. As we'll analyze below, lower mortgage rates have done wonders to revitalize the stumbling US single-family housing market, which saw starts jump to the highest level since January even as multifamily construction activity pulled back this summer. Homebuilder sentiment climbed to the highest level this year while mortgage activity continues to surge, though primarily from the recent refinancing boom. At Home (HOME), Walmart (WMT), Trex Company (TREX), Realogy (RLGY) were the top performers on the week in the housing sector.
This week, we published our quarterly update on the apartment sector, Apartment REITs: Roaring Rents. It’s a good time to be a landlord yet again. Before 2019, renters actually enjoyed a brief reprieve from rising rents over the prior two years as landlords competed to fill a record number of newly completed high-end apartment units. That relief was short-lived as apartment rent growth reaccelerated last quarter to the highest rate since 2016 as all seven major apartment REITs raised 2019 same-store net operating income and FFO guidance in the second quarter. Multifamily construction has pulled back this year even as rental vacancy rates remain near multi-decade lows.
We also published our update on the office sector, Office REITs: WeWork's Reckoning. Despite a record 106 consecutive months of job growth, office REITs have been perennial underperformers in the post-recession period as the sector has struggled with weak pricing power. The rapid growth of co-working – highlighted by industry heavyweight WeWork – has been one of the more significant demand drivers over the past half-decade. WeWork’s (WE) upcoming IPO could be a moment of reckoning for the highly valued but fast-growing co-working sector, whose growth has been fueled by a seemingly limitless pool of venture capital funding. While office REITs themselves have minimal direct exposure to co-working firms, a slowdown in co-working leasing activity would come at a bad time as supply growth remains at cycle-highs.
Real Estate Economic Data
Housing Starts & Permits Remain Soft
Housing starts data missed estimates in July, as the headline data was dragged down by the second-straight weak month in the volatility multifamily segment. Housing permitting data was better-than-expected, however, and single-family housing starts actually jumped to the highest level since January, consistent with strong order growth and commentary from the largest single-family homebuilders. Total housing starts, however, remain lower by roughly 2% over the past twelve months. As we've continued to discuss, this recent moderation in home construction comes amid a period of robust demographic-driven housing demand as the US continues to see the effects of a lingering and mounting housing shortage.
With the slower-reacting data finally beginning to see the positive effects of lower mortgage rates, the more forward-looking housing market indicators continue to point to a solid back-half of 2019. Ahead of the closely-watched new and existing home sales data next week, homebuilder sentiment climbed to the highest level of this year. The current sales and buyer traffic sub-indexes each climbed to the highest level since last October. Consistent with home sales and starts data, the South and West regions continue to drive the gains while the high-tax Northeast region continues to lag. The divergence between homebuilder sentiment and growth in single-family housing starts has widened this year, suggesting that either homebuilders are overly optimistic or that single-family housing starts are set to recover following the slowdown in 2018.
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 primarily 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.
Retail Sales Solid in July, Powered By Amazon
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, but data has been relatively strong this summer despite the volatility seen in the financial markets. Retail sales beat estimates last month led by a surge in e-commerce sales, no doubt related to Amazon's (AMZN) Prime Day which did more sales volume on the site than Black Friday and Cyber Monday 2018 combined, according to Amazon. Brick and mortar retail sales have been decent but clearly slowing this year with the performance of individual retailers continuing to diverge, as illustrated by strong results this week from Walmart but comparative weak numbers posted by Macy's.
We recently published Retail REITs: Fears of Retail Apocalypse 2.0. Store closings have unexpectedly surged in 2019. 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 job growth has been negative on a year-over-year basis for all of 2019.
Inflation Perks Up On Rising Housing Inflation
Inflation expectations have trended lower across the globe this year, dragging down global bond yields along with it. 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. Moderating global growth has quelled much or all of that inflationary pressure, but consumer prices have firmed-up a bit this summer following several quarters of cooling. Core CPI was warmer-than-expected in July, coming in at 2.2% on rising housing inflation and firming goods costs. Core PPI and Core PCE, however, have generally trended lower since late 2018 as 10-year inflation expectations in the US retreated to the lowest level since 2016.
As we noted in the introduction, what's largely behind this summer's warmer-than-expected consumer inflation has been the leg higher in housing inflation. 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 roughly than 1%. Housing inflation has reaccelerated over the last several months after moderating slightly in 2018. Consistent with earnings results from the apartment REITs and private-market data showing a reacceleration in rents since late 2018, at 3.5% CPI: Shelter is within 10 basis points of multi-decade highs.
As discussed above, apartment rent growth reaccelerated last quarter to the highest rate since March 2016. A “perfect storm” of factors - rising wages, solid job growth, elevated mortgage rates last year, and lack of total housing supply - has rejuvenated the residential rental markets, even as multifamily supply growth remains relatively elevated. The Zillow ZRI Rent Index shows that rent growth in both the single-family and multifamily category jumped to the highest rate since 2016 despite moderating home price appreciation.
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.
2019 Performance Recap
After giving up their YTD gains earlier this summer, REITs have again gained the edge over the S&P 500 amid the sharp pullback in interest rates over the past several months. The broad-based REIT index is now higher by roughly 22% on a price-basis and 25% on a total return basis, outpacing the 15% gains on the S&P 500. The US Housing sector has climbed 20% this year led by the 34% surge in Homebuilder stocks. At 1.54%, the 10-year yield has retreated by 115 basis points since the start of the year and is a remarkable 170 basis points below peak levels of 2018 around 3.25%.
Bottom Line: REITs Extends Gains Amid Turbulence
On another wild week for financial markets amid a flurry of volatility, US stocks couldn’t quite claw back all of their early-week declines, ending lower for the third straight week. Record-low bond yields around the globe, including new historic lows on the US 30-year Treasury yield, helped to power the real estate sector to another week of outperformance.
Lower mortgage rates have revitalized the US single-family housing market, which saw starts jump to the highest level since January. Homebuilder sentiment and mortgage demand data was also solid. Strong retail sales data eased investor concern over the health of the US consumer, but industrial and manufacturing production data continues to show weakening demand for goods from abroad. Core inflation has unexpected perked up a bit this summer, primarily led by rising housing costs. The rise in CPI: Shelter is near the highest level in a decade.
With the slower-reacting data is finally beginning to see the positive effects of lower mortgage rates, the more forward-looking housing market indicators continue to point to a solid back-half of 2019. New and existing home sales data highlights the economic calendar in the week ahead.
If you enjoyed this report, be sure to "Follow" our page to stay up-to-date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Apartments, Homebuilders, Student Housing, Single-Family Rentals, Manufactured Housing, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Apartments, Shopping Centers, Hotels, Office, Storage, Timber, and Real Estate Crowdfunding.
Disclosure: I am/we are long VNQ, HOME, WMT, TREX, RLGY, SUI, OC, ESS, LPX, VTR, ELS. 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: I am/we are long EQIX, DLR, COR, 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.