Real Estate Weekly Outlook
So much for that relaxing summer vacation. The volatile summer for global markets continued this past week as Friday's steep sell-off erased what would have been the first weekly gain for the S&P 500 (SPY) since late July. While European and Asian economies continue to show signs of stress, however, the US economy continues to chug along. Economic data was generally better-than-expected this week with strong housing data and a tick lower in jobless claims, although PMI data cooled more than expected. The highlight of this week was on the earnings front with strong results from Home Depot (HD), Target (TGT), and Lowe's (LOW), each strong indications that the US consumer remains resilient despite increased market volatility.
As we've been discussing for several months, the 'Goldilocks' economic conditions of low interest rates, modest new supply growth, and still-solid domestic economic growth have been an ideal macroeconomic backdrop for the long-middling REIT sector. While the broad-based REIT ETFs (VNQ and IYR) dropped 0.5% last week, it marked the fourth straight week of outperformance for the sector. The S&P 500, meanwhile, dropped 1.4% on the week while the Nasdaq (QQQ) declined 1.8%. REITs are outperforming the S&P 500 by roughly 8% so far this year, although there has been a wide 60% gap between the best and worst performing real estate sectors, cell tower and mall REITs, respectively.
On the week, the Hoya Capital US Housing Index, which tracks the GDP-weighted performance of the US Housing Industry, finished the week higher by 0.8% after touching all-time record closing highs on Thursday. As we'll discuss in more detail below, lower mortgage rates have revived the single-family markets following the worst year for the homebuilding sector since 2008. Last month, existing home sales recorded their first year-over-year increase in sales in seventeen months while the upwardly revised rate of new home sales in June was the strongest in twelve years. As mentioned above, strong earnings results from the home furnishings and home improvement retailers powered this week's gains.
Ironically, the global economic slowdown has been a boon for the domestic-focused commercial and residential real estate sectors, which continue to outperform as interest rates continued their sharp decline with the 10-year yield now lower by a remarkable 170 basis points since last November. As we'll discuss more detail in our earnings recap next week, the residential and technology REIT sectors were the standouts of a better-than-expected 2Q19 REIT earnings season that saw an impressive 50% of REITs raise full-year guidance expectations, well above the recent second-quarter averages.
On that point, last week we published our update on the single-family rental sector: Renting The American Dream. Whether they’re renting or owning, the maturing millennial generation will enter the single-family housing markets in full-force in the 2020s in a magnitude not seen since the 1970s. Over the last decade, single-family rentals have become the de-facto “starter home” as rising home values and tight credit conditions have made homeownership a mounting challenge. In the report, we discussed how a rising share of new construction is being built specifically for renting and why we remain bullish on the maturing single-family rental REIT sector.
Last week, we also published our quarterly update on the apartment sector, Apartment REITs: Roaring Rents. If you thought the rent was “too damn high” already, wait until your next renewal letter. It’s a good time to be a landlord yet again as all seven major apartment REITs raised 2019 same-store net operating income and FFO guidance in the second quarter. Apartment rent growth reaccelerated last quarter to the highest rate since 2016; however, the rent acceleration has been led by the secondary markets of which REITs are generally underweight. Among REIT-heavy markets, Boston, San Francisco, Atlanta, and Washington, DC have seen the strongest rent growth in 2019.
Real Estate Economic Data
Home Sales Data Beats Estimates
While homebuilder earnings results and most other forward-looking metrics have indicated for some time that a housing market recovery is on tap for 2H19, the slower-reacting home sales data had been stubbornly slow to reflect these improved conditions. Well, patience is a virtue, as the pickup in single-family housing market activity is finally being reflected in the sales data. Existing home sales data beat estimates, recording its first year-over-year increase in sales since late 2017, rising 0.6%. New home sales also beat expectations after accounting for June's huge upward revision, which was the strongest rate of growth in 12 years. New home sales are now higher by 4.3% year-over-year on a seasonally-adjusted basis.
For the first time since early 2018, inventory levels of both new and existing homes are again retreating, and we expect this retreat in inventory to again put upward pressure on home values following a period of moderation that began in mid-2018. Inventory levels were building throughout all of last year as mortgage rates rose sharply and homebuilders had some mild difficulty dealing with an excess supply of newly completed homes. Corresponding with the sharp pullback in mortgage rates, inventory levels have been on a continuous decline since late 2018, which may keep a lid on the growth potential of existing home sales.
As we discussed in our quarterly update on the homebuilding sector, in the market-level home price data and the new home sales regional data below, we note the divergence between the weak-performing coastal markets and the better-performing sunbelt markets. Feeling the effects of tax reform and the cap on SALT deductions, home sales in the relatively high-tax Northeast and West Census regions continue to lag the national averages. Seemingly taxed into oblivion over the last several decades, the Northeast region now accounts for less than 5% of total new home sales while the South Census region accounts for more than 50% of new home sales. Over this time, the Northeast has generally been the most challenging region for developers to build due to restrictive zoning and a more hostile regulatory regime. Demographics are especially weak in the northeast markets where boomers outnumber millennials by nearly 20%, adding extra headwinds on home values and home sales over the next decade.
Tracking the 10-year Treasury yield, the 30-year fixed mortgage rates dipped to the lowest level since 2016 last week. At 3.55% according to Freddie Mac, mortgage rates are a steep 140 basis points below their peak last November. While low inventory levels of single-family homes has blunted some of the impacts of lower rates, the MBA Purchase Index, a useful leading indicator of new and existing home sales, remains higher by nearly 10% over the past six months compared to the prior six months. The real activity has been in the refinancing market, where sharply lower rates have sparked a refinancing boom. For the second straight week, the MBA Refinancing Index surged to the highest level since late 2016 and is higher by roughly 75% over the past six months.
As we've been discussing since February despite a wave of bearish sentiment on the housing markets, we continue to view the slowdown in 2018 and forecasted reacceleration in 2019 as more akin to the post-taper-tantrum conditions of 2014 and 2015 than to anything like the pre-bubble period of 2007. In the wake of the "taper tantrum," the 30-year mortgage rate shot higher by 120 basis points, prompting a significant slowdown in single-family housing data over the next year before bouncing back strongly in 2015 as rates again pulled back. Over the past decade, there has been a very strong correlation between changes in mortgage rates and growth in new home sales, as highlighted in the chart below.
The continuing theme of the post-recession period has been the lingering underinvestment in new home construction. New home sales peaked in 2015 at an annualized rate just shy of 1.3 million and bottomed in 2011 at a rate of 300k. While existing home sales quickly recovered most of the lost ground after the housing crisis, new home sales remain far below even 1990s levels. Besides continued tight supply in the single-family markets, a secondary effect of the relative underinvestment in new single-family homes is the aging of the housing stock. The median age of a single-family home in the US is nearly 40 years old according to the American Community Survey, the oldest on record.
2019 Performance Recap
After giving back their YTD outperformance 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 14% gains on the S&P 500 and the 18% gains on the Nasdaq. The US Housing sector has climbed 21% this year led by the 37% surge in homebuilder stocks. At 1.53%, the 10-year yield has retreated by 116 basis points since the start of the year and is a remarkable 170 basis points below peak levels of 2018 around 3.25%.
This week, we discussed the worst-performing real estate sector so far this year, mall REITs, in our quarterly update: Get Busy Livin' or Get Busy Dyin'. Store closings have unexpectedly surged in 2019 as the combination of higher minimum wages, tariff-related cost pressures, and heavy discounting have pressured margins at softline retailers. The bifurcation between top-tier and lower-tier mall REITs continues to widen. While some malls are thriving, we believe that dozens of low-productivity malls are a recession away from extinction.
On that point, there's been a huge disparity in performance between REIT sectors this year with a 62% gap between the best and worst-performing sector, cell towers and mall REITs. This week, we co-authored a report, You Can Do Better Than VNQ, discussing this disparity and the implications for investors of using a single ETF to represent one's entire allocation to the real estate asset class. Among other findings, we discussed how utilizing a single fund discounts these vast differences of investment characteristics and that real estate ETF investors and financial advisors can significantly enhance investment outcomes through portfolio customization.
Week Ahead: Home Prices & Income Data
The week ahead will be another busy week for economic and housing data. Durable goods orders kicks off the busy week on Monday while Tuesday will see both the Case Shiller and FHFA home price indexes. Pending home sales, which is a forward indicator of existing home sales, will be released on Thursday. The second revision to Q2 GDP data is released on Thursday and those closely-watched personal income and consumer spending data are released on Friday, along with PCE inflation data.
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, Shopping Centers, Hotels, Office, Storage, Timber, and Real Estate Crowdfunding.
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Disclosure: I am/we are long VNQ, TGT, HOME, LOW, BBBY, OSTK, HD, WSM, KBH, LEN, RP, INVH, AMH, SPG, TCO, EQR, AVB, UDR, AIV, CPT, MAA. 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.