Real Estate Weekly Outlook
Bad news sells papers and generates clicks. Take it from us, as our five most-read research reports of the past half-decade have been our five most bearish. While the financial and mainstream media pounds the recession drumbeat, the US consumer remains resilient and healthy, even in the face of persistent trade-related tensions and clear signs of slowing growth abroad. US equity markets snapped their four-week losing streak this week as economic data - particularly income and spending data - and better-than-expected retail earnings showed that the consumer-led US may be reasserting itself as the primary engine of global growth, an ideal "Goldilocks" macroeconomic scenario that is a favorable backdrop for continued outperformance from the domestic-focused commercial and residential real estate sectors.
The S&P 500 (SPY) climbed nearly 3% this past week, ending the volatile month of August down 2%, a relatively modest decline considering the sharp intra-day moves including two of the seven largest one-day point drops in the Dow Jones Industrial Average. Investors and consumers remain on edge as trade tensions between the two largest economies are likely to persist into 2020. Funds continue to flow into the domestic-focused, defensively-oriented sectors, including real estate and utilities. REITs (XLRE) and Utilities (XLU) were the lone equity sectors in positive territory for the month, each climbing about 4%. The four largest real estate ETFs have seen inflows of nearly $3 billion so far this year, which would be the best year of ETF fund flows since 2016 for the sector.
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 2.1%, ending within 1% of all-time record highs. The home improvement retail and home building products and materials sectors led the gains this past week. Timber REITs were among the standouts, which have benefited from more signs of accelerating home building activity, and given an extra boost by potential impacts in the Southeast related to Hurricane Dorian, which also gave a boost to Lowe's (LOW) and Home Depot (HD). Weyerhaeuser (WY), PotlatchDeltic (PCH), American Woodmark (AMWD) and Mohawk (MHK) were among the biggest gainers in the housing sector on the week. Manufactured Housing REITs, Equity LifeStyle (ELS) and Sun Communities (SUI), which hold sizeable portfolios in the Southeast US, were among the worst-performers this past week as the Dorian approached the East Coast.
This week, we published our Earnings Recap, The REIT Revival Is Real. The domestic-focused, defensively-oriented REIT sector has been a standout so far in 2019 following several years of middling performance. 2Q19 earnings results confirmed the positive momentum. Earnings season was better than expected. 60% beat FFO estimates, which was roughly in line with historical averages. An impressive 50% of REITs raised guidance, however, which was well above historical averages. Property-level metrics have been accelerating as well, helped by a slowdown in supply growth and resilient demand across most sectors. Same-store NOI growth jumped to 2.64% from the downwardly revised 2.45% last quarter.
As counterintuitive as it seems, elevated valuations are actually welcome news for REITs that have historically tapped the equity markets for capital to fuel external growth. For the first time since 2015, REITs are now trading at a Net Asset Value premium. This valuation premium has allowed REITs to kick-start external growth, which has historically been responsible for more than half of FFO per share growth across the REIT sector. REITs were net buyers again in 2Q19, buying $12.5 billion in assets while disposing of $6.6 billion. The $5.9 billion in net acquisitions was the largest quarterly "buy" since 4Q17, and we expect this trend to continue into 2020 given the favorable valuation environment.
Real Estate Economic Data
Housing Data Still Choppy But Trend Remains Positive
The US housing industry has quietly delivered a solid year despite a persistently negative overriding narrative of a "slowing" housing market. While overall housing data has turned decidedly positive this year, individual data points remain choppy, giving the financial media plenty of individual data points to cherry-pick. Don't believe us? New Home Sales recorded its strongest month in nearly twelve years in June on a seasonally-adjusted annualized basis and was higher by 4.3% compared with a year ago in July according to last week's data.
That didn't stop Reuters from printing the headline: "U.S. new home sales drop sharply, point to more housing weakness." While we appreciate that bad news pays the bills, we see more journalists pushing the boundaries in pursuit of this negative narrative to the detriment of investors and the broader public. After better-than-expected Existing Home Sales data in the prior week, Pending Home Sales data was softer-than-expected this past week, retreating 0.3% from the same period last year as low inventory levels continue to restrain potential growth in existing sales.
As we pointed out last week, 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.
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, as the median age of a single-family home in the US is nearly 40 years old according to the American Community Survey. The eventual realization of this trillions-of-dollars-worth of deferred home improvement spending has positive implications for companies involved in the home improvement and home building products sectors over the next decade.
Incomes Are Finally Outpacing Home Prices
Despite the growing drumbeat of recession warnings from the financial and mainstream media, the US consumer has shown signs of resilience in the face of slowing global growth. Consumer spending, which represents roughly two-thirds of US GDP, has shown early signs of reacceleration, following a slowdown in the second half of 2018. Personal income and spending data released this week was generally better than expected with personal incomes rising 4.6% and personal spending growing 4.2%. While consumers continue to see healthy wage growth, they are increasingly on edge, as both the Michigan Consumer Sentiment Index and Conference Board Consumer Confidence Index ticked lower in August.
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 3.1% year-over-year gain in June, 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.
While there is a consensus that, over the long term, home prices naturally exhibit a strong correlation with income growth, there is debate over which of the many income measures to use to evaluate affordability. 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. Taking it another step further, the disposable income measure looks at after-tax income, which has been boosted by the tax reform package of 2017.
As shown below, home price appreciation has tracked disposable personal income per capita growth most closely over the past three decades. By this measure, home prices have generally outpaced income growth in the post-recession period amid a lingering undersupply of housing in many major markets, but home prices are not terribly out of line with income growth. 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 above total income growth (Index:1995) following the steep post-recession correction in home values.
As we discussed in our recent report on the Homebuilding sector, 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.
2019 Performance Recap
With gains of nearly 22% so far in 2019, the broad-based REIT ETFs (VNQ and IYR) have significantly outperformed the S&P 500, which has climbed roughly 14%. Not all REITs are seeing the windfall, however, exhibited by the 60% performance gap between the best- and worst-performing REIT sectors. The US Housing sector has climbed 21% this year led by the 37% surge in Homebuilders (ITB). At 1.53%, the 10-year yield has retreated by 116 basis points since the start of the year and is roughly 170 basis points below peak levels of 2018 around 3.25%.
This week, we also published our quarterly report on the Self-Storage REIT sector. Self-storage units are the "Hotel California" of the real estate sector: once you’re checked in, "you can never leave." A sticky tenant base has supported the sector despite record supply growth. Storage REITs hit "rock bottom" in 2018 and have turned the corner since then. Storage REITs have jumped nearly 30% this year as 2Q19 earnings continued the positive momentum. Self-storage rent growth continues to closely track the multifamily sector, which has seen a notable reacceleration since mid-2018.
Week Ahead: Jobs Data & PMIs
The economic calendar this coming week is highlighted by employment and PMI data. While the consumer has shown signs of resilience, the US manufacturing and industrial sector has slowed more significantly over the last year following a strong reacceleration through 2018. Sometimes forgotten is that industrial and manufacturing production already had a significant contraction during this recovery between 2014 and 2016 before reaccelerating after the 2016 election and the tax reform package of 2017. Manufacturing PMI data is released on Monday, as is construction spending. ADP employment data is released on Wednesday while BLS data is released on Friday with expectations of around 160k in job growth.
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Disclosure: I am/we are long VNQ, AMWD, HOME, LPX, COST, HBAN, MHK, RF, LOW, BBBY, PCH. 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.
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