Real Estate Weekly Outlook
While far from the "grand bargain" trade deal that seemed possible many months ago, a trade truce this week between the US and China was welcome news for investors after weeks of escalating trade tensions that bled into mainstream American sports and entertainment culture.
An agreement on a rough "phase one" of a deal framework averted another round of planned tariffs on Chinese goods, but will likely only scratch the surface of addressing the larger underlying structural issues between the two largest global economies.
The status quo isn't too bad for the US economy at this point, which has reasserted itself as the engine of global growth, nor is it bad for US consumers, who have seen minimal net inflation impact from this year's tariffs while job growth and wages continue to show decent strength.
US equity markets ended a three-week losing streak following news of the trade truce, with the S&P 500 (SPY) gaining 0.7% and the Nasdaq (QQQ) gaining 1.2%. REITs and other defensive and yield-sensitive equity sectors, which have been among the most robust outperformers in 2019, sold-off on signs of easing tensions. The broad-based REIT ETF (VNQ) declined by 0.4%, dragged down by the data center, office, and net lease REIT sectors. The 10-Year yield jumped 23 basis points as the yield curve shifted back to positive territory.
The Hoya Capital US Housing Index, the benchmark that tracks the performance of the US Housing Industry, climbed to new record highs this week, gaining more than 1% despite a retreat in the homebuilders (ITB) and residential REITs (REZ) as higher rates pressured the more yield-oriented sectors. After two quiet weeks for housing data, the economic calendar ramps up again with Housing Starts and Homebuilder Confidence released next week. Single-family housing data completed the 'Perfect Month' in September with better-than-expected results in all six of the major housing data releases.
While it was a quiet week of housing data and earnings reports, the home furnishings sector jumped more than 5% this week, led by a nearly 30% surge in Bed Bath & Beyond (BBBY) after the company named Mark Tritton, CMO at Target (NYSE:TGT), as the company's new CEO to lead the turnaround efforts, a move that was applauded by investors and analysts. Home improvement retailers including Home Depot (HD) and Lowe's (LOW) also delivered a strong week, as did Restoration Hardware (RH), American Woodmark (AMWD), and Williams-Sonoma (WSM). The earnings calendar next week includes homebuilder NVR (NVR) and home building products producer PPG (PPG).
REIT earnings season kicks off next week with reports from Prologis (PLD), SL Green (SLG), Crown Castle (CCI), and Brandywine (BDN). After sliding from 2016 through 2018, REIT growth metrics have reaccelerated over the past several quarters. FFO and dividends per share grew at the fastest rate since 2016 as an improved cost of capital has finally re-opened the external growth channel, which we'll explain in greater detail below.
FFO per share grew an impressive 6.5% over the past year while dividends per share rose nearly 4%. 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.
The "REIT Rejuvenation" of 2019 has restored the coveted NAV premium for most sectors, giving these REITs the currency to re-open the acquisition pipeline which had essentially shutdown since 2017. 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
Inflation Data Cools After Warm Summer
CPI inflation data showed signs of cooling in September following a mild acceleration this summer. Headline CPI and Core CPI both missed estimates at 0.0% and 0.1%, respectively, on a month-over-month basis. Dragging on the headline data, food and energy prices remain in deflationary territory as oil prices remain lower by nearly 30% from the same time last year.
Core CPI rose 2.36% on a year-over-year basis, retreating from last month's 12-year high of 2.40%. Earlier in the week, the BLS reported Producer Price Index data for September. Core PPI decelerated sharply to 1.99% after perking higher last month. Released last week, at 1.73%, Core PCE is still below the Fed's "symmetrical" inflation target of 2.0%.
Housing costs continue to be the primary driver of what little overall inflation that there is. 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 20 basis points of multi-decade highs and at 3.8%, Primary Rents are within 10-basis points of 12-year highs.
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.
Jobs Market Remains Resilient
Following a generally solid - but softening - week of employment data last week, headlined by a 136k rise in nonfarm payrolls in September, the U.S. Bureau of Labor Statistics reported job openings and labor turnover (JOLTS) data this week, which gives a more detailed snapshot of hiring trends. Job openings were little changed in August, coming in at 7.1 million versus expectations of 7.2 million.
While still a solid reading, August's reading was the lowest level since March 2018. After peaking at a growth rate near 20% in late 2018, the rate of growth in job openings have been trending lower this year, consistent with cooling job growth seen across most labor market metrics.
The rate of voluntary quits has continued to rise this year, a sign of increased labor market dynamism and an indication that workers are still feeling confident about their financial situation. Despite several announced layoffs that are given extensive media coverage, the rate of involuntary layoffs remains near record lows. Within separations, the quits rate was largely unchanged at 2.3%, and the layoffs and discharges rate was unchanged at 1.2%.
On that point, initial and continuing jobless claims haven't shown any real signs of cracks this summer as both metrics remain near historic lows. After trending slightly higher this summer, the 4-week moving average of initial jobless claims is again flirting with historical lows at around 214k. Meanwhile, at 1,684k, continuing jobless claims remain near the lowest level since 1973 as the prior week's revised report was just 1k above historical lows of 1,654k.
Overall, while job growth has certainly moderated following a reacceleration in 2018, the "recession" narrative appears far out-of-line with trends in the underlying data. We have yet to see any real signs of cracks in any of the major employment data sets, and if indeed a trade truce could stabilize the softening trends in the goods-producing sectors, we think the economy is on very solid footing heading into next year.
2019 Performance Recap
Despite this week's underperformance, the broad-based REIT ETFs have gained nearly 25% this year, continuing to outpace the S&P 500, which has climbed roughly 19%. Not all REITs are seeing the windfall, however, exhibited by the nearly 60% performance gap between the best- and worst-performing REIT sectors.
The US Housing sector has climbed 29% this year led by the 53% surge in Homebuilders. At 1.75%, the 10-year yield has retreated by 93 basis points since the start of the year and is roughly 150 basis points below peak levels of 2018 around 3.25%.
Next Week's Economic Calendar
With equity markets back within 2% of all-time record highs, and with positive developments on the trade and geopolitical front, suddenly the October Federal Reserve rate cut is no longer a done-deal. Rate hike odds dipped from above 90% at one point last week week to below 70% at one point on Friday afternoon before recovering to 75% as of Friday night, according to the CME FedWatch Tool.
It'll be a fairly busy week of economic data with Retail Sales and Homebuilder Sentiment data released on Wednesday and Housing Starts & Building Permits released on Thursday. Starts and Permits are each coming off their best months in more than 12 years, powered by the tailwinds of significantly lower mortgage rates and strong demographic-driven demand.
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Disclosure: I am/we are long BBBY, SNBR, AAN, HOME, RLGY, AOS, TJX, RH, AMWD, WSM, PLD. 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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