Good News Becomes Bad News For REITs

Summary

  • Done deal. US equity markets closed a wild week at fresh record highs after the U.S. and China clinched a long-awaited "Phase One" trade deal to avert tariffs on Sunday.
  • Along with a decisive election victory in the UK, the trade deal seems to resolve two critical geopolitical uncertainties. Investors, however, remain skeptical after endless false-starts in the trade dispute.
  • Good news has seemingly become bad news for the domestic, defensively-oriented REIT sector, which was on pace for a banner year before losing altitude over the past two months.
  • With potential clarity on key macroeconomic uncertainties, investors fear a return of the "rates up, REITs down" paradigm that dogged the REIT sector for 2016 through 2018.
  • For now, the "Goldilocks" macroeconomic environment under which REITs thrive remains intact. CPI and PPI data this week continued to reflect muted inflationary pressure.
  • This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

Real Estate Weekly Outlook

A wild 24 hours of geopolitics appeared to resolve months of macroeconomic uncertainty both in the U.S. and across the pond, sending domestic equity markets to fresh record highs. Just two days before the planned punitive tariff hike on Sunday, the U.S. and China agreed to a limited trade deal that signaled a temporary truce in the escalating trade dispute between the two largest economies. In the United Kingdom, a decisive election victory for the conservatives all but assured a U.K. "Brexit" from the European Union, removing a lingering cloud hanging over the Eurozone.

real estate news

(Hoya Capital, Co-Produced with Brad Thomas through iREIT on Alpha)

For the third straight week, the S&P 500 ETF (SPY) finished at record weekly closing highs, climbing 0.8% on the week and bringing the large-cap index's total returns to just shy of 30% for the year. Good news has seemingly become bad news for the domestic, defensively-oriented REIT sector, which was on pace for a banner year before losing altitude over the past two months. The broad-based Real Estate ETF (VNQ) finished the week lower by nearly 3% with the most yield-sensitive sectors including net lease and healthcare down by 5% or more on the week.

real estate weekly

As discussed in our recent Real Estate Earnings Report, REITs aren't bonds, but they sure act that way at times. The near-lockstep correlation between the broad-based Real Estate ETF (VNQ) and the 10-Year Treasury Yield (IEF) has been a continuing theme throughout the post-recession period and hasn't shown any signs of letting up in 2019 explained in part by the high degree of passive ownership of REIT shares. Correlations between individual REITs tend to be even more elevated in periods like these with significant macroeconomic headlines. This week's laggards included mall REITs: Washington Prime (WPG) and CBL & Associates (CBL); healthcare REITs: Medical Properties (MPW) and Healthpeak (PEAK); and net lease REITs: Spirit Realty (SRC), W.P. Carey (WPC), all of which were off by more than 5%.

rate up reits down

Less than 10 REITs in our coverage of 150+ names ended the week in positive territory, led by hotel REITs: DiamondRock (DRH), Park Hotels (PK), and Host Hotels (HST). Office REIT SL Green (SLG) ended higher by more than 2% after Amazon (AMZN) signed a new lease for 335,000 square feet in Manhattan's Hudson Yards neighborhood in one of SL Green's office properties. Cell Tower REITs including American Tower (AMT) and Crown Castle (CCI) also finished higher as all eyes turn to the ongoing merger trial which is seen as the final hurdle in the Sprint (S) and T-Mobile (TMUS) merger.

Even as the 10-Year Treasury Yield (IEF) finished the week essentially unchanged, with potential clarity on key macroeconomic uncertainties, investors fear a return of the "rates up, REITs down" paradigm that dogged the REIT sector for 2016 through 2018. For now, the "Goldilocks" macroeconomic environment under which commercial and residential real estate equities thrive remains intact. Top-performers among equity sector ETFs this week included the Technology (XLK), Consumer Discretionary (XLY), and Financials (XLP) sectors while the Commercial Real Estate (XLRE), Consumer Staples (XLP), Healthcare (XLV), and Utilities (XLU) sectors lagged.

invest in real estate

Housing Sector Looks To Continue Positive Momentum

This week, we published Homebuilders: Rejuvenation Set To Continue Into 2020. For the 10 homebuilders in our coverage, third-quarter earnings were impressive, to say the least. While revenue growth rose just 3% from last year, the most closely-watched forward-looking metric, net order growth, significantly exceeded expectations, rising more than 15% from last year confirming that lower mortgage rates and resilient demographic-driven demand are indeed translating into improved order growth, and at a rate stronger than even many of the most bullish analysts predicted. Commentary on earnings calls was decidedly positive with most builders noting momentum continuing in the weeks since quarter-end.homebuilder earnings

Homebuilders remain an unloved sector, still trading at deep discounts to historical and market multiples despite double-digit earnings growth. Homebuilders have increasingly shifted into entry-level segments where projected demand growth is strongest. Luxury homebuilder Toll Brothers (TOL) reported earnings that beat estimates on the top and bottom line including an 18% jump in order growth, but remains the far-and-away weakest-performing builder in the sector this year. Homebuilders focusing on the entry-level product have generally outperformed this year, led by KB Home (KBH), Meritage (MTH), D.R. Horton (DHI), NVR (NVR), PulteGroup (PHM), and Lennar (LEN), all of which are up more than 50% this year.

For homebuilders, it's all about the "5 Ls": lending, lumber, labor, land, and legislation, and in 2018, all five of these factors were stiff headwinds. Most notably, for lending, higher mortgage rates pushed affordability to cycle-lows while lumber, labor, and land costs were all significantly higher throughout the year. Legislation - through tax reform and the continued challenges on the zoning and permitting front - may have been the most significant headwind of all given the reduction in homeownership incentives associated with doubling the standard deduction and the State and Local Tax deduction cap. Helping to power this year's recovery, at least two of these headwinds - lending and lumber - have become significant tailwinds in 2019 with mortgage rates flirting with historic lows and lumber and other construction materials prices pulling back significantly after hitting record highs in 2018.5 l

Real Estate Economic Data

real estate economic data

Inflation Remains Cool Despite Tariffs

CPI and PPI data this week continued to reflect muted inflationary pressure. Producer price inflation was cooler-than-expected in November as Core PPI was flat on a month-over-month basis and was higher by just 1.3% year-over-year, the smallest gain since September 2016. Also this week, the BLS released Core CPI data, which was in line with estimates with the year-over-year rate remaining steady at 2.3%. While some analysts had expected a tariff-related uptick in inflation, the effects of Chinese currency depreciation and a more general moderating in global economic activity have overwhelmed any upward pressure on US consumer prices so far in 2019.

inflation november 2019

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%. Consistent with earnings results from the apartment REITs and private-market data showing solid rent growth since late 2018, CPI Shelter remains well above the broader rate of inflation at 3.3%. Primary rents rose 3.7% on a year-over-year basis while Owner Equivalent Rents rose 3.3%. CPI: Shelter has now been above 3% for more than 50 consecutive months.

housing inflation 2019

Retail Sales Missed Estimates in November

Total retail sales in the US increased less than expected in November, though the monthly data may have been impacted by the relatively late Thanksgiving holiday. Other reports from private data providers have painted a brighter picture, however, with Adobe Analytics reporting double-digit gains in Black Friday and Cyber Monday sales in the prior week. Total retail sales rose 0.2% month-over-month and are higher by 3.3% from the same month year, shy of consensus economists' estimates of 3.4% year-over-year gains. E-commerce sales jumped 11.5% from last year, continuing a period of reacceleration that began in early 2019. Sales growth at brick and mortar stores, however, has continued to slow throughout 2019. Brick and mortar categories were higher by just 1.6% year-over-year and recorded the lowest rate of TTM growth since 2010.

retail sales september

E-commerce and auto-related retailers recorded the strongest rate of growth last month. Five of the ten brick and mortar categories recorded a sequential decline in sales with department stores, clothing and health/personal care retailers seeing the most pronounced declines over the last month. Sales at department stores and clothing retailers are now lower by 7.2% and 3.3%, respectively, from the same month last year. Standouts to the upside in November were the electronics and appliance retailers and the food and beverage category.

real salesAs discussed this week in our report on the mall REIT sector, softline (clothing and accessories) and specialty retailers have weakened considerably in 2019 after seeing relatively robust growth last year. During the so-called "retail apocalypse" of 2016-2017, these categories were particularly weak. After recovering nicely throughout 2018, these softline and specialty retailers have again fallen on tougher times this year as the rate of store closures - particularly in the clothing and softline categories - has again reaccelerated. Lower-productivity mall REITs including CBL & Associates (CBL) have been hit especially hard by this year's slowdown, as the company was forced to suspend its dividend on both common and preferred stocks last week.

softline retail category

While nearly 90% of total retail sales are still completed through the traditional brick-and-mortar channels, e-commerce sales account for roughly a fifth of "at-risk" retail categories, which exclude food, auto, and gasoline sales and brick-and-mortar retailers have been losing share at a rate of roughly 1% per year. The market share loss has been even more significant for the traditionally mall-based retail categories including department stores, clothing, sporting goods/books, and electronics retailers. Beneficiaries of the trend toward e-commerce include industrial REITs like Prologis (PLD) and Duke Realty (DRE), which we discussed in a recent report titled Industrial REITs: We Love Logistics.

e-commerce mall REITs

2019 Performance Recap & Sector Reports

With this week's underperformance, the broad-based commercial real estate indexes are now higher by 21% YTD on a price basis, lagging the 27% gains on the S&P 500. The residential real estate sector, however, continues to hold onto outperformance with the Hoya Capital Housing Index higher by more than 28% so far in 2019, led by the 52% gain from the single-family homebuilders. At 1.82%, the 10-year Treasury yield has retreated by 87 basis points since the start of the year and is roughly 140 basis points below peak levels of 2018 of 3.25%.

invest in real estate

In addition to our report on the homebuilding sector, we also published Self-Storage REITs: Storage Wars Wage On. Once a perennial top-performer in the REIT sector, developers and new operators have flocked to the sector in recent years, adding new supply at a furious rate, weakening fundamentals. 2019 was shaping up to be a strong year for the sputtering self-storage REIT sector, but 3Q19 earnings were a setback on the road to recovery. Competition remains fierce in an oversupplied market. Symptomatic of the ongoing storage wars, marketing spending jumped nearly 60% from last year for these REITs, pressuring same-store NOI growth to essentially zero.self-storage REIT fundamentals

Pressured by these rising expense line items, the previously high-flying self-storage sector has seen a steep drop-off in same-store NOI growth since peaking in early 2016 at above 10%. On a trailing 12-month average, as reported by NAREIT's T-Tracker, same-store NOI growth ticked to the slowest rate of growth since 2010. While the self-storage REIT sector has historically shown a high degree of correlation with the residential REIT sector, the performance of the two categories has diverged since 2018 with residential REITs now seeing some of the strongest same-store NOI growth across the real estate sector.

self-storage REIT same-store NOI growth

Next Week's Economic Calendar

It'll be another busy week of economic data, highlighted by a flurry of housing data including NAHB Homebuilder Sentiment on Monday, Building Permits and Housing Starts on Tuesday, and Existing Home Sales on Thursday. Housing has been one of the bright spots for the US economy over the past six months with signs of continued reacceleration across most home sales and construction metrics since early summer. Building Permits reached new 12-Year highs in October while Housing Starts are higher by 8.5% compared with a year ago in October on a seasonally-adjusted annualized basis. Last month, Existing Home Sales were higher by 4.6% year-over-year in October, marking the fourth straight month of year-over-year increases in existing sales. We'll also get a third look at 3Q19 GDP as well as some income and inflation data with PCE and personal income data on Friday.

real estate economic 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.

Announcement: Hoya Capital Teams Up With iREIT

Hoya Capital is excited to announce that we’ve teamed up with iREIT to cultivate the premier institutional-quality real estate research service on Seeking Alpha! Sign-up for the 2-week free trial today!

This article was written by

Hoya Capital profile picture
29.55K Followers
Build sustainable portfolio income with premium dividend yields up to 10%.

High YieldDividend Growth • Income. Visit www.HoyaCapital.com for more information and important disclosures. Hoya Capital Research is an affiliate of Hoya Capital Real Estate ("Hoya Capital"), a research-focused Registered Investment Advisor headquartered in Rowayton, Connecticut. Founded with a mission to make real estate more accessible to all investors, Hoya Capital specializes in managing institutional and individual portfolios of publicly traded real estate securities, focused on delivering sustainable income, diversification, and attractive total returns. 

Collaborating with ETF Monkey, Retired Investor, Gen Alpha, Alex MansourThe Sunday Investor, and Philip Eric Jones for Marketplace service - Hoya Capital Income Builder. 

Nothing on this site nor any commentary published by Hoya Capital is intended to be investment, tax, or legal advice or an offer to buy or sell securities. Neither the information, nor any opinion, contained on this website or any published commentary by Hoya Capital constitutes a solicitation or offer by Hoya Capital or its affiliates to buy or sell any securities, nor shall any such security be offered or sold to any person in any jurisdiction in which such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction. No representation or warranty is made as to the efficacy of any particular strategy or fund, or the actual returns that may be achieved.

Investing involves risk. Loss of principal is possible. Investments in real estate companies and/or housing industry companies involve unique risks. Real estate companies, including REITs, may have limited financial resources, may trade less frequently and in limited volume, and may be more volatile than other securities. Many factors may affect real estate values, including the availability of mortgages and changes in interest rates. Real estate companies are also subject to heavy cash flow dependency, defaults by borrowers, and self-liquidation. The housing industry can be significantly affected by the real estate markets. Compared to large-cap companies, small and mid-capitalizations companies may be less stable and their securities may be more volatile and less liquid.

There are also unique risks associated with investing in ETFs. Shares may be bought and sold in the secondary market at market prices and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Although it is expected that the market price of an ETF will approximate the Fund's NAV, there may be times when the market price of an ETF is more than the NAV intra-day (premium) or less than the NAV intra-day (discount) due to supply and demand of the ETF or during periods of market volatility.

Before acquiring the shares of an ETF, it is your responsibility to read the fund's prospectus. The prospectus to the ETFs in which Hoya Capital advises are available at www.HoyaETFs.com.

An investor cannot invest directly in an index. Index performance does not reflect the deduction of any fees, expenses, or taxes. The information and any index data presented do not reflect the performance of any fund or other strategies or accounts managed or serviced by Hoya Capital, and there is no guarantee that investors will experience the type of performance reflected.

Data quoted represents past performance, which is no guarantee of future results. The views and opinions in all published commentary are as of the date of publication and are subject to change without notice. There is no guarantee that any historical trend illustrated will be repeated in the future, and there is no way to predict precisely when such a trend will begin.

Commentary and data are believed to be accurate, but we cannot guarantee it's accuracy. We do not represent that it is a complete analysis of all factors and risks. It should not be relied upon as the sole source of suitability for any investment. Please consult with your investment, tax, or legal adviser regarding your individual circumstances before investing.

Decisions based on information contained on this site or any commentary published by Hoya Capital are the sole responsibility of the reader, and in exchange for using this website or reading any published commentary, the reader agrees to hold Hoya Capital harmless against any claims for damages arising from any decisions that the reader makes based on such information.

Hoya Capital has no business relationship with any company discussed/mentioned. Hoya Capital never receives compensation from any company discussed/mentioned. Hoya Capital, its affiliates, and/or its clients and/or its employees may hold positions in securities or funds discussed on this website and our published commentary. A complete list of holdings is available and updated at www.HoyaCapital.com.

Follow

Disclosure: I am/we are long VNQ, STOR, PLD, AMT, AMZN. 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: Hoya Capital Real Estate advises an ETF. In addition to the long positions listed below, Hoya Capital is long all components in the Hoya Capital Housing 100 Index. It is not possible to invest directly in an index. Real Estate and Housing Index definitions and holdings are available at HoyaCapital.com.

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.

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.