From bad to worse. There were few places to hide on another punishing week for global equity markets as the coronavirus-related shutdowns continued to wreak havoc on the global financial system. Tremors of instability turned into outright earthquakes as a mounting wave of government-mandated shutdowns spread across the globe, pushing millions of Americans out of jobs and into the unemployment lines. Despite unprecedented monetary policy action by central banks and promises of substantial fiscal stimulus, a forthcoming recession appears inevitable and unavoidable based on the magnitude of the economic shutdowns, but hopefully short-lived before it can inflict lasting and potentially permanent damage on the American economy.
Following a decline of nearly 10% last week, the S&P 500 ETF (SPY) plunged another 15% while the Dow Jones Industrial Average (DIA) dipped another 4,000 points on the worst week for U.S. stocks since 2008. Those declines, however, paled in comparison to the sharp sell-off in any and all real estate-related equities. Following declines of 12% last week, the broad-based commercial Real Estate ETF (VNQ) plunged by nearly 25% in by-far the worst single-week for REITs with nearly half of all REITs lower by 30% or more on the week. The Mortgage REIT ETF (REM), meanwhile, dipped by nearly 40% amid a violently volatile week that saw the forced liquidation of several leveraged mortgage REIT-tracking exchange-traded notes.
Despite an emergency 100-basis-point rate cut by the U.S. Federal Reserve last Sunday night, it was a similarly brutal week for credit as investment-grade and high-yield corporate bonds fell by the most since the depths of the financial crisis despite a slight decline in the 10-Year Treasury Yield (IEF) to close at 0.94%. Investors fled risk assets and liquidated into cash while funds from across the world flowed into safe-haven U.S. dollars. Among equity sector ETFs, there was not necessarily a rhyme or reason to the liquidity-driven trading action as all eleven GICS sectors were lower by at least 11% on the week with real estate equities dragging on the downside.
As discussed in our recent special coronavirus crisis report, for real estate, this time should be different compared with the struggles faced by the sector during the financial crisis based on underlying fundamentals, but the market clearly thinks otherwise. Despite the fact that most REITs have been exceedingly conservative in their balance sheet management and strategic decisions in the post-recession period, REITs have plunged by more than 40% over the last month while single-family homebuilders have dipped nearly 50% in moves that are more sharp and sudden than those seen during the financial crisis. The S&P 500, meanwhile, is lower by nearly 32% over the last month from recent highs back in February, the sharpest 30% drawdown ever.
The nearly 25% dip in the broader REIT index actually looks relatively attractive compared to the downright bloody week for dozens of individual REITs that plunged more than 40%. Mall REIT stalwart Simon Property (SPG) plunged nearly 50% after announcing the closure of all of its properties until March 29th, a move that was soon followed by fellow mall REITs. Billboard REIT Outfront Media (OUT) dipped nearly 60% on the week on the assumption that advertising budgets will be the first to get slashed amid an economic downturn. Net lease REITs, generally a safe haven during a garden-variety recession, continue to be pounded due to their exposure to experience-based retail and restaurant categories, underscored by EPR Properties (EPR) plunge of 45% this week.
Good riddance? The intense market volatility claimed a handful of victims today in the real estate exchange-traded note (ETN) space. Three leveraged real estate ETNs have liquidated over the past two week, returning cash to shareholders but amplifying the intense volatility seen this week in the mortgage REIT sector in the meantime with names like Annaly (NLY) and New Residential (NRZ) exhibiting wild price action throughout the week. Two of the leveraged ETNs to close this week - MORL and MRRL - tracked a 2x-leveraged index of mortgage REITs while one of the ETNs - HOML - tracked a 2x-leveraged homebuilder index. We speculate that other leveraged ETNs in the sector (both bullish and bearish) are at risk of closure in the weeks ahead.
As have many Americans, we've been tracking the coronavirus outbreak since mid-January when it began spreading the Chinese city of Wuhan. While data through early March suggested that the outbreak could potentially be contained given the relative success of China, South Korea, Singapore, and Japan, the outbreak has unfortunately intensified and spread through Western Europe, which has seen a concerning intensification of the outbreak, particularly in Italy. The United States - and rest of the world - is seemingly at a crossroads between two paths. It could go the east Asia route, where economic activity has already returned to relative normalcy within weeks of the outbreak, or it could be like Western Europe, in which the outbreak appears certain to send major European economies into a damaging recession.
Below, we analyze the most important macroeconomic data points over the last week affecting the residential and commercial real estate marketplace.
One of the most real-time indicators of labor market conditions is initial jobless claims data, and the normally overlooked data every Thursday morning will surely become a closely watched report in the coming weeks. Prior to the coronavirus crisis, initial and continuing jobless claims data were at or near historically-low levels. Jobless claims data is lagged one week, so this week's report reflects data compiled through the end of last week. Initial jobless claims climbed to 281,000 last week, not as bad as many economists feared. Next week's report is expected to show a historic (but hopefully temporary) jump that could easily top 1.5 million to 2.5 million. By comparison, the single-week peak during the financial crisis was 665,000.
U.S. housing markets were red hot into late February before the coronavirus crisis and absent the outbreak. 2020 was poised to be a huge year for the U.S. housing industry as lower mortgage rates and millennial-led demographic-driven demand had spurred an uptick in much-needed home construction activity over the prior 10 months amid a lingering housing shortage across most major markets. Housing Starts came in at 1,599 thousand units in February, beating estimates of 1,500 thousand while the prior month was revised higher. Total housing starts were higher by 39.1% in February, the strongest rate of year-over-year growth since 2012. Despite reaching cycle-highs in early 2020, however, housing starts are still below the 1970-2010 average of 1,600 thousand and substantially below the pre-crisis peak of roughly 2,200 thousand.
Existing Home Sales also beat expectations in February, rising to post-recession highs at 5.77 million, representing a 7.3% year-over-year growth rate, the strongest since 2016. The strong end of 2019 and start of 2020 for U.S. housing industry came after one of the worst eight-to-12-month periods for home construction and home sales since the financial crisis that we dubbed the "mini-housing-recession." This industry recession, interestingly, flew under the radar amid an otherwise strong year of economic growth in 2018 and was driven almost entirely by rising mortgage rates, which peaked above 5.0% in late 2018. After dragging on GDP growth for six straight quarters before 3Q19, the rejuvenation of the housing industry was poised to be a significant contributor to economic growth in 2020.
This strong data was consistent with Tuesday's homebuilder sentiment data, which remained quite strong in the NAHB's March report. Survey data was compiled from the end of February and early March during the early outset of the outbreak but before the wave of shutdowns of major swaths of the U.S. economy. The Housing Market Index ticked lower to 72 from 74 in the prior month, just shy of record highs of 76 set in December, but a sizable drop should be expected in the April data on fears that Boston's shutdown of construction projects could be a template of things to come if the CV-19 outbreak intensifies further. Additionally, this week the Trump administration asked construction companies to donate their inventories of N95 masks to local hospitals and to stop ordering more, suggesting that some further restrictions may be forthcoming if the outbreak cannot be contained.
Despite the strong end to the decade, the 2010s will be remembered as a decade of historic underbuilding, which should provide an additional buffer to support home price valuations and occupancy in the U.S. housing sector. Despite a US population nearly double the size of the 1960s, the US produced 30% fewer housing units, pressuring vacancy rates of both rented and owned units to historic lows in early 2020 compared with historically high vacancy rates in the run-up to the financial crisis in 2008.
Combined with the significant deleveraging seen across the housing sector during the past decade and the forthcoming government support through fiscal stimulus and mortgage relief, there is ample reason to believe that the U.S. housing markets should be a source of stability to buffer the blows of a potential recession. As we discussed last week, owing to years of tight mortgage lending conditions and a generally slow post-recession recovery in homeownership, the housing market has undergone a "great deleveraging" over the last decade. At the end of 2019, the mortgage debt service payment ratio as a percent of disposable income reached the lowest level on record at 4.12%.
The housing industry entered this period of uncertainty on stable footing amid this lingering undersupply of housing and a decade of deleveraging, a vastly different fundamental environment than the pre-crisis period. Despite this, the market is pricing in substantial, lasting pain for the housing sector which we view as fundamentally unwarranted and a reflection of expectations that this recession will be substantially similar to the 2008 recession. We continue to see significant value in these housing-related names and believe that in any reasonable scenario from the coronavirus outbreak, that the long-term secular growth story of limited supply and strong millennial-led demographic-driven demand remains a compelling long-term investment thesis.
Retail sales data, particularly in the brick-and-mortar segments, were surprisingly solid in February during the early onset of the CV-19 outbreak according to Retail Sales data on Tuesday from the US Census Bureau. Total retail sales were higher by 4.3% on a year-over-year basis in February, boosted by upward revisions to the prior months. Excluding auto and gas, retail sales were higher by 4.4% from last year. On a seasonally adjusted year-over-year basis, brick and mortar sales were higher by 3.7% in February, the strongest growth in nearly two years while e-commerce sales were higher by 7.5%.
The strongest retail segment in the February report was the Miscellaneous category, which surged 14.8% from the same period last year. On a year-over-year basis, the building material and garden, food service and drinking, and grocery stores recorded the strongest growth while the department stores and electronics retailers recorded the weakest growth. Data in March, however, is likely to see historically large month-over-month declines in essentially every category besides food & beverage stores and e-commerce amid the wave of regional and state-level shutdowns. The coronavirus pain will be felt across the "softline" retail sector - clothing, electronics, sporting goods/books - after the dust settles. The extent of the damage will hinge on the length of the coronavirus shutdowns and could, unfortunately, be the final "nail in the coffin" for many struggling retail locations and restaurants.
REITs are now lower by roughly 35% this year compared with the 23% decline on the S&P 500 and 33% decline on the Dow Jones Industrial Average. Homebuilders, meanwhile, are lower by more than 50% and are trading at historically low valuations based on a P/E and P/B. The top-performing REIT sectors of 2019 have continued their strong relative performance through the early stages of 2020 including data centers, cell towers, industrial, and manufactured housing REITs. At 0.95%, the 10-Year Treasury yield has retreated by a remarkable 98 basis points since the start of the year and is 230 basis points below recent peak levels of 3.25% in late 2018.
This week, our partner Brad Thomas published a report that examined the sector-by-sector exposure to the coronavirus crisis. The "stress test" scored each of the REIT sectors based on three metrics: average leverage metrics (debt/market value and EBITDA coverage), FFO payout ratio, and CV-specific sector risk. We concluded that the manufactured housing, timber, cell tower, and single-family rental sectors were among the least-exposed across these metrics while the lodging, gaming, billboard, and mall sectors were among the most at-risk. Of course, within each sector, individual REITs have very different leverage and payout metrics, but the analysis serves as a useful guide to drive sector-level allocations amid the evolving CV-19 outbreak.
On that point, we recently published "Manufactured Housing: Find Shelter Amid Volatility." The most affordable housing option in most markets, regulatory impediments to housing supply growth have supported sector-leading NOI growth for MH REITs, which has averaged more than 6% since 2015. Beyond the sector-leading internal growth, external growth through acquisitions and site expansions provide an added boost. While competition has heated up, these REITs command a superior cost of capital. Strong internal and external growth resulted in core FFO growth averaging 8.0% in 2019, making for the fourth straight year of over 8% growth.
While it'll again be surely overshadowed by the continued coronavirus coverage and discounted as backward-looking, it'll be another busy week of economic data, highlighted by New Home Sales data on Tuesday and the blockbuster Initial Jobless Claims data on Thursday which could reach as high as 2.5 to 3 million. PMI data will be released on Tuesday while on Wednesday, we'll see Home Price data from the FHFA. The week concludes with Personal Income and Spending data from February on Friday, along with Consumer Sentiment data for March.
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, Manufactured Housing, Student Housing, Single-Family Rentals, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Shopping Centers, Hotels, Billboards, Office, Storage, Timber, and Real Estate Crowdfunding.
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