Reopening Rally Sputters On 'Second Wave' Fears

Summary

• U.S. equity markets retreated this week following a frenzied "reopening rally" as investor attention - and the media spotlight - returned to the coronavirus pandemic amid concerns of a "second wave."
• Reminiscent of the "risk-on/risk-off" trading pattern seen during the early stages of the last post-crisis recovery, trading action over the past few weeks has exhibited a clear "reopening vs. stay-at-home" paradigm.
• The S&P 500 dipped by 4.7% on a volatile week that saw the large-cap index briefly climb into positive territory for the year before hitting a stretch of mid-week turbulence.
• After surging by 11% last week amid a historic rally, the broad-based equity REIT ETFs finished lower by 5.4% with all 18 property sectors in negative territory while Mortgage REITs retreated by 2.6%.
• Housing data was again the bright spot in an otherwise mediocre slate of economic data. Mortgage applications to purchase a home rose for the eighth straight week as mortgage rates dipped to historic lows.
• This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

Real Estate Weekly Outlook

U.S. equity markets retreated this week following a frenzied "reopening rally" as investor attention - and the media spotlight - returned to the coronavirus pandemic amid concerns that recent protests could spark a "second wave" of the outbreak. Outside of several isolated hotspots, however, the preponderance of evidence indicates that the pandemic continues to wane in the United States as daily new cases and deaths in the U.S. reached the lowest levels since March this week. Investors exhibited concern, however, that resistance to economic reopenings - whether scientifically-justified or not - could compromise the potential "V-shaped" economic rebound.

(Hoya Capital Real Estate, Co-Produced with Brad Thomas)

Following a nearly 5% surge last week, the S&P 500 ETF (SPY) dipped by 4.7% on a volatile trading week that saw the large-cap index briefly climb back into positive territory for the year before hitting a stretch of mid-week turbulence. The return of the "stay-at-home" theme helped to push the Nasdaq (QQQ) to fresh record-highs by Wednesday but closed out the week with declines of 1.6%. After surging by 11% on a historic week that saw many beaten-down REITs nearly double in value, the broad-based Equity REIT ETFs (VNQ) (SCHH) finished lower by 5.4% with all 18 property sectors in negative territory while Mortgage REITs (REM) retreated by 2.6%.

Reminiscent of the "risk-on vs. risk-off" trading pattern seen during the early stages of the last post-crisis recovery, trading action over the past few weeks has exhibited a clear "reopening vs. stay-at-home" paradigm. On a comparatively quiet week of economic data following the blockbuster slate of employment data last week, all 11 GICS sectors finished in negative territory as Small-Cap (SLY) and Mid-Cap (MDY) stocks that led the "reopening rally' posted sharp declines of 9.5% and 7.8%, respectively. The 10-Year Treasury Yield (IEF) pulled back 20 basis points to close at 0.70% after Federal Reserve Chairman Powell projected that the Fed wouldn't raise interest rates until after 2022, and that it would maintain its unprecedented balance sheet expansion through the purchase of Treasury and mortgage securities.

This week's declines were accelerated by somewhat disappointing employment data as another 1.54 million Americans filed for Initial Jobless Claims last week, down from 1.89 million in the prior week, which marked the 10th consecutive week of sequential declines. Continuing Claims data, however, remained stubbornly high at 20.9 million which did little to quiet the skepticism of last week's nonfarm payrolls report which showed a record single-month employment gain of 2.5 million. Regardless, continuing claims do appear to have peaked in early May at around 25 million and have decreased by roughly 4 million over the last four weeks, a positive sign that many of the recent layoffs are indeed proving to be temporary, consistent with high-frequency metrics such as mobility data showing a robust rebound in activity.

Real Estate Economic Data

Below, we analyze the most important macroeconomic data points over the last week affecting the residential and commercial real estate marketplace.

Housing Continues to Lead Economic Rebound

So much for that "Housing Crash 2.0" narrative. Housing data was the bright spot in an otherwise mediocre week of economic data as the all-important residential real estate sector continues to lead the post-pandemic economic rebound. The Mortgage Bankers Association reported that mortgage applications to purchase a home rose for the 8th straight week and are now 13% higher from the same week last year compared to the 35% decline in early April. Among other factors driving this "stunning" recovery, mortgage rates on the popular 30-year fixed mortgage dipped to historic lows this week, finishing the week at 2.95% on the Mortgage News Daily index.

This follows fresh data last week from Hoya Capital Housing Index component Redfin (RDFN) which showed that home buying demand is now up a stunning 22% from pre-pandemic levels after seven straight weeks of gains. The brokerage firm noted that "mortgage rates near 3% and inventory shortages drove prices up 7% and have increased competition for homes... rising prices and the freedom to work from home are causing buyers to reconsider their options." Consistent with the "post-pandemic urban exodus" theory, Redfin noted that website searches for cities under 50,000 people and rural areas are growing five times faster than pageviews for cities with more than one million people.

Americans have been spending more time than ever in their homes - perhaps the "ultimate essential service" - and households have exhibited a propensity to prioritize housing-related payments and investments in home improvement and living situation upgrades amid the potential dawn of the "work-from-home" era. The sharp rebound in housing market activity has been aided by longer-term macroeconomic trends of favorable millennial-led demographics, historically low housing supply, near-record low mortgage rates, and a potential post-pandemic "suburban revival" that should remain tailwinds well into the 2020s as the housing industry continues to play catch-up after a "lost-decade" of accumulated underinvestment in residential fixed investment.

Consistent with the basic laws of supply and demand, a supply-constrained housing market has continued to put unrelenting upward pressure on prices, exhibited both through rental rates and home values. Rising rents are now the only thing standing in the way of outright deflation as the Bureau of Labor Statistics reported this week reported that the Core Consumer Price Index rose just 1.24% in May, the lowest rise in core inflation since 2010. Excluding shelter, however, Core CPI ex-Shelter rose a paltry 0.27% in May, the lowest year-over-year increase since the BLS began tracking that series in 1967. Shelter, which accounts for a third of the CPI basket, remains incredibly "sticky" given the supply/demand backdrop. Primary rents remain higher by 3.5% from last year while Owner Equivalent Rents (OERs) are higher by 3.1%.

While housing costs supported the CPI index to the upside, dragging on the downside in May was another month of sharp declines in the prices of gasoline, clothing, and transportation. The "headline" CPI index recorded a year-over-year rise of just 0.2% in May, the lowest since 2015. In addition to Consumer Price data, we also saw Producer Price data this week, which also came in cooler-than-expected. Core PPI rose just 0.33% in May, the lowest since 2015. Completing the trifecta of disinflation, data released last week showed that Core PCE rose just 1.04% in May, the lowest since 2010, which certainly gives the Federal Reserve and U.S. Federal government plenty of wiggle-room to push ahead with unprecedented economic stimulus measures.

Commercial Equity REITs

Sentiment around the commercial equity REIT sector has certainly improved over the past several recent weeks, no doubt aided by another round of solid rent collection updates from several dozen REITs. While the sector continues to be whipped around by broader market trends, below the surface these updates have generally been quite positive with most REITs reporting similar or stronger collection rates in May as in April while bigger-picture commentary has generally been quite optimistic. "Essential" property sectors including housing, industrial, and technology REITs, along with self-storage and office REITs, all reported collection of more than 90% of rents in April and May.

Capturing the headlines this week was news that Simon Property (SPG) plans to pull the plug on its planned acquisition of fellow Class A mall operator Taubman Centers (TCO) on an ill-timed deal that was announced just weeks before the coronavirus pandemic began to wreak havoc on the retail real estate industry. Both REITs dipped roughly 15% this week as the messy merger saga will continue to play out in the months ahead. This week, we published Mall REITs: Surviving The Apocalypse, For Now where we noted that the sector is longing for the days when the "retail apocalypse" was its biggest concern. The pace of store closings is expected to increase substantially in 2020 during the coronavirus fallout, adding to what was already a record year of store closings in 2019. Fundamentals were weak long before the pandemic, which surely won't help to ease the pain. Low-productivity mall REITs saw a nearly 30% decline in FFO growth in 1Q20 while high-productivity mall REITs saw a -4.3% year-over-year decline.

We have tracked 54 equity REITs - primarily retail and lodging REITs - out of our universe of 165 equity REITs that have now announced a cut or suspension of their common dividends, but we think that we'll begin to see many of these REITs announce dividend resumptions during 2Q earnings season beginning in a few weeks. Of note, Realty Income (O) announced a dividend increase this week, a notable show of confidence from the free-standing retail-focused REIT that collected roughly 80% of rents in April and May. Last week, we published Dividend Cuts And Overdue Rent: REIT Earnings Recap where we discussed fundamental trends observed in first-quarter earnings reports and noted that even with a faster-than-expected reopening, fundamental metrics are likely to be the weakest since at least 2009.

Several property sectors continue to be at least somewhat immune from the pandemic-related pain. These "essential" property sectors - residential, technology, and industrial - were outperformers again the week. This week, we published Data Center REITs: The New Digital Office? Data center REITs have jumped nearly 15% so far in 2020 even as most property sectors were ravaged - at least temporarily - by the coronavirus pandemic. Leasing activity - the most closely-watched earnings metric - surged in the first quarter to the highest level since mid-2018 as the sector continues to ride substantial secular tailwinds. We believe that the pandemic may accelerate enterprise investment in cloud computing technologies, as spending on the "virtual office" may replace spending on physical office space.

Just eight equity REITs finished in positive territory this week, led to the upside by small-cap infrastructure REITs CorEnergy (CORR) and Power REIT (PW) along with data center REIT Equinix (EQIX). Among the laggards was small-cap shopping center REIT Urstadt Biddle (UBA), which was the first REIT to report Q2 results. UBA noted that it collected 60.3% of May rent and 68.7% of April's rent, continuing a trend of retail REITs reporting generally similar rent collection metrics in May as in April. UBA also announced that it is cutting its common dividend from $0.70 per quarter to $0.28 per quarter.

Mortgage REITs & REIT Preferreds

The number of Americans seeking forbearance on their mortgages dropped for the second week in a row according to data from Black Knight amid continuing signs that the residential mortgage market continues to stabilize. Residential mREITs eked out a gain of 0.2% while commercial mREITs dipped by 6.6%, weighed down by the sector's heavy exposure to the hotel, office, and retail property sectors. AG Mortgage (MITT) finished the week higher by 43% after finally reporting Q1 earnings results. The single hardest-hit mREIT by the period of violent volatility in March, the surge came despite confirming interim updates that its book value per share plunged 90% to $2.63 on March 31 from $17.61 on Dec. 31, 2019, compared to the average mREIT which reported a decline in book value of roughly 20%.

Last week, we published REIT Preferreds: Higher-Yield Without Excess Risk where we introduced our all-new REIT Preferred and Bond Tracker and discussed the investment characteristics of these "hybrid" securities. The REIT Preferred ETF (PFFR) ended the week lower by 3.2%, driven by declines from the preferred issues from office, retail, and hotel REITs. Among REITs that offer preferred shares, the performance of these securities has been an average of 14.2% higher in 2020 than their common shares. Preferred stocks generally offer more downside protection, but in exchange, these securities offer relatively limited upside potential outside of the limited number of "participating" preferred offerings that can be converted into common shares.

2020 Performance Check-Up

REITs are now lower by roughly 16.1% this year compared with the 5.5% decline on the S&P 500 and 9.9% decline on the Dow Jones Industrial Average. Consistent with the trends displayed within the REIT sector, mid-cap and small-cap stocks continue to underperform their larger-cap, although this underperformance gap has closed significantly in recent weeks. The top-performing REIT sectors of 2019 have continued their strong relative performance through the early stages of 2020 as industrial REITs recently joined data centers and cell tower REITs as the lone real estate sectors in positive territory for the year. At 0.70%, the 10-Year Treasury Yield has retreated by 122 basis points since the start of the year and is 255 basis points below recent peak levels of 3.25% in late 2018.

Next Week's Economic Calendar

Following a fairly slow week of economic data, we have a busy slate of economic data in the week ahead, highlighted by Retail Sales data on Tuesday and Housing Starts and Permits data on Thursday. Retail Sales data is expected to record a bounce-back in May following the historic declines in April that saw some categories plunge more than 80%. Homebuilder sentiment data is released on Tuesday with expectations for a continued bounce-back amid signs of a V-shaped recovery in the housing sector. Continuing jobless claims data, released on Thursday, will also continue to be our focus for indications that temporarily-unemployed Americans are returning to work.

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Disclosure: Hoya Capital Real Estate advises an Exchange-Traded Fund listed on the NYSE. In addition to any long positions listed below, Hoya Capital is long all components in the Hoya Capital Housing 100 Index. Index definitions and a complete list of holdings are available on our website.

Analyst’s Disclosure: I am/we are long HOMZ, AMT, ARE, AVB, BXMT, DRE, DLR, EFG, EQIX, FB, FR, MAR, MGP, NLY, NHI, NNN, PLD, REG, ROIC, SBRA, SPG, SRC, STOR, STWD, PSA, EXR, AMH, CUBE, ELS, MAA, UDR, SUI, CPT, NVR, EQR, INVH, ESS, PEAK, LEN, DHI, HST, AIV, MDC, ACC, PHM, TPH, MTH, WELL. 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.

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