Real Estate Weekly Outlook
The “unofficial end” of summer came with one final “splash” in its final days as volatility returned to U.S. equity markets following several months of relative tranquility. This week’s sell-off had a different and perhaps “healthy” feel to it compared to the sharp declines seen in March and April as the losses came despite an encouraging slate of employment data that showed a continued rebound in labor markets. In what we described as a “Robinhood shakeout,” the highest-flying technology names were among the hardest-hit this week while the “shutdown sensitive” sectors were generally among the leaders.
(Hoya Capital Real Estate, Co-Produced with Brad Thomas)
Snapping a six-week winning streak and retreating from its mid-week record highs, the S&P 500 ETF (SPY) dipped 2.3% on the week. All eyes were on the high-flying technology stocks – the primary source of the volatility seen this week – as the Nasdaq 100 ETF (QQQ) dipped nearly 7% over the last final trading days, ostensibly the first real “challenge” to its relentless rally over the last four months. Real estate equities – particularly in the “shutdown-sensitive sectors” were curiously among the safe-havens this week amid the sell-off. The Equity REIT ETF (VNQ) finished lower by 0.7% this week with 10 of the 18 property sectors finishing in positive territory. The Mortgage REIT ETF (REM), however, finished lower by 2.6% this week after last week’s 2.9% gain.
Unlike the volatility seen during the peak of the pandemic in March and April, the choppiness seen this week was purely an equity market phenomenon. The 10-Year Treasury Yield (IEF) was essentially unchanged on the week, as were valuations of Investment Grade (LQD) and High-Yield (HYG) corporate bonds. Even so, 9 of the 11 GICS equity sectors were lower on the week, dragged down by the Energy (XLE), Technology (XLK), and Communications (XLK) sectors. The tech-related weakness seemed to extend into a broader “reverse momentum” theme as even the high-flying homebuilders and broader Hoya Capital Housing Index pulled back this week despite another strong slate of housing market and employment data.
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.
This week’s declines came despite an encouraging slate of employment data. The Bureau of Labor Statistics reported that the U.S. economy added 1.37 million jobs in August – slightly better than economists’ estimates for gains of 1.35 million. Most notably, however, the “headline” unemployment rate ticked down to 8.4% from 10.2% in the prior month as the separate BLS Household Survey – on which the unemployment rate is derived from – showed employment gains of 3.76 million jobs in August – the second largest month of job growth in the survey’s history. Even with the rebound of 10.6 million jobs over the last four months, however, total nonfarm payrolls are still roughly 11.5 million below pre-pandemic levels. This follows ADP data earlier in the week which showed that 428k jobs were added in August – below expectations of 950k – but prior months were again revised higher.
We’ve remained quite a bit more optimistic than consensus on the employment and economic outlook since early May as the devastating economic lockdowns began to be lifted. We’ve discussed that investors not to underestimate the “unstoppable force” of WWII-levels of fiscal stimulus and the unprecedented levels of monetary support, and better-than-expected data has been common theme over the last several months as the Citi Economic Surprise Index has remained at or near record-high levels. There may still be more “low-hanging-fruit” left in the rebound as roughly 65% of recent job losers continue to classify themselves as on “temporary layoff” totaling over 6 million, which is down from a peak of 18 million back in April.
In fact, we’ve “only” seen an additional 2.1 million Americans report to be “permanent” job losers above the “normal” pre-pandemic levels in February, but we did see 534k Americans become “permanently employed” last month after July saw a modest decline. Jobless claims data this week was also better than expected as Initial Claims declined to 0.89 million in this week’s DOL report, retreating from 1.01 million last week. Perhaps more encouragingly, Continuing Claims dipped by another 1.24 million last week to 13.25 million. Since the peak in early May at around 25 million, Continuing Claims have retreated by 11.6 million – roughly consistent with the 10.6 million jobs recovered from the aforementioned BLS nonfarm report.
In addition to employment data, we also saw a slate of solid PMI data throughout the week, and a mixed report on construction spending. Residential spending has bounced back over the last three months, consistent with data showing clear signs of a V-shaped recovery in the U.S. homebuilding sector. Perhaps some good news for commercial real estate landlords: nonresidential construction spending has pulled back sharply in 2020 since the start of the pandemic as developers take a “wait-and-see” approach to new projects amid immense uncertainty over future demand for office, retail, and lodging space. The Commerce Department said on Tuesday that total construction spending decreased 0.1% from last July, pressured by a 4.3% annualized year-over-year decline in private nonresidential spending.
The U.S. housing market isn’t showing any signs of cooling as the industry continues to lead the early stages of the post-pandemic economic recovery. The Mortgage Bankers Association reported this week that mortgage applications to purchase a single-family home are now higher by 28% from last year. Helping to power this rebound has robust demographic-driven demand and a decline in the 30-Year Fixed Mortgage Rate, which now stands at 3.08%, barely above record-low levels. Despite historically low housing inventory, millennial purchase activity continued to rise in July, according to the latest Ellie Mae Millennial Tracker. The share of all purchase loans closed to millennials reached 61% for the month, up five percentage points from June.
Commercial Equity REITs
It was a slow week of newsflow in the commercial real estate sector, but we did hear several business updates that showed continued sequential improvement in rent collection rates since April. Net lease REIT Realty Income (O) announced it collected 93% of August rents, up from 88% in Q2. Fellow net lease REIT Agree Realty (ADC) announced that it collected 96% of August rent payments. Apartment REIT Independence Realty (IRT) announced that it collected 98% of July and August rents, ahead of Q2 rates. Industrial REIT First Industrial (FR) announced that it has now collected 99% of August rents after collecting 99% of Q2 rents. Finally, fellow industrial REIT EastGroup Properties (EGP) announced it collected 98% of August rents, roughly in line with Q2 collection rates.
As discussed last week REITs: This Time Was Different where we discussed some of the fundamental factors that resulted in the “lost decade” for REITs. While the coronavirus crisis isn’t yet over, the REIT sector appears likely to avoid the type of long-term, lingering pain that was felt by the sector during the Financial Crisis. Some aspects of this crisis were more acute than the Financial Crisis – including the wave of dividend cuts – but strong balance sheets and access to capital prevented the type of shareholder dilution that resulted in a “lost decade” for much of the REIT sector from 2005 to 2015.
Interestingly, the REIT sector actually finished in slightly positive territory this week if one were to use an equal-weight index across all 170 REITs in our coverage universe. Underscoring the quirkiness of this week’s price action, small-cap retail and hotel REITs were among the strongest performers with Seritage Growth (SRG), Kite Realty (KRG), and SITE Centers (NYSE:SITC) all higher by at least 6% while student housing REIT American Campus (ACC) also delivered a strong week. The recently-high-flying data center and timber REIT sectors were among the laggards this week as Weyerhaeuser (WY), Digital Realty (DLR.PK), and CyrusOne (CONE) all dipped more than 5%.
This week, we published Single Family Rentals: The Burbs Are Back. Amid the coronavirus pandemic, residential REITs – particularly the traditionally countercyclical single-family rentals – have proven to be a source of relative shelter for investors as single-family rental REITs are one of five real estate property sectors in positive territory in 2020. Despite the pandemic-related headwinds, SFR REITs reported near-perfect rent collection and strong rental growth. Fueled by the maturing millennial generation, the 2020s were already poised to be a decade of “suburban revival,” and behavioral changes in the post-coronavirus world have provided an added spark.
We also published Office REITs: Work-From-Home Reckoning. Despite reporting near-perfect rent collection throughout the pandemic, office REITs continue to be under pressure as the “Work From Home” paradigm threatens the long-term outlook. Survey data and commentary from corporations indicate that the WFH paradigm is here to stay long after the pandemic subsides. Technology has accelerated the pre-existing trends of increased workplace efficiency. As “WFH” days become the industry standard, the office sector’s loss is the housing market’s gain. Nuance is required, however, as suburban and Sunbelt office assets are likely to see robust demand over the next decade, mimicking similar trends as those seen after the 9/11 terrorist attacks amid a broader “suburban revival”.
Mortgage REITs finished lower this week as residential mREITs dipped 3.3% while commercial mREITs finished lower by 2.5%. Amid another quiet week of mREIT-related newsflow, the sector was pressured by uncertainty over the impact of a newly-announced CDC regulation to pause evictions, a patchwork relief measure after stimulus talks broke down last month which were expected to extend a federal moratorium on evictions from properties with federally backed mortgages. While regulatory relief measures have generally provided support for the mortgage markets over the last several months, the rather unprecedented White House order through the CDC comes after a series of surprising measures by the FHFA and does raise some eyebrows and set a regulatory precedent that appeared to spook some investors.
Residential mortgage REITs did rebound late in the week, however, after data from Black Knight (BKI) showed a continued improvement in the health of the mortgage market. The number of mortgages in active forbearance continued to decline throughout August and are now down about 1 million since the peak in May, a decline of more than 20%. Through the first four weeks of August, forbearance starts were down 13% month over month from the comparable four-week period in July, a pleasant surprise considering that many analysts had expected a reacceleration in forbearance starts after lawmakers were unable to extend several key stimulus measures.
We recently published our Mortgage REIT Earnings Recap. After 31 of 42 mREITs cut or suspended dividends from March through June, we haven’t seen any additional cuts since the start of July. However, only one mREIT, Arbor Realty (ABR), has raised distributions to rates above last year’s levels. Several residential mREITs have resumed or raised dividends after initially cutting including MFA Financial (MFA), Ellington Financial (EFC), Great Ajax (AJX), ARMOUR Residential (ARR), New Residential (NRZ), PennyMac Mortgage (PMT), and Two Harbors (TWO), but none of these distributions are back above pre-pandemic levels. We see the current distributions rates as relatively attractive with an average dividend yield of 8.0% for residential mREITs and 7.6% for commercial mREITs.
Last quarter, we published REIT Preferreds: Higher-Yield Without Excess Risk. The REIT Preferred ETF (PFFR) ended the week higher by 0.2%. The preferred issues from embattled mall REITs – CBL & Associates (CBL) and Pennsylvania REIT (PEI) were among the laggards this week as these REITs continue to teeter on the edge of bankruptcy. Among REITs that offer preferred shares, the performance of these securities has been an average of 18.9% 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
For the year, Equity REITs are now lower by roughly 15.9% and Mortgage REITs are off by 40.7% compared with the 6.4% gain on the S&P 500 and the 1.2% decline on the Dow Jones Industrial Average (DIA). Five of the eighteen REIT sectors are now in positive territory for the year while on the residential side, five of the eight U.S. housing industry sectors in the Hoya Capital Housing Index are in positive territory for the year. The gap between the best-performing REIT sector – data centers – and worst-performing REIT sector – malls – has closed over the last several weeks, but remains a whopping 71% in 2020. At 0.72%, the 10-year Treasury Yield has retreated by 120 basis points since the start of the year and is roughly 250 basis points below recent peak levels of 3.25% in late 2018.
Next Week’s Economic Calendar
The economic calendar slows down in the holiday-shortened week ahead after a frenetic slate of employment and housing data over the last two weeks. Inflation data highlights the slate of data with Producer Price Index data on Thursday and Consumer Price Index data on Friday. Inflation metrics showed signs of life in the prior month after most inflation metrics hit multi-decade lows in May and June. As usual, we’ll be watching the weekly Mortgage data on Wednesday and Jobless Claims data on Thursday for signs that the housing and employment recovery can continue into early autumn.
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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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