Real Estate Weekly Review
REITs (VNQ and IYR) finished the week lower by 2.3%, the second straight week of losses after three straight weeks of strength. Geopolitical tensions with North Korea weighed on equities. The more economic-sensitive real estate sectors were hit especially hard, including hotels and malls. The S&P 500 declined 1.3% after reaching record highs earlier in the week. The 10-year yield declined 6bps on cool inflation data and a broader flight to safety.
(Hoya Capital Real Estate, Performance as of 12pm Friday)
Outside of the REIT space, the other real estate equity sectors were generally weaker on the week. Homebuilders and commercial construction were lower by more than 1.5% on the week. Mortgage REITs climbed 0.2% while ex-US real estate fell 1.7%.
Within the Equity Income categories, we note the performance and current income yield of the Utilities, Telecom, Consumer Staples, Financials, and Energy. Within the Fixed Income categories, we look at Short, Medium, and Long Term Treasuries, as well as Investment Grade and High Yield Corporates, Municipal Bonds, and Global Bonds.
REITs are now lower roughly 1% YTD on a price-basis and higher by roughly 2% on a total-return basis. REITs ended 2016 with a total return of 9%, lower than its 20-year average annual return of 12%.
Earnings Season Recap
Earnings season concluded on a relatively strong note this week. 50% of REITs beat consensus estimates while 20% missed. 35% raised full-year guidance while 15% lowered guidance. This distribution is roughly in-line with recent quarterly averages. Shopping Center, Industrial, Apartments, Net Lease REITs and Data Centers were the winners of earnings season. Healthcare, Storage, and Student Housing were disappointing.
This week, we continued our REIT Rankings quarterly updates, which we will complete over the next several weeks.
Net Lease: 2Q17 performance was generally better-than-expectations. Occupancy improved across the sector. The acquisition market appears healthy and the “Big 3” net lease REITs continue to plow ahead with external growth. Spirit Realty’s credit issues with Shopko were partially put-to-rest as the REIT announced plans to spin-off its troubled assets. Overall, portfolios remain very healthy and have limited apparel-exposure. Berkshire Hathaway’s investment in Store Capital was a critical stamp of approval.
Healthcare: Healthcare REITs delivered results that were generally below expectations in 2Q17. Broader trends of deteriorating fundamentals across the entire healthcare-provider industry continued. There’s hope that GOP-led reforms may reverse this, a possible positive catalyst for Skilled Nursing. Meanwhile, private-pay healthcare REITs are facing a different set of challenges. While longer-term demographics remain highly favorable, supply growth continues to outpace demand for senior housing facilities.
Data Center: Data Center REITs continue to be the standouts in the REIT space. 2Q17 earnings in the Data Center sector were stellar across the board. Despite high levels of construction activity in recent years, REIT executives report that supply/demand conditions appear balanced across most markets and supply-constrained in several key markets. The shift towards public and hybrid cloud pressures Data Center REITs, though. For now, the hyperscale cloud providers have a symbiotic relationship with these Data Center REITs. Demand for connectivity greatly exceeds their ability to build capacity for themselves.
Malls: The bifurcation between top-tier and lower-tier mall REITs continued in 2Q17. High-quality mall REITs reported a strong quarter with improved traffic, higher tenant sales, and strong rental rate increases. Lower quality malls continue to struggle and have been hit disproportionally hard by the wave of bankruptcies and downsizing in the clothing and apparel segments. Department stores continue to lag.
Last week, we discussed quarterly results in the Apartments, Student Housing, and Manufactured Housing sectors. We will publish our Q2 REIT Earnings Report Card that summarizes the performance of all 13 sectors this weekend. Below we show the performance since the start of earnings season. Shopping Centers have surged more than 6% while Healthcare and Office have declined more than 4%.
The best five performing REITs on the week were Invitation Homes (INVH), Starwood (SFR), Mid-America Apartments (MAA), National Health Investors (NHI), and AvalonBay (AVB).
The worst five performers were Pennsylvania REIT (PEI), Washington Prime (WPG), Sabra Healthcare (SBRA), Brandywine (BDN), and Paramount Group (PGRE).
Every week, we like to dive deeper into the economic data that directly impacts real estate.
(Hoya Capital Real Estate, HousingWire)
Inflation: Cooler Than The Other Side of the Pillow
CPI and PCE inflation continues to trend down. Core CPI came in at just 1.8% YoY, near the lowest rate since late 2015. Core PPI was slightly also cooler than expected, higher by just 1.9% YoY. Low inflation data should keep down the pressure on the Fed to raise interest rates.
Shelter inflation accounts for nearly 30% of CPI, and the robust growth in rents since 2013 explained most of the modest spike in inflation seen in 2015. Right now, shelter inflation is one of the few components keeping inflation in positive territory. We track the rent growth spread over inflation below, which shows that at its peak, rent inflation was over 3% higher than the overall level of inflation. The robust levels of multifamily completions that will sustain through 2018 have brought the rent spread down, but rent growth has stabilized in recent months. Core CPI ex-shelter is higher by just 0.6%, the lowest rate in 13 years.
Declining healthcare inflation has also contributed to the recent weakness in inflation. Medical care inflation spiked in early 2016 to more than 5% and has since retreated back below 3% as the services component has declined sharply.
Combined with lower oil prices and the potential for lower healthcare costs, we see more downside pressure on inflation than upside pressure from tight labor markets. These three components (rents, energy, healthcare) are primary drivers of inflation. Lower inflation would be positive for fixed income securities and keep interest rates lower for longer.
Confidence Higher, Labor Markets Continue To Show Strength
Labor markets in the US are the strongest they have been in a generation. Job growth has slowed over recent months, peaking at 2.2% YoY growth in Jan 2015 to 1.6% growth in the most recent month. As ‘full employment’ has neared, wage growth has accelerated.
JOLTS data was strong this week, showing over 6.1 million job openings in July. Firms are reporting difficulty finding skilled labor, and as a result, the ‘skills gap’ between job openings and hires has been moderately expanding. Generally, tight labor markets lead to higher wage growth and more productivity as firms invest in machines and technology to increase output.
Despite a persistent narrative that “wage growth is stagnant,” the data actually shows that real wages have seen one of the best periods of growth in forty years. Real wages have increased 7.3% since 2014. Real wage growth is primarily a function of productivity growth and low inflation.
REITs finished the week lower by more than 2%, part of a broader equity sell-off amid heightened geopolitical tensions with North Korea. REITs erased their YTD gains on a price-basis but remain higher by roughly 2% on a total-return basis.
Single Family Rental was the best performing sector after news that Invitation Homes plans to merge with Starwood. The merged company will own roughly $20 billion in rental homes.
Inflation continues to be ‘cooler than the other side of the pillow.’ CPI and PPI both came in cooler than expected on moderating rent inflation and declining healthcare inflation. JOLTS data was strong this week, showing over 6.1 million job openings in July. Firms are reporting difficulty finding skilled labor, and as a result, the ‘skills gap’ between job openings and hires has been moderately expanding. Despite a persistent narrative that “wage growth is stagnant,” the data actually shows that real wages have seen one of the best periods of growth in forty years.
Earnings season concluded in the REIT space. 50% of REITs beat consensus estimates while 20% missed. 35% raised full-year guidance while 15% lowered guidance. Shopping Center, Industrial, Apartments, Net Lease REITs and Data Centers were the winners of earnings season. Healthcare, Storage, and Student Housing were disappointing.
We also recently began a new series: “Building the Optimal REIT Portfolio for the Generalist” with Part 1: Yield REIT s and Part 2: Growth REITs. We noted that more than other investment sectors, real estate is a dynamic ecosystem of independent subsectors that each react and respond very differently to a given set of economic conditions. Most of our research looks at REITs at the sector-level, breaking the real estate universe into 13 asset categories. Investors often take a different approach when building a portfolio.
We introduced a different categorization of the REIT universe that better addresses these goals and constraints and hopefully allows generalist investors to have a better understanding of how their REIT holdings fit within their portfolio. We use our quantitative models to break REITs into three categories: Yield, Growth, and Hybrid REITs. We outline the characteristics of these three categories below.
Next week, we will continue updating our REIT Rankings series with quarterly updates for the remaining six real estate sectors: Single Family Rentals, Industrial, Self-Storage, Shopping Center, Hotels, and Office.
Please add your comments if you have additional insight or opinions. We encourage readers to follow our Seeking Alpha page (click “Follow” at the top) to continue to stay up to date on our REIT rankings, weekly recaps, and analysis on the real estate and income sectors.
Sector ETFs Mentioned: (VNQ, IYR, SPY, XHB, ITB, PKB, REM, VNQI, IYZ, IDU, KXI, IYF, LQD, JNK, IEF, VDE, VGLT, ISTB, BNDX)
Disclosure: I am/we are long VNQ, SPY, MAA, CPT, CCP, OHI, PLD, GGP, TCO, PEI, STOR, SHO, SUI, ELS, ACC, EDR, DLR, COR, REG, CUBE, PSA, EXR, BXP.
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: All of our research is for educational purpose only, always provided free of charge exclusively on Seeking Alpha. Recommendations and commentary are purely theoretical and not intended as investment advice. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. For investment advice, consult your financial advisor.