Real Estate, Homebuilders Continue To Roll

Real Estate Weekly Outlook

Gaining for the second straight week following three straight weeks of declines, US equity markets edged closer to new record highs, powered by an upbeat start to peak earnings season and signs of mounting strength in the US housing markets. Retail sales data and bank earnings this week provided more evidence that the US consumer remains relatively unfazed by the domestic and international political drama, while housing data and homebuilder earnings suggested that the recent reacceleration in the US single-family housing markets - the most economically important asset class in the world - may still have quite a bit more room to run into the start of the next decade.

The S&P 500 (SPY) gained 0.6% this past week, while the tech-heavy Nasdaq (QQQ) gained 0.3% as the major averages were able to hold onto gains despite losing steam on Friday after weak economic data out of China. REITs and homebuilders continue to lead the way as the "Goldilocks" economic conditions of low-interest rates and consumer-led growth continue to provide an ideal backdrop. The broad-based REIT ETF (VNQ) gained 1.6% on the week, led to the upside by the timber, cell tower, and industrial REIT sectors. After surging 23 basis points last week, the 10-Year yield ended the week flat at 1.75%.

The Hoya Capital US Housing Index, the benchmark that tracks the performance of the US Housing Industry, climbed to new record highs this week, jumping more than 2.5%. Lower mortgage rates have done wonders to revive the sputtering single-family housing market after the worst 8-12 month period since the housing crisis. As we'll discuss in more detail below, housing data this week continued to show signs of accelerating into year-end.

Homebuilders (ITB) led the way this week following better-than-expected results from NVR (NVR), which reported an 11% Y/Y surge in new orders. The strength in the US housing sector, however, is being felt far beyond the builders themselves. Redfin (RDFN) and Zillow (Z) each surged 9% or more this week while mattress maker Tempur Sealy (TPX), single-family rental operator Invitation Homes (INVH), and manufactured housing community operator Sun Communities (SUI) have each gained more than 50% this year.

REIT earnings season kicked off this week with reports from Prologis (PLD), SL Green (SLG), Crown Castle (CCI), and Brandywine (BDN). Prologis and Crown Castle were the relative standouts, each beating expectations and gaining 4% or more on the week. This week, we published our Real Estate Earnings Preview. The "REIT Rejuvenation" of 2019 has restored the coveted NAV premium for most sectors, giving these REITs the currency to re-open the acquisition pipeline, which has historically been a primary driver of AFFO growth.

Below we compiled the notable earnings that we're watching across the residential and commercial real estate sectors. Highlights next week include Equity Lifestyle (ELS), Equity Residential (EQR), Sun Communities (SUI), Kimco (KIM), CubeSmart (CUBE), Washington Prime (WPG), and Ventas (VTR). We'll have full real-time coverage of earnings on the iREIT on Alpha Marketplace and we'll recap results in our Real Estate Weekly Outlooks.

Real Estate Economic Data

Housing Starts & Building Permits Remain Solid

After surging to the highest monthly rate in 12 years in August, housing starts and building permits moderated in September, but continue to indicate strength into year-end. The combination of lower mortgage rates and pent-up demographic-driven demand has spurred a recovery in new home construction this year following the "mini-housing recession" experienced in 2018. The US Census Bureau reported that housing starts moderated from last month's 12-year highs to a seasonally-adjusted annualized rate (SAAR) of 1,256k units, which was a decline of 9% from last month, but higher by 1.6% from the same period last year.

Below the volatile multifamily data that swings around the monthly data, single-family starts and permits continue to show signs of reacceleration, rising for the fourth straight month. Single-family starts rose 4.3% on a SAAR basis, while multifamily starts dipped 5.8%. On a trailing 12-month basis, single-family starts remain lower by 3.0% while multifamily starts are off by 0.9%. The strong summer for home construction comes after one of the worst 8 to 12 months for home construction since the financial crisis.

With the slower-reacting data finally beginning to see the positive effects of lower mortgage rates, the more forward-looking housing market indicators continue to point to a solid back-half of 2019. Ahead of the closely-watched housing starts data tomorrow and existing home sales data next week, homebuilder sentiment climbed to the highest level since February 2018. All three sub-components showed notable acceleration since last month, headlined by the 54 print in buyer traffic, which was the first read over break-even 50 since last October. All four regional indexes ticked higher on a three-month average, led by continued strength in the West and South regions.

By nearly every metric, housing markets remain significantly undersupplied. Household formations outpaced new housing starts by more than 100k in 2018 as the vacancy rate for both owner-occupied and renter-occupied homes reached multi-decade lows in the fourth quarter. The United States has been under-building homes since the early 1990s, and that trend of underbuilding has intensified dramatically since the housing bubble burst in 2008. A shortage primarily rooted in sub-optimal public policy at the local, regional, and national levels, the US is building homes at a rate that is less than 50% of the post-1960 average after adjusting for population growth.

Retail Sales Miss Estimates in September

Retail sales fell on a month-over-month basis for the first time in seven months in September, but the internal numbers were better than the headline print. Total retail sales fell 0.3% from the prior month, but remain higher by 4.1% from the same period last year on a seasonally-adjusted annualized basis. We saw some mean reversion in this month's data with the strongest performing segments this year - including e-commerce and autos - pressuring September's data. While not falling off a cliff, brick-and-mortar retail sales have continued to decelerate after reaching the strongest rate since 2012 last year.

This year's store wave of announced closings certainly won't help, and we forecast continued deceleration into year-end in the categories most affected by this year's closings. For retailers, the more significant issue over the last two years has not been on the demand side, but rather on the expense side. Before even considering the margin hit from tariffs and excess inventory, labor costs have risen considerably over the last two years as 18 states raised their minimum wage in 2018 and many cities (largely in already high-cost markets) have raised minimum wages over the last two years, oftentimes far above market rate, which has begun to result in retail job cuts and store closures. Hourly earnings surged to 5% in early 2019, outpacing the roughly 3% growth in retail sales, while retail has been negative on a year-over-year basis for all of 2019.

While the majority of the store closings (on a square footage basis) over the last five years were concentrated in the anchor and big-box space, more than half of the store closings so far in 2019 have been in the specialty categories, indicating that smaller businesses have been hit especially hard by minimum wage pressures. While hardline and food retailers tend to be somewhat immune from e-commerce related disruption, softline and specialty retail categories are generally more at risk. During the so-called "retail apocalypse" of 2016-2017, these categories were particularly weak but recovered nicely in 2018 before turning lower again over the last two quarters.

2019 Performance Recap

With this week's outperformance, the broad-based REIT ETFs have gained more than 26% this year, continuing to outpace the S&P 500, which has climbed roughly 19%. The US Housing sector has climbed 29% this year led by the 60% surge in single-family homebuilders (XHB and ITB). Not all real estate sectors are seeing the windfall, however, exhibited by the 60% performance gap between the best- and worst-performing REIT sector. At 1.75%, the 10-year yield has retreated by 94 basis points since the start of the year and is roughly 150 basis points below peak levels of 2018 around 3.25%.

In addition to our Real Estate Earnings Preview, this week we published Healthcare REITs: Out Of Rehab. While just a tiny slice of the total housing market, senior housing has been one of the few housing segments seeing ample speculative supply growth in preparation for demographic-driven demand. Healthcare REIT fundamentals have gradually improved in 2019. For senior housing, the construction pipeline is finally moderating just as demand growth is accelerating. Skilled nursing REIT fundamentals remain more challenged.

Next Week's Economic Calendar & Fed Watch

Not-too-hot, not-too-cold. Economic data and geopolitical developments have been just-about-right to keep the Fed on course to cut interest rates at the end of this month. Rate cut odds climbed from last week and stand above 90% as of Friday night, up from roughly 67% odds at the end of last week.

It'll be another fairly busy week of economic data with Existing Home Sales released on Tuesday, the FHFA Home Price Index on Wednesday, and New Home Sales data released on Thursday, in addition to a flurry off PMI and manufacturing data next week. New Home Sales is coming off the best month in more than 12 years and expectations call for the second straight month of 700k or more units sold.

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, andReal Estate Crowdfunding.

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Disclosure: I am/we are long VNQ, TPH, RDFN, LPX, NVR, Z, TMHC, BECN, KBH, FRC, TPX, CUBE, ELS, SUI.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:

It is not possible to invest directly in an index. 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.

Hoya Capital Real Estate advises an ETF. In addition to the long positions listed above, Hoya Capital is long all components in the Hoya Capital Housing 100 Index. Real Estate and Housing Index definitions and holdings are available at HoyaCapital.com.