Real Estate Weekly Outlook – Inflation Is A Problem

Real Estate Weekly Outlook

U.S. equity markets declined for a second-straight week as inflation data confirmed that consumer and producer prices surged at the highest rate in nearly four decades in late-2021, forcing the Fed’s hand to tighten financial conditions. The dreaded “S-word” – stagflation – re-emerged this past week as hotter-than-expected inflation reports were accompanied by weaker-than-expected retail sales and slumping consumer sentiment.

Following declines of 1.9% last week, S&P 500 (SPY) declined 0.3% on another choppy week while the tech-heavy Nasdaq 100 (QQQ) finished flat after posting its worst week in nearly a year. The Mid-Cap 400 (MDY) declined 0.4% but the Small-Cap 600 (SLY) eked out a 0.2% gain. Real estate equities have stumbled out of the gates in 2022 following strong gains last year as the Equity REIT Index declined another 1.4% on the week with technology REITs again dragging to the downside and offsetting a strong week for housing REITs and homebuilders while Mortgage REITs gained 2.3%.

After eclipsing the highest level since the start of the pandemic last week, the 10-Year Treasury Yield remained steady this past week as hot inflation data was offset by somewhat “dovish” from Fed Chair Powell during his confirmation hearing and on data showing that hospitalizations in the U.S. hit fresh record-highs. Nine of the eleven GICS equity sectors were lower on the week, but the Energy (XLE) sector continued its strong start to 2022. Homebuilders and the broader Hoya Capital Housing Index were among the leaders on the week following several analyst upgrades and positive industry commentary – including strong guidance from KB Home (KBH) – which indicated that housing demand remains robust into early winter.

Real Estate Economic Data

Below, we recap the most important macroeconomic data points over this past week affecting the residential and commercial real estate marketplace.

Inflation Stays Red Hot: the BLS reported this week that consumer prices surged at the fastest pace in nearly four decades in December as inflation has so far proven to be less “transitory” than many economists projected. The Consumer Price Index rose 7.0% year-over-year – roughly in line with consensus estimates – but this was the highest annual increase since June 1982. Core Consumer Prices – which excludes food and energy – rose 5.5% from last year – higher than expected. Prices for food, rent, and gasoline were once again the largest contributors to inflation as the energy index rose 29.3% and the food index increased 6.3%. Meanwhile, the BLS also reported that producer prices rose at the fastest rate on record in December with the headline PPI Index soaring 9.7% from last year.

We continue to see persistent near-term pressure on inflation metrics due to the delayed impact of soaring rents and home values, which are just beginning to filter in the data. The cost of shelter posted an annual rise of 4.0%, but private market rent data has shown that national rent inflation has been in the 10-15% range over the past quarter while home values have risen by 15-20%. The Dallas Fed published a report highlighting the data issues at the BLS, finding a 16-month lag between the BLS inflation series and real-time market pricing of home prices and rents which will add an estimated 0.6-1.2% to the Core CPI index in 2022 and 2023.

Ongoing concerns over inflation have weighed on consumer confidence in recent months, sending the University of Michigan’s consumer sentiment index tumbling back towards 10-year lows in January. Expectations for one-year inflation rates increased to 4.9% – the highest level since the summer of 2008. Earlier in the week, the IBD/TIPP Economic Optimism Index showed a similar slump across all of their monthly metrics, particularly their measure of approval of Federal policies. These concerns have weighed heavily on President Biden’s approval rating, which tumbled to just 33% in the latest Quinnipiac poll, reflecting a deep voter dissatisfaction and making the outlook bleak for any major policy actions before the midterm elections in November.

This slumping sentiment was reflected in December retail sales data as well as the Census Bureau reported this week that sales dipped 1.9% in December – far worse than the 0.1% expected decline – as Omicron concerns and surging prices impacted the critical holiday period. Despite the miss in December, however, retail sales posted total gains of 19.3% for full-year 2021 – the highest annual gain on record. Since the start of the pandemic, spending on housing-related items have been one of the key drivers of growth as the Building Materials category has climbed 30% since the end of 2019, outpaced only by the Nonstore (e-commerce) retail category, which has gained nearly 50% combined over 2020 and 2021.

Equity REIT & Homebuilder Week In Review

Homebuilders: KB Home surged nearly 25% this past week after reporting solid Q4 results and providing strong guidance which calls for 30% revenue growth in 2022, which follows the 37% revenue growth reported in full-year 2021. KBH delivered EPS growth of more than 70% in 2021 despite “extremely challenging operating conditions with labor shortages and supply chain disruptions, along with municipal and related delays.” This week, we published Homebuilders: Growth At A Very Reasonable Price which discussed how profit margins have climbed to record highs as builders have more-than-offset cost pressures through higher prices. Scale remains a key competitive advantage as the larger public builders continue to gain market share.

Single-Family Rental: Small-cap diversified REIT Presidio Property (SQFT) – which owns a portfolio of office buildings, shopping centers, and model homes in homebuilder communities – gained more than 4% on the week after it announced that it will sponsor a Special Purpose Acquisition Vehicle, aiming to acquire “one or more businesses in the real estate industry which may include companies in the home building business, real estate owners and operators, arrangers of financing, insurance, and other services for real estate, and adjacent businesses and Property Technology businesses. We discussed the emerging PropTech business in our recent Single Family Rental report.

Following a wave of more than 130 REIT dividend hikes in 2021, we’ve already reached a half-dozen hikes through two weeks of 2022. UMH Properties (UMH) hiked its dividend by 5.3% to $0.20/quarter. Before UMH’s dividend hike last year, it had held its rate steady for over a decade. Gladstone Land (LAND) rallied 3% after it bumped its monthly dividend higher by 0.2% while Gladstone Commercial (GOOD) finished flat after raising its dividend by 0.1%. STAG Industrial (STAG) slumped more than 2% despite hiking its dividend by 0.7%. As discussed in our State of the REIT Nation report, FFO growth significantly outpaced dividend growth in 2021, pushing REIT dividend payout ratios to just 67% in Q3 indicating that REITs are well equipped to continue to raise their payouts in the quarters ahead.

Malls: Pennsylvania REIT (PEI) slumped more than 10% on the week after announcing a plan to raise $350M+ in multiple phases which is targeted to reduce debt and interest burden. Central to this capital raising plan is the targeted sale of $200M in land for multifamily development and it expects to close on $40M in sales before the end of Q2 2022. PREIT also announced that it saw a “meaningful” increase in shopper traffic over the holiday season, building on strong sales during the early shopping season in October and November. Traffic during the holiday season (November and December) grew by 25% over 2020 at core malls. Mall REITs snapped their five-year streak of underperformance in 2021 with total returns of more than 93%.

Healthcare: This past week, we published Healthcare REITs: Vaccine Hesitancy. After a vaccine-driven revival, Healthcare REITs were the weakest-performing property sector in 2021 as the promising recovery in skilled nursing and senior housing has suffered Omicron-driven setbacks. Staffing shortages have become critical issues at skilled nursing and senior housing facilities, which operators attribute to a combination of COVID-related sick days, vaccine mandates, unemployment benefits, and uncompetitive wages. While near-term headwinds will persist until the pandemic abates, we remain optimistic on the longer-term outlook for healthcare REITs as Baby Boomers are substantially larger and wealthier than any prior generation.

Mortgage REIT Week In Review

Mortgage REITs were mixed on the week with commercial mREITs gaining 2.0% while residential mREITs slipped 1.6%. For 2021, the Mortgage REIT Index delivered price returns of 7.0% and total returns of 16.0%. Seven Hills Realty (SEVN) rallied more than 10% on the week after it hiked its dividend by 67% to $0.25/share. Orchid Island Capital (ORC) dipped nearly 9% after reducing its dividend by 15%, noting that its net interest margins remain muted due to the “persistence of longer-term rates remaining at or below levels observed earlier in 2021.” Despite the reduction, ORC remains the highest-yielding REIT with a forward yield of 15.6%.

2022 Performance Check-Up & 2021 Review

Through two weeks of 2022, Equity REITs are now lower by 5.6% this year on a price return basis while Mortgage REITs have advanced 1.3%. This compares with the 2.2% decline on the S&P 500 and the 2.1% gain on the S&P Mid-Cap 400. Led by the office and hotel REIT sectors, all nineteen REIT sectors are now in positive territory for the year, while on the residential side, all two of the eight sectors in the Hoya Capital Housing Index are higher. At 1.77%, the 10-year Treasury yield has climbed 26 basis points since the start of the year and is 125 basis points above its all-time closing low of 0.52% in August 2020, but still 148 basis points below its 2018 peak of 3.25%.

Among the ten major asset classes, Equity REITs (VNQ) finished 2021 as the best-performing asset class on a total returns basis with total returns of 40.1%, which comes after a rough 2020 in which REITs were the worst-performing asset class with total returns of -4.7%. REITs are now the fourth best-performing asset classes since the start of 2010, producing average annual total returns during this time of 13.5%, producing superior total returns to Bonds (AGG), TIPS (TIP), Commodities (DJP), Emerging Markets (EEM), and International (EFA) stocks.

Economic Calendar In The Week Ahead

We have a jam-packed week of housing market data in the four-day week ahead. Stock and bond markets will be closed Monday in observation of Martin Luther King Day. On Tuesday, we’ll see NAHB Homebuilder Sentiment data for January which climbed to 10-month highs last month amid a reacceleration in housing market activity. On Wednesday, we’ll see Housing Starts and Building Permits data for December. Last month, Housing start Starts climbed to 8-month highs. Finally, on Thursday, we’ll see Existing Home Sales data for December which increased for a third-straight month in November to fresh 11-month highs.

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, Casinos, Industrial, Data Center, Malls, Healthcare, Net Lease, Shopping Centers, Hotels, Billboards, Office, Storage, Timber, Prisons, and Cannabis.

Disclosure: Hoya Capital Real Estate advises two Exchange-Traded Funds 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 and in the Hoya Capital High Dividend Yield Index. Index definitions and a complete list of holdings are available on our website.