Halbergman
This is an abridged version of the full report posted on the Hoya Capital Income Builder Marketplace on July 22.
Weekly real estate forecast
“Bad news is good news” was the theme again this past week as US stock markets posted broad-based gains after weakening US and eurozone economic data pushed benchmark interest rates to two-month lows ahead of the Federal Reserve’s critical interest rate decision in next week. Weaker-than-expected PMI and housing data – along with a tepid start to the second-quarter earnings season – showed that economic activity had contracted significantly in both the US and the eurozone over the past four weeks, but market participants and Fed officials increasingly believe that a recession may indeed be the best and fastest “medicine” to cure inflation.
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Securing only its fourth “up week” in the last sixteen weeks, the S&P 500 (SP500) advanced 2.6% – its best week in more than a month – as expectations for US economic leadership amid a broader global slowdown drove the Mid-Cap 400 and Small-Cap 600 to gains of more than 4% each. The tech Nasdaq 100 gained 3.5% in a volatile week ahead of key reports from several tech giants. Real estate stocks and other yield-sensitive sectors were among the week’s best performers, lifted by moderating interest rates and a strong start to the real estate earnings season. The Equity REIT Index advanced 3.0% on the week, with 17 of 18 property sectors in positive territory, while the Mortgage REIT Index rose nearly 5%.
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With the Atlanta Fed’s GDPNow data now showing that the U.S. is indeed in recession from early 2022, all eyes will be on the Federal Reserve next week as easing conditions quickly shift the narrative away from the Fed being “behind ahead of the curve’ to potentially ‘ahead of the curve’. The benchmark 10-year Treasury yield fell to its lowest level since late May – just above the upper bound of next week’s expected overnight Fed funds rate. With inflation and higher interest rates seen as the “bigger enemy” of long-term earnings prospects – and the driving force behind both consumer and investor sentiment falling to historic lows – market participants are pleased with the emerging are signs of cooling growth and inflationary pressures. Nine of the eleven GICS capital sectors finished higher for the week with a particularly strong week from housebuilders and the wider Hoya Capital Housing Index following decent results from a pair of the biggest construction companies and amid hopes that moderate interest rates could soften the landing in the critical US housing sector.
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Real estate economic data
Below, we summarize the most important macroeconomic data of the past week affecting the residential and commercial real estate market.
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Economic activity contracted sharply in both the US and the eurozone in July, according to flash PMI data from S&P Global released this week. The US PMI Composite Output Index fell to 47.5 in July, down significantly from 52.3 in June – marking the sharpest drop since May 2020, as both manufacturers and service providers reported subdued conditions on demand. Eurozone PMI fell to 49.4 in July from 52.0 in June – the lowest level since February 2021. Notably, companies pointed to “serious inflationary pressures and interest rate hikes” for weakness in demand, two forces , which may be “self-correcting” to some extent. The velocity-driven slowdown in demand has apparently started to trickle down into the “real” economy in recent weeks, as employment data this week was similarly soft, with initial jobless claims rising to the highest level since last November.
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The U.S. housing sector has so far borne the brunt of the impact of rising interest rates — but also potentially stands to benefit the most from peak inflation and rate hike expectations — as rising mortgage rates have poured cold water on previously red-hot housing market. Data this week showed that sales of existing homes fell to their slowest pace since the pandemic began in June, while mortgage demand was similarly weak. Single-family housing starts also fell to a two-year low, according to Housing Starts data last week, in line with a sharp decline seen in homebuilder confidence, with the NAHB homebuilder sentiment index falling 12 points to 55, the most -the biggest drop in a month on record. Notably, some regions continue to see robust housing demand, with the South seeing the strongest conditions — the region where publicly traded homebuilders are most concentrated — while the Midwest is the weakest.
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Homebuilders: DR Horton ( DHI ) — the nation’s largest homebuilder with nearly two-thirds of its inventory in the southern U.S. — rose more than 5% on the week after reporting results that were not so as weak as analysts had feared, commenting that “still seeing a very good level of underlying demand there.” It should be noted that although DHI lowered its full-year forecast, it continued to report revenue growth of 23% for full year. DHI noted that its cancellation rate “increased sharply in June” and remained high in June, but “has not continued with a much higher trend.” Investors remain historically bearish on homebuilders, as DHI currently trades at a P/E below 5x based on updated EPS estimates.Tri Pointe ( TPH ) finished lower by about 3% after its results were relatively solid — meeting or exceeding its previous guidance on all metrics – but showed more p cautious outlook from DHI, withdrawing its full-year outlook, citing “rapidly changing market conditions and significant uncertainty related to the broader economy.”
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Equity REIT Review of the Week
This week’s best and worst performers in the REIT sector
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Industrial: No signs of slowing down here. Industrial REITs kicked off the REIT earnings season with impressive results from the sector’s four biggest names, which were criticized last quarter after Amazon ( AMZN ) announced plans to cut costs in its logistics network. First Industrial ( FR ) rose more than 5% on the week after reporting stellar results and significantly raising its full-year outlook. Citing strong leasing trends, FR now sees FFO growth of 11.2% this year — up 200 basis points from its previous outlook. Prologis ( PLD ) also advanced nearly 5% after it also raised its full-year NOI and FFO outlook while registering an acceleration in renewal rates with a record-high 45.6% increase in effective rents. Meanwhile, Rexford Industrial ( REXR ) reported incredible lease spreads of 83% GAAP and 62% cash while maintaining an occupancy rate of 99%. REXR also raised its full-year FFO and NOI growth forecast, noting that “tenant demand continues to exceed supply.”
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Net Lease: Alpine Income (PINE) jumped more than 7% on the week after reporting strong results and raising its full-year outlook, citing “attractive asset pricing” that led to “attractive net investment spreads and improved growth in the profits’. PINE — which posted nearly 30% FFO growth last year — raised its full-year FFO outlook by 200 basis points to 0.9%. PINE expects to accelerate its disposal activity, which reflects its “continued confidence in our ability to sell assets at attractive valuations”. PINE noted that despite the jump in interest rates, private market prices of net rental properties remain firm, commenting “in terms of smaller property sales, you’re really seeing very high net worth and some institutional investors, buying these properties on a cap . prices that really haven’t changed much since six months ago.”
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Farmland: Gladstone Land ( LAND ) rose nearly 4% on the week after raising its monthly dividend by 0.4% to $0.0456/share – its third dividend increase this year. Farmland REITs — which were the best-performing sector in the first quarter of this year — sold off last quarter as concerns about inflation were replaced by fears of a recession. LAND fell nearly 50% from its all-time highs in mid-April to its recent lows in mid-June as concerns about drought conditions in the West added to macroeconomic pressures. California, in particular, continues to struggle with a multi-year drought as snowpack levels, YTD precipitation and reservoir levels are below historical averages, putting pressure on farmland valuations on water-constrained farms. Farmland Partners (FPI) — which has more limited exposure to the West Coast — posted more modest declines of roughly 15% in the latest quarter.
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Cannabis: Sticking with the agricultural theme, small-cap cannabis REIT Power REIT ( PW ) — which had fallen more than 75% this year due to problems with tenant rent payments — rallied nearly 30% on the week after providing an update on the status of lease negotiations with its largest tenant, Marengo Cannabis, noting that after a long delay it successfully secured a certificate of occupancy for the property, which PW noted was a “significant hurdle” after the city initially refused to issued a CO. Annualized straight-line rent based on the amended lease translates into incremental Core FFO per share of approximately $0.38 per quarter. Last week Innovative Industrial (IIPR) – which has also been downgraded this year due to tenant concerns – did confirm that one of its tenants – Kings Garden – had stopped paying rent in July. IIPR has started discussions with other operators about re-leasing the properties.
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Cell Tower: Crown Castle ( CCI ) was roughly flat this week after reporting operating results and maintaining its full-year outlook calling for FFO growth of 5.9% and revenue growth of 9.5%. Notably, CCI reiterated its belief that “the US represents the world’s highest growth and lowest risk market for communications infrastructure ownership” and dropped the “International” from its company name. CCI also…
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