This is an abridged version of the full report published on Hoya Capital Income Builder Marketplace on October 7th.
U.S. equity markets snapped a three-week skid in another choppy week after employment data showed signs of softening in labor markets - but likely not soft enough to alter the Federal Reserve's aggressive tightening path. 'Bad news is good news' was the theme of the week as markets rallied on JOLTS data showing one of the largest monthly plunges in job openings on record, but then sold off sharply in the subsequent three days on slightly better-than-expected employment reports from ADP and the BLS. Contributing to the late-week selling pressure was a historic surge in global oil prices in the wake of OPEC production cuts, sending consumer gasoline prices higher once again.
Bouncing off its lowest levels in over two years, the S&P 500 advanced 1.6% on the week - clinging to early-week gains despite a 5% slide into the weekend - while the Mid-Cap 400 and Small-Cap 600 posted stronger advances of nearly 3% each. The tech-heavy Nasdaq 100 climbed 0.7% but remains lower by more than 30% on the year. The downward pressure on real estate equities continued this week as long-term interest rates continued to climb. The Equity REIT Index dipped another 3.4% on the week as sharp selling across the heavily-weighted cell tower and data center REIT sectors offset strength from more economically-sensitive property sectors while homebuilders rebounded following several analyst upgrades, citing historically deep discounts. The Mortgage REIT Index dipped another 4.7% as interest rate volatility remained at historically-elevated levels.
The faint quivers of financial market instability became more widely-felt tremors following a series of updates from Credit Suisse (CS) - the seventh largest financial institution in the world - that raised questions over the bank's solvency amid pressure from a historic pace of central bank monetary tightening. Unfazed by concerns of instability, a chorus of Federal Reserve officials continued to closely toe the party line across more than a dozen public appearances this week including comments that the Fed is still “quite a ways away” from pausing rate hikes. The 10-Year Treasury Yield swung around considerably during the week, briefly dipping back to the low 3.60%-level early in the week before surging into the weekend while the U.S. Dollar Index pushed higher towards two-decade highs. Crude Oil prices surged more than 15% after the OPEC+ group of oil producers announced major production cuts despite pleas from the Biden Administration, likely sending consumer gasoline prices higher in the weeks before midterm elections.
Below, we recap the most important macroeconomic data points over this past week affecting the residential and commercial real estate marketplace.
Soft, but not soft enough. The Bureau of Labor Statistics reported this week that the U.S. economy added 263k jobs in September - the slowest pace of hiring since December 2020 - but nevertheless a decent report in light of emerging signs of economic weakness observed across other recent indicators. ADP data earlier in the week also roughly matched consensus estimates at 208k. There were additional signs that the still-tight labor market is cooling, however, as average hourly earnings increased 0.3% for the month and 5.0% from a year ago, both 0.1 percentage points below estimates. The headline U-3 unemployment rate and broader U-6 unemployment rate; however, each declined due primarily to a downtick in the labor force participation rate, which is still 1.1 percentage points below its pre-pandemic level from February 2020.
Employment gains weren't as broad-based in September as in prior months as three categories recorded job losses - Retail Trade, Financial Services, and Transportation & Warehousing - while job gains in Education, Healthcare, and Hospitality drove the overall increases. Notably, while the leisure and hospitality sector gained 83k jobs in September, the industry is still down by 1.1 million jobs, or 6.1%, since February 2020. Of note, the category with the strongest relative increase in hiring was Temporary Help Services - a category that has recorded total job growth of nearly 9% since February 2020 - the second-highest increase behind the Transportation and Warehousing category during that time, which has seen cumulative job growth of 15%.
Earlier in the week, the Job Openings and Labor Turnover Survey - which is lagged by a month - showed that the number of job openings plunged by more than a million in August - one of the most significant one-month declines in the history of the JOLT survey - providing a potential early sign that labor market conditions may finally be easing. Data showed that the number of available positions totaled 10.05 million for the month, a 10% drop from the 11.17 million reported in July and well below the 11.1 million consensus estimate. Health care and social assistance saw the biggest drop in vacancies, falling by 236,000. The number and rate of layoffs and discharges were little changed at 1.5 million and 1.0 percent, respectively. Also of note, S&P Global Composite PMI Index data released this week showed that the economy was in contraction in all three months of Q3 in the U.S, Eurozone, and U.K..
Best & Worst Performance This Week Across the REIT Sector
Cannabis: Beginning with the upside standouts, cannabis REITs delivered a strong week after the Biden Administration took several steps towards further marijuana decriminalization, seeking to fulfill a campaign promise ahead of the midterm elections next month amid disappointment over the lack of progress in federal marijuana legislation during the first two years in office. The President announced that he would pardon federal offenses for simple possession and urge governors to issue similar pardons. The President is also asking for a review of marijuana’s classification as a Schedule 1 drug. Existing in a legal "grey area" in which federal, state, and local laws often contradict, cannabis has been federally restricted since the 1930s, but medical usage is now legal in 38 states while recreational usage is legal in 18 states following a burst of activity last year which saw five additional states legalize weed: New Jersey, New York, Virginia, New Mexico, and Connecticut. Just four U.S. states currently maintain a full prohibition of any cannabis-based product - Idaho, Nebraska, Kansas, and South Carolina - but even within these states, cannabis usage has been incrementally decriminalized over the past decade.
Hotels: Sotherly Hotels (SOHO) - a small cap REIT focused on limited-service hotels in Sunbelt markets - was among the best-performing REITs this week after providing an update that showed a strong September of operating performance with its Revenue Per Available Room ("RevPAR") rising 8.2% compared to 2019-levels - up from the 1.6% spread in July and -2.1% spread in August. Service Properties (SVC) was also among the better performers after announcing that it refinanced its credit facility to remove the current restrictions on paying dividends. This week we published Hotel REITs: Winter Is Coming which discussed how hotel REITs have held up surprisingly well throughout the recent market turmoil and remain one of the top-performing property sectors this year following a solid summer of operating performance. Several years of pent-up leisure demand from COVID delays helped to offset a slow business travel recovery, but we remain skeptical over the sustainability of the recovery in the upscale urban markets given the complexion of the RevPAR recovery - driven by pent-up leisure travel and surging room rates rather than an underlying occupancy recovery.
Net Lease: Realty Income (O) was among the better performers on the week after providing a business update Oct. 3 noting that its acquisition activity totaled $1.8B in Q3 - bringing its full-year year-to-date investment to $5.0B - pushing back on concern that the higher-rate environment may have significantly slowed the net lease acquisition pipeline. In its second-quarter earnings report back in early August, Realty Income raised its full-year acquisition target to "Over $6.0B" from its prior target of "Over $5B." In this week's update, Realty Income also noted that it raised $700M in proceeds from common stock sales through its at-the-market ("ATM") issuance program and that it has another 20M shares in potential future ATM issuance representing $1.3B in gross proceeds. Elsewhere in the net lease sector, Broadstone Net Lease (BNL) traded flat on the week after it reaffirmed its FFO outlook for full year 2022 but raised its acquisition target to $950M at the midpoint - up $200M from its prior update.
Manufactured Housing: As expected, Equity LifeStyle (ELS) and Sun Communities (SUI) each provided updates on the impacts of Hurricane Ian which were generally consistent with the forecasts we discussed last week. ELS noted that it does not believe that damages will significantly impact its operations or financial condition. Based on its initial assessments, "wind-related structural damage to common areas appears limited... and consistent with prior storm events, newer homes appear to have held up well during the hurricane." ELS specifically cited five properties that did "suffer significant flooding and wind-related damage" which included three RV properties near Fort Myers - Gulf Air RV, Fort Myers Beach RV, and Pine Island RV - and two marinas in the area - Palm Harbour Marina and Fish Tale Marina. The update from SUI noted that three RV properties in the Fort Myers area, comprising approximately 2,500 sites, "sustained significant flooding and wind damage" and one marina property suffered damage to the sea wall and docks. While it did not comment on the expected financial impact, it reiterated that it maintains insurance for its portfolio of communities.
Healthcare: Welltower (WELL) was among the laggards this week after it provided a business update noting that it now expects Q3 normalized FFO per share trending below the midpoint of its previous guidance of $0.82-$0.87/share due to the delayed disbursement of funds from the U.S. Department of Health and Human Services. WELL also commented that occupancy growth in its Senior Housing segment is expected to be in line with previous guidance while "pricing power remains robust as evidenced by strong realized renewal rate growth and interim price increases contemplated by several operators." For Q4, the company expects an additional ~$0.03 per share headwind compared with Q3 2022 resulting from higher interest rates (~$0.02 per share) and the stronger U.S. dollar (~$0.01 per share), assuming the forward interest rate curve and exchange rates remain at current levels. Medical Properties Trust (MPW) - a target of several short-selling firms - was also sharply lower on the week after one of its smaller tenants, Pipeline Health, filed for Chapter 11 bankruptcy protection on Monday.
Mortgage REITs had another wild week with substantial daily swings as the critical measure of interest rate volatility - the ICE BofAML MOVE Index - remained near the highest levels since March 2020. Residential mREITs ultimately ended the week lower by 2.0%, on average, while commercial mREITs managed to push higher by 0.5%. Among the laggards on the week was Hannon Armstrong (HASI) - a commercial mREIT focused on renewable energy - which dipped following a Financial Times interview with short-selling firm Muddy Waters, which has been critical of the firm's accounting practices and business model. Small-cap Sachem Capital (SACH) was the leader on the week after announcing a stock repurchase program for up to $7.5M which will continue through next September. Ellington Financial (EFC) and Ellington Residential (EARN) each ended the week higher after holding their dividends steady with current rates.
The REIT Preferred Index (PFFR) rebounded by 0.4% this week after two weeks of sharp declines - outperforming the broader iShares Preferred and Income Securities ETF (PFF) which ended the week off by 1.1%. As with recent weeks, we observed significant dispersion between otherwise similar securities - symptomatic of disruptions caused by the clashing of large passive and/or programmatic fund flows with relatively illiquid individual securities. Examples this week included an 11% performance spread between NYMT Series F (NYMTL) and its NYMT Series D (NYMTN) and near-double-digit dispersions on the preferred issues of AGNC Investment (AGNC), MFA Financial (MFA), Invesco Mortgage (IVR), Arlington Asset (AAIC), and Summit Hotel (INN).
Amid the surge in rates, large capital raises have been few and far between in the REIT sector - down more than 80% through August compared to last year - but we did see some activity this week as net lease REIT Realty Income (O) priced $750M of 5.625% senior unsecured notes due 2032 while office REIT Kilroy Realty (KRC) closed on a new $400M unsecured term loan facility due 2026. A handful of REITs amended and extended their short-term credit facilities including office REIT Armada Hoffler (AHH) - which increased its capacity to $550M from $355M - and Alpine Income (PINE), which amended and restated its senior credit facility to $350M. Elsewhere, S&P Ratings affirmed Digital Realty's (DLR) “BBB” issuer credit and issue-level ratings and its “B+” rating on its preferred stock with a stable outlook.
Through the three quarters and a week of 2022, Equity REITs are now lower by 33.2% on a price return basis for the year - the worst YTD performance for the REIT Index on record through this date - while Mortgage REITs are lower by 41.4%. This compares with the 23.6% decline on the S&P 500 and the 20.2% decline on the S&P Mid-Cap 400. Within the real estate sector, all eighteen property sectors are now in negative territory for the year including eleven that are lower by more than 30%. At 3.88%, the 10-Year Treasury Yield has surged 237 basis points since the start of the year - the highest weekly closing level since May 2010 - and well above its prior ten-year highs of 3.25% seen back in late 2018.
Inflation data highlight a busy week of economic data in the coming week ahead of the Fed's November meeting the first week of November. On Thursday, the BLS will report the Consumer Price Index which investors - and the Fed - are hoping to show that the fastest pace of year-over-year increases is finally behind us. The headline CPI is expected to moderate to an 8.1% year-over-year rate but the Core CPI is expected to accelerate slightly to 6.5% as the effects of the delayed recognition of housing inflation from 2021 continue to add upward pressure to the metrics. Consumer gas prices were, on average, 7% lower in September compared to the prior month but have since jumped by 8% from their bottom on September 18th. Earlier in the week on Wednesday, we'll see the Producer Price Index for September which is expected to exhibit similar trends of peaking price pressures. On Friday, we'll see Retail Sales data and get our first look at Michigan Consumer Sentiment for September. The Fed is particularly interested in the 5-Year Inflation Expectations survey, looking for signs of a potential "wage-price inflation spiral" through elevated consumer wage expectations.
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, Farmland, Storage, Timber, Mortgage, and Cannabis.
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Disclosure: I/we have a beneficial long position in the shares of RIET, HOMZ, STOR, NLY, AGNC, SRC, BXMT, UBA, GTY, MGP, ACC, NNN, STWD, HIW, CCI, SPG, SBRA, DOC, ILPT, SUI, INVH, AMT, REG, DRE, CUBE, IIPR, ARE, FR, CPT, EQIX, APLE, MAA, PCH, PLD, DLR, LAMR, MDC, KRG, STAG, GLPI , NRZ, ABR, UMH, GMRE either through stock ownership, options, or other derivatives. 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: Hoya Capital Research & Index Innovations (“Hoya Capital”) is an affiliate of Hoya Capital Real Estate, a registered investment advisory firm based in Rowayton, Connecticut that provides investment advisory services to ETFs, individuals, and institutions. Hoya Capital Research & Index Innovations provides non-advisory services including market commentary, research, and index administration focused on publicly traded securities in the real estate industry. This published commentary is for informational and educational purposes only. Nothing on this site nor any commentary published by Hoya Capital is intended to be investment, tax, or legal advice or an offer to buy or sell securities. This commentary is impersonal and should not be considered a recommendation that any particular security, portfolio of securities, or investment strategy is suitable for any specific individual, nor should it be viewed as a solicitation or offer for any advisory service offered by Hoya Capital Real Estate. Please consult with your investment, tax, or legal adviser regarding your individual circumstances before investing. The views and opinions in all published commentary are as of the date of publication and are subject to change without notice. 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. Any market data quoted represents past performance, which is no guarantee of future results. There is no guarantee that any historical trend illustrated herein will be repeated in the future, and there is no way to predict precisely when such a trend will begin. There is no guarantee that any outlook made in this commentary will be realized. Readers should understand that investing involves risk and loss of principal is possible. Investments in real estate companies and/or housing industry companies involve unique risks, as do investments in ETFs. The information presented does not reflect the performance of any fund or other account managed or serviced by Hoya Capital Real Estate. An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Hoya Capital Real Estate and Hoya Capital Research & Index Innovations have no business relationship with any company discussed or mentioned and never receives compensation from any company discussed or mentioned. Hoya Capital Real Estate, its affiliates, and/or its clients and/or its employees may hold positions in securities or funds discussed on this website and our published commentary. A complete list of holdings and additional important disclosures is available at www.HoyaCapital.com.