Displaying items by tag: real estate

The rising rate environment has been brutal for REIT stocks with double-digit losses in 2022. In 2023, the sector saw decent gains in the first-half of the year, however these gains have been wiped out amid the breakout in longer-term yields. 

However, this could be setting up a contrarian opportunity especially as the odds of a ‘soft landing’ continue to inch higher. Inflation is moderating, while the economy continues to modestly expand as evidenced by the September jobs report and upwards revisions to the July and August payroll data. In addition, Q2 GDP was better than expected, and consumer sentiment continues to move higher.

In essence, a soft landing scenario would be bullish for residential REITs. It implies no significant spike in defaults, while lower rates would also lead to a generous tailwind for the sector. In contrast, commercial REITs are facing more significant challenges and have more structural issues especially with offices and retail. 

To be clear, the odds of a soft landing have increased, but it’s far from a certainty. Some threats to this outlook include a resurgence of inflation or the economy suddenly deteriorating due to pressure from higher rates. 

Finsum: The odds of a soft landing have moved up higher after a recent spate of positive economic data. Here’s why residential REITs would outperform in such a scenario.

A combination of factors has led to the worst housing affordability in decades. During the pandemic, there was a surge in real estate prices as many moved out of urban locations to the suburbs due to the rise of remote and hybrid work arrangements. 

This increase in demand also coincided with a tight supply-demand dynamic as new home construction has lagged population growth ever since the Great Recession and subprime mortgage crisis. Another factor supporting demand is that Millennials are entering their peak consumption years in their 30s and 40s. 

Additionally, after more than a decade of low rates, current monetary policy is at its most restrictive in decades. Thus, mortgage rates are now hovering above 7%, while they were at 3% for most of 2020. 

According to Andy Walden, the VP of enterprise research for ICE Mortgage Technology, household incomes will have to increase by 55%, home prices decline by 35% with mortgage rates back to 3%, for affordability to revert back to historical norms, or some combination of these factors. 

Of course, such dramatic developments are unlikely. Walden believes that inventories are a key leading indicator for home prices. In recent months, there has been a modest bump in listings, but nothing significant enough to affect affordability. 

Finsum: A combination of factors has led to housing becoming unaffordable for many prospective buyers, creating a major challenge for the real estate market.

The Federal Reserve’s tightening campaign surprisingly has had a muted impact on the broader economy as evidenced by continued expansion despite the highest rate in decades. In terms of the stated goal of curbing inflation, results are mixed as well. 

However, the vector which immediately responded to tighter policy is real estate given that affordability has declined due to higher rates. In some markets, activity has simply cooled, while in those with poor fundamentals, prices are falling more precipitously. 

Within real estate, commercial real estate (CRE) is the most challenged given oversupply and the recent rise of remote work. For Barron’s, Rob Csneryik covers why some contrarian investors are seeing opportunity in the beaten-down sector.

In essence, it’s a buyer’s market with so many traditional sources of funding out of the picture, leading to more favorable terms and higher returns. Further, there is less risk with values already down so much. Many believe that office occupancy rates will start to gradually rise especially if the economy does weaken which would give employers more leverage to force employees back to the office. CRE would also likely benefit from a mild recession as it would compel the Fed to cut rates which would turn a major headwind into a tailwind. 

Finsum: Commercial real estate is the weakest segment of the real estate market. However, some contrarians see opportunities amid the carnage.

Many contrarian investors are certainly interested in buying the dip in REITs given the low valuations, generous yields, and upside in the event of a Fed pivot. Further, many components of the real estate market remain healthy such as healthcare and industrials. However, there are some risks that investors need to consider.

There are secular problems in areas like retail and office buildings due to oversupply, while there have also been significant changes in people’s behavior, affecting demand. Additionally, investors should be aware that every bear market results in a handful of value and yield traps which become plagued by balance sheet and liquidity issues especially in high-rate environments.

Value traps are situations in which stocks look attractive by conventional metrics, however these low valuations are a reflection that the market isn’t optimistic about the company’s prospects. Similarly, ‘yield traps’ are when yields look attractive, but the market is expecting a dividend cut as current payout ratios are not sustainable. 

For investors interested in REITs, they must prioritize quality and strong financials. This is especially true in the current situation where the path and trajectory of monetary policy remains highly uncertain. If rates do stay elevated for a long period of time, some REITs will go bankrupt, while many will have to pay their dividends in order to remain solvent. 

Finsum: REITs are attracting interest from contrarian investors, but here are some downside risks to consider.

Ever since the Fed embarked on its tightening campaign starting in the early months of 2022, the real estate market experienced the most immediate impact due to rising mortgage rates negatively affecting home affordability.

Initially, publicly traded real estate stocks saw deep drawdowns while private real estate performed much better. Now, this gap is beginning to shrink as private real estate has been following public real estate lower. One factor is that it’s increasingly becoming clear that high rates are not going to disappear anytime soon due to the resilience of the economy and inflation. In fact, inflationary pressures seem to be reigniting given the recent strength in oil and auto workers striking.

In terms of when private real estate will bottom, some indicators to watch are an increase in transaction volume even at lower prices, a change in monetary policy, and increase in lending standards. Currently, all 3 are working against private real estate given that many markets are ‘frozen’ as sellers are unwilling to cut prices, while buyers don’t see many attractive deals at current yields. The Fed’s focus remains on stamping out inflation whether through further hikes or keeping rates ‘higher for longer’. Finally, lending standards are unlikely to loosen especially with so many banks struggling with balance sheet issues and/or an inverted yield curve. 

Finsum: Private real estate was immune to the weakness in public real estate for so long. Find out why this is starting to change.