Bricks and mortar are impervious to viruses. And if any sector of the US economy has made a true V-shaped recovery, it appears to be home-building. The latest survey of the National Association of Home Builders shows that the proportion seeing decent conditions is back almost to its highs of the last few years — having never fallen to the depths of a decade ago after the housing bubble burst. The continued decline in benchmark mortgage rates has had a lot to do with it.
This raises the interesting question of whether real assets will have a chance to blossom after this crisis. Perhaps surprisingly, listed real estate in the US has outperformed the S&P 500 over the last three decades, on a total return basis — which allows for the reinvestment of the high rental yields generated by real estate investment trusts, or REITs.
There is now the possibility of a shakeup within the sector, in both the residential and commercial segments, and across the world. Home builders in the US are positive because the demand for their services in the suburbs is rising as a result of the virus. The NAHB’s chief economist, Robert Dietz said:
"New home demand is improving in lower density markets, including small metro areas, rural markets and large metro exurbs, as people seek out larger homes and anticipate more flexibility for telework in the years ahead. Flight to the suburbs is real."
If there are any lasting changes from the pandemic, an interest in more dispersed living, and a departure from crammed city lifestyles, is one of the more likely. That will be good for home builders. However, the corollary of more telework, lower demand for office space, isn’t as yet having as severe an impact as might be expected. The following chart compares FTSE’s overall global REIT index with Bloomberg’s sectoral indexes for US regional malls, hotels, and office property. After a recovery into early June, hotels and malls are back at levels less than half of where they started the year. Meanwhile US offices are in line with the global average, which still sees commercial property in a bear market.
Is it reasonable to hope for a recovery from here? It might well be. Bond yields have dipped, as we are all aware. This makes the dividend yield that REITs are able to pay out of their rental income that much more attractive. In this chart, Capital Economics Ltd. of London shows the REIT dividend yield compared to the earnings yield (the inverse of the price-earnings ratio) of the S&P 500. This exercise suggests that REITs are at last attractively priced after years of looking expensive.
Trying the same exercise for FTSE’s global REIT index compared to the MSCI World index, and using dividend yields in both cases, we see that the spread in favor of REITs rose sharply with the beginning of the Covid crisis, and remains at roughly the same level.
Naturally, dividend yields are high for a reason. In the grips of recession, the fear is that a lot of rents will go unpaid. But this still creates possibilities.
One is at the level of what might be called stock selection. In the confusion following a serious economic shock, it remains unclear who will benefit and who will lose. According to President Trump, there is a risk that a newly elected President Biden would attempt to abolish the suburbs. That appears unlikely. But if some areas grow less popular, former tenants and owners will relocate. Working out the winners could be very profitable.
Secondly, at a macro level, real estate is still priced on the assumption of a major and enduring economic downturn. Data centers are the only commercial real estate sector to have gained since the pre-Covid peak on Feb. 19. Meanwhile, as the chart from Capital Economics shows, REITs as a whole are performing very much in line with airline stocks, which are an obvious play on the duration of the pandemic and its impact on economic activity.
For those who want to bet that the economy will do better than many now expect, and that there will be a shorter Covid interruption than we believe, real estate looks like a good way to make that bet. It behaves like airlines, only with extra yield.
Bloomberg
