High demand, strong borrowing conditions and a host of promising economic signals made 2018 seem like a ripe ecosystem for real estate investments.
Homebuilders like Lennar Corporation and D.R. Horton Inc. entered the year pushing new all-time highs that were 30 to 40 percent above their average range in 2017. At the same time, REITs like Prologis Inc and Equinix Inc. also showed strong momentum, though some in the sector struggled early in the year.
Now, as we approach the back end of 2018, property-based equity is flagging under the weight of high materials’ costs, and rising interest rates, along with the threat of high housing costs, as well as inflation driving down consumer and business buying power. Just take a look at the chart below for the Direxion Daily MSCI Real Estate Bull and Bear 3X Shares ETF (DRN, DRV) and Daily Home Builders & Supplies Bull 3X Shares ETF (NAIL).
DRN & DRV vs. MSCI REIT Index
Data Range: 9/24/2018 – 10/23/2018. Source: Bloomberg. The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For standardized performance and the most recent month-end performance, click here.
NAIL vs. Dow Jones Home Construction Index
Data Range: 9/24/2018 – 10/23/2018. Source: Bloomberg. The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For standardized performance and the most recent month-end performance, click here.
This trend isn’t surprising, with one more interest rate hike expected before the year is out and persistent headwinds for builders in the form of tariffs on basic materials, the market is rotating to more stable options.
However, despite their shared hardships now, the possible fate of homebuilders and REITs might actually be pretty distinct. Let’s look at the next four months might hold for each to understand whether the real estate’s resurgence is really as dead as it might first seem.
Homebuilders
In the case of homebuilders, the headwinds certainly outnumber the things the industry might have going for it. Tariffs against China and Canada on basic materials like steel and wood have already been a drag on an inflated housing market. While climbing interest rates don’t help, the larger factor limiting new home starts is depressed buying power among consumers.
Inflation, tariffs and lagging wages play a role, but it’s really supply that has the housing market down in Q4. New lots are scarce and a tight labor market has meant new construction hires are hard to come by. These trends bear out in the most recent housing data for August, which shows that, despite an uptick in new home starts, building permits are down, forecasting the likelihood of fewer new home starts in the coming months.
However, these factors alone don’t spell the end for homebuilders. Despite an uptick in inventory, existing home prices are still high. One key element that could buoy the industry is high consumer confidence, which might prompt buyers to spend extra for a new home. Another short-term influence is the “broken windows fallacy,” which — because of the destruction brought on by Hurricane Florence — might boost the bottom line for some of these companies involved in the repair effort come earnings season.
Overall, larger economic forces are standing in the way of long-term strength in the homebuilders. The best indication for a turnaround will likely first be seen in a resolution to the trade wars or an actual gain in median wages. However, the threat of inflation looms large over the industry.
REITs
Despite the overall stronger year REITs have had when compared to homebuilders, they’ve also felt the shock of recent headlines. Things like the September rate hike’s potential effect on property investments and increased borrowing rates as well as fluctuations in retail performance impacting retail REITs have put some downward pressure throughout the industry.
However, these issues might only be the market reacting for the sake of reacting, as the fundamental picture on REITs is little changed from where it was six months ago. For one, the impact of interest rate increases is largely overblown given the countervailing factors impacting the asset value of a REIT-owned property. Second, the aforementioned consumer confidence levels in addition to broader economic indicators suggest the near-term outlook on retail is solid.
While the near-term potential for REITs remains better than the street might suspect, obstacles from a tightening economic picture could spell trouble for real estate holdings. For one, rising oil prices and already high premiums on goods being taxed at the border could prove more of a drag on overhead spending for companies who might otherwise looking to expand. These might also take a hit from the tightening economic picture both here and around the world, if projections for GDP begin to falter.
Related Leveraged ETFs
- Direxion Daily MSCI Real Estate Bull 3X Shares ETF (DRN)
- Direxion Daily MSCI Real Estate Bear 3X Shares ETF (DRV)
- Direxion Daily Home Builders & Supplies Bull 3X Shares ETF (NAIL)