Realist Real Estate Roundup, December 9–13

Part 5

Week in review: Must-know retail sales and Toll Brothers earnings

The ten-year bond is the basic driver of REITs and homebuilders

Long-term interest rates are priced off the benchmark long-term bond, which is the ten-year Treasury. These days, the ten-year bond reacts to economic data through the Federal Reserve’s asset purchase program, also known as quantitative easing (or QE). As a general rule, economic data that shows weakness is bond bullish (positive). However, data that shows strength isn’t necessarily bond bearish (negative).

Retail SalesEnlarge Graph

Bonds sell off on stronger-than-expected economic data

Last week was pretty slow with important economic data. We were sandwiched between the jobs report and the upcoming FOMC meeting. About the only truly important data point was the retail sales data for November, which came in stronger than expected. Consumer spending has been the Achilles’ Heel of the recovery, so it was good to see some strong numbers for November. We also had good news, as household net worth increased by half a trillion dollars to 1.9 trillion.

REIT earnings are largely over. The REITs de-leveraged their balance sheets pretty aggressively over the past five months and are now in a much better position to weather an increasing interest rate environment.

Homebuilder earnings and M&A

Toll Brothers (TOL) announced better-than-expected earnings last week, and the most surprising number was the increase in average selling prices—from 651,000 to 703,000 between Q2 and Q3. The homebuilding segment has definitely been a case of two sectors—the luxury sector, which is doing extremely well, and the first-time homebuyer sector, which is getting bombarded from increasing real estate prices, increasing interest rates, and a lousy job market.

We’re starting to see mergers and acquisitions (M&A) activity in the homebuilding space, with two deals. First, Tri Pointe Homes (TPH) is buying Weyerhaeuser’s homebuilding unit, and second, Toll Brothers is buying Shapell. We can attribute much of this to the two-tiered financing market in general. Large companies are able to borrow at exceptionally low interest rates and almost have money thrown at them by the Street. Smaller builders, however, are stuck dealing with the banks, and credit is much tighter for them.

Implications for mortgage REITs

Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. The mortgage REITs have been crushed as the ten-year bond has sold off, but they’ve been trying to form a bottom here. For REITs, it’s all about the Fed’s exit of QE (quantitative easing). The jobs report and GDP report were probably strong enough to bring a December taper back into the picture, and at this point, it’s probably a 50-50 bet.

Implications for homebuilders

Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. The jobs report certainly was a positive for them. Earnings season for the builders is winding up and we’re heading into a seasonally slow time for the builders.

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