Good Riddance, 2022 | Seeking Alpha

This is an abridged version of the full report and rankings published on Hoya Capital Income Builder Marketplace on December 31st.

Real Estate Weekly Outlook

U.S. equity and fixed income markets closed out their worst year since the Great Financial Crisis with a fourth-straight week of declines as Treasury yields jumped back to seven-week highs on lingering inflation worries and renewed COVID concerns emanating from China – a fitting conclusion to a tumultuous year defined by uneven and often-painful regressions to pre-pandemic realities and atonement for pandemic-era excesses.

Dragging its full-year declines to nearly 20%, the S&P 500 slipped 0.1% on the week while the tech-heavy Nasdaq 100 dipped another 0.4% – shedding nearly a third of its value in 2022. The Mid-Cap 400 and Small-Cap 600 each finished lower by 0.2% on the week as all four major benchmarks posted their worst year since 2008. The particularly rough year the yield-sensitive real estate sector ended with another week of broad declines with the Equity REIT Index slipping by 0.3% while the Mortgage REIT Index dipped by 6.0%. Homebuilders declined by 0.6% on housing data showing a continued rate-driven “winter chill” across the previously-red-hot single-family market.

Concern over the potential inflationary and public health impact of China’s pivot away from “COVID zero” policies sparked renewed selling pressure across global fixed-income markets this week, sending the 10-Year Treasury Yield (US10Y) higher by 13 basis points to 3.88% – the highest weekly close since early November – while the U.S. Dollar Index slid to its lowest levels in over six months. An unwelcome development for the inflation outlook, Crude Oil advanced 1% this week to push their three-week rebound to nearly 13% while U.S. consumer gasoline prices have rebounded by 10 cents since hitting their lowest levels in eighteen months. Eight of the eleven GICS equity sectors finished lower on the week with Financials (XLF) and Energy (XLE) stocks leading on the upside while Materials (XLB) stocks lagged.

Good riddance, 2022. There were few places to hide across financial markets in a historically brutal year for investors that wiped out nearly a fifth of global financial wealth. The typically-steady US bond market delivered its worst year in history with a loss of 13.01% on the Bloomberg US Aggregate Bond Index, which is over 4x larger than the previous worst year back in 1994 (-2.9%). At 3.88%, the 10-Year Treasury Yield surged 237 basis points since the start of the year. Among the ten major asset classes, Commodities (DJP) were the only segment to see positive inflation-adjusted returns for the year. Fittingly on a year defined by performance reversions, the commodities complex is still the weakest-performing asset class since the start of 2010.

After leading the charge last year, REITs finished in the basement of the performance tables among the ten major asset classes on a total return basis with declines of roughly 25%. Within the real estate sector, just one property sector finished in positive territory for the year – Casino REITs – while six property sectors finished the year with declines of 30%. Despite the underperformance this year, REITs remain the fourth best-performing asset class since the start of 2010 with average annual total returns of roughly 10%, outpacing Bonds (AGG), TIPS (TIP), Commodities (DJP), Emerging Markets (EEM), and International (EFA) stocks.

Real Estate Economic Data

Below, we recap the most important macroeconomic data points over this past week affecting the residential and commercial real estate marketplace.

Ahead of a critical slate of employment data next week, weekly jobless claims data this past week showed that filings for Continuing Jobless Claims rose to the highest levels since early February at over 1.7 million. Per Bespoke Research, the magnitude of the increase in continuing claims – rising 25% on a three-month basis – has never occurred outside of a recession. With the Fed leaning heavily on tight labor markets to justify their historically swift monetary tightening course, we’ve noted how the strength seen in the primarily BLS nonfarm establishment survey has been at odds with most other employment metrics including the BLS’ household survey in the same report. ‘Good news is bad news’ will likely be the theme of the employment reports next week as investors and the Fed wait for clearer signs of the long-awaited cool down in the most closely-watched BLS establishment survey.

A pivot in Fed policy can’t come soon enough for the U.S. housing markets, which are bearing the brunt of the impact of historic levels of monetary tightening. The Case-Shiller US National Home Price Index declined 0.5% in October from the prior month – the fourth-straight month-over-month decline – but the dip in October was less steep than the prior two months which saw the largest single-month decline since November 2011. Home values are now about 3% below their recent peaks in June 2022 but some home price metrics – including the NAR’s Median Price of Existing Homes – are now showing double-digit price declines from their early 2022 peak in some regions and markets. Zillow (Z) data shows that four markets have seen home prices fall at least 5% from their recent peaks through November: Austin (-7.5%), San Francisco (-6.2%), Phoenix (-5.8%), and Las Vegas (-5.1%).

Equity REIT Week In Review

Best & Worst Performance This Week Across the REIT Sector

Net Lease: The holiday week didn’t slow down the pace of deal-flow in the net lease space this week. Realty Income (O) announced an $894M deal to acquire up to 185 single-tenant retail and industrial properties from privately-traded REIT CIM Real Estate Finance Trust at a 7.1% cap rate – notably above Realty Income’s typical acquisition cap rate in the 5-6% range in recent years. The portfolio has a weighted average remaining lease term of 9.2 years with 48% of the portfolio’s rents derived from investment-grade rated clients. The deal – expected to close in Q1 – is expected to be immediately accretive to earnings on a leverage-neutral basis. Elsewhere, Four Corners Property (FCPT) announced a pair of acquisitions – a four-property portfolio of restaurants operated by Buffalo Wild Wings in Illinois for $14.3M at a 7.3% cap rate and a two-property portfolio of restaurants operated by Red Lobster and Smokey Bones in New York $6.9 million at a 6.5% cap rate.

Casino: The busy month of deal-flow continued for VICI Properties (VICI) as well, which announced this week that it will provide up to $350M in mezzanine loan financing to complete the construction of Fontainebleau Las Vegas, a 67-story hotel and casino at the north end of the Las Vegas Strip owned by an investment group that includes Koch Industries. The long-delayed project – which originally broke ground in 2007 and has changed hands several times during its $3.7B development – is finally expected to open in the fourth quarter of 2023. The casino will feature 3,700 hotel rooms along with 550,000 square feet of convention space. The loan is the third major deal of the past month for VICI, which announced in November a $5.5B deal to acquire the MGM Grand and Mandalay Bay from Blackstone and announced a $300M deal last week to acquire two hotel-and-casino properties in Mississippi.

Cannabis: The pressure on cannabis stocks continued this week on reports that the FDA is considering regulations on cannabis compounds in food and supplements. This week we published Cannabis REITs: Smoked Out which noted how the cannabis REIT sector – perennial performance leader in the REIT sector before this year – has been slammed in 2022 amid concern over defaults from their cannabis cultivator tenants, which have in turn been smoked by plunging wholesale cannabis prices and setbacks on federal legalization. Production efficiencies fueled by industry consolidation and the “institutionalization” of cannabis supply chains have pushed wholesale prices down 60% since 2020, which has begun to “weed out” some smaller operators. For Cannabis REITs – which have concentrated leasing and lending efforts on larger multi-state operators (“MSOs”) and publicly-traded firms in recent years – tenant default issues have remained limited to a handful of smaller single-state operators. We noted that while all cannabis stocks are inherently speculative given the obvious policy risk, these REITs have carved out a legitimate competitive niche as primary capital providers to a maturing industry on an undeniable secular demand growth trajectory.

Office: Vornado Realty (VNO) was among the weaker performers this week after S&P announced an index reshuffling that will send the REIT from the S&P 500 to the S&P Mid-Cap 400 to make room for GE HealthCare Technologies in the large-cap benchmark following its spin-off from General Electric (GE). All index moves are effective prior to the opening of trading on Thursday, Jan. 5. Vornado was one of 30 REITs included in the S&P 500 but will join 32 other REITs in the Mid-Cap 400. Elsewhere, New York City REIT (NYC) – a micro-cap REIT that owns eight office properties in New York City – dipped more than 14% today after it announced that it will revoke its REIT status and become a taxable C-corporation as part of a business shift that “includes expanding the nature and type of assets owned and operated,” while commenting that “the pace of recovery of the office segment since the COVID outbreak remains challenged.” Recent data from Kastle Systems shows that office utilization rates remain below 50% nationally with transit-heavy coastal markets continuing to significantly lag behind Sunbelt and secondary markets.

Hotels: The leisure and hospitality industry was in focus this week after the “Bomb Cyclone” across North America resulted in thousands of flight cancellations and disrupted travel plans during the critical holiday week. TSA checkpoint data shows that passenger throughput averaged just 87% of 2019-levels on the seven days through December 29th – dragging the month-to-date totals for December to the lowest since August as a percent of pre-pandemic levels. Braemar Hotels (BHR) was among the better performers this week, however, after it announced that it closed on a $100M mortgage loan for the Four Seasons Resort Scottsdale at Troon North in Scottsdale, Arizona. The interest-only loan is priced at SOFR+3.75% and has a three-year initial term with two one-year extension options. BHR plans to use the proceeds to pay off a more expensive loan secured by the Ritz-Carlton Reserve Dorado Beach, which has a floating interest rate of LIBOR+6%.

Mortgage REIT Week In Review

Pressured by the renewed selling pressure across fixed-income securities, mortgage REITs finished broadly lower on the final week of 2022 with the iShares Mortgage Real Estate Capped ETF (REM) sliding 6.0%. On an otherwise quiet week of mREIT newsflow, ARMOUR Residential REIT (ARR) slipped about 4% despite maintaining its current monthly dividend rate of $0.10/share. For the year, all 42 mortgage REITs finished in negative territory. Upside performance standouts for the year included a trio of commercial mREITs: Seven Hills (SEVN), Franklin BSP Realty (FBRT), and NexPoint Real Estate (NREF). Notable laggards in 2022 included ground lease-focused iStar (STAR), construction lender Broadmark Realty (BRMK), and renewable energy lender Hannon Armstrong (HASI).

For the year, the mortgage REIT and equity REIT benchmarks each delivered their worst year of performance since 2008 but produced notably similar total returns at -27.3% and -26.0%, respectively, which was the narrowest performance spread on record for the two real estate indexes. Last month, we published Mortgage REITs: High Yields Are Fine, For Now, which noted that despite paying average dividend yields in the mid-teens, the majority of mREITs have been able to cover their dividends, but we flagged a handful of mREITs with payout ratios above 100% of EPS.

REIT Capital Raising & REIT Preferreds

Despite the upward pressure on benchmark interest rates, the REIT Preferred Index (PFFR) advanced 0.8% this week, outperforming the broader iShares Preferred and Income Securities ETF (PFF) which ended the week lower by 0.7%. For the year, however, REIT Preferred stocks still delivered the worst year since 2008 as well with total returns of -23.89%, which also lagged the broader preferred benchmark which produced total returns of -18.18%. Notable movers on the upside this week included the preferreds of Arbor Realty (ABR), TPG Real Estate (TRTX), Invesco Mortgage (IVR), and PennyMac Mortgage (PMT). Notable laggards for the week included the preferreds of EPR Properties (EPR), Cherry Hill (CHMI), and ACRES Commercial (ACR).

Economic Calendar In The Week Ahead

Employment data highlight a critical holiday-shortened week of economic data in the week ahead headlined by JOLTS data on Wednesday, ADP Payrolls and Jobless Claims data on Thursday and the BLS Nonfarm Payrolls report on Friday. Economists are looking for job growth of roughly 200k in December – which would be the smallest gain since December 2020 – and for the unemployment rate to stay steady at 3.7%. ‘Good news is bad news’ will likely be the theme of these reports as investors and the Fed await the long-awaited cooldown in labor markets which has yet to fully materialize. Strong job gains observed in the BLS’ nonfarm establishment survey, have been at odds with most other employment metrics showing a more material slowdown in hiring including the BLS’ household survey in the same report which showed a second-straight month of net job last month.

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.

Disclosure: Hoya Capital Real Estate advises two Exchange-Traded Funds listed on the NYSE. In addition to any long positions listed below, Hoya Capital is long all components in the Hoya Capital Housing 100 Index and in the Hoya Capital High Dividend Yield Index. Index definitions and a complete list of holdings are available on our website.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.