After a start to the year where the equity markets moved close to hitting year-end targets in one month, volatility returned with a vengeance, spurred most likely by the release of the Employment Situation Summary on February 2nd reporting a 2.9% year-over-year increase in average hourly earnings. Everyone became a Philips Curve acolyte and fears of runaway inflation took hold, leading to a sharp correction in risk assets. For the rest of the quarter, financial markets were buffeted by the daily drama emanating from the White House and shaken by the specter of trade wars and untested leadership at the FOMC; as First Quarter drew to an end, investors were left eagerly awaiting earnings with risk assets trading near February lows.
Economic data released during the quarter was good. The third estimate of Fourth Quarter GDP growth came in at 2.9 %, compared to 3.2% for Third Quarter 2017 and average GDP growth of 1.9% and 2.0% in 2016 and 2015, respectively. According to the Bureau of Labor Statistics, changes in total nonfarm payroll in the past three months were 176,000, 326,000 and 103,000, respectively, an average of 202,000 compared to an average of 182,000 for the 12 months prior. The yield on the 10-Year Treasury Note rose from 2.405% to 2.741%.
The Wilshire US REIT Index (“Index”) was down 7.5% in First Quarter, lagging both the S&P 500 and Russell 2000 Indices which fell 0.8% and 0.1%, respectively; this is the seventh consecutive quarter of REIT underperformance. Only 11 out of the 114 constituents of the Index produced positive returns of which five were Hotel REITs. Ryman Hospitality was the best performing name, advancing 13.5%, compared to the worst, Cedar Realty Trust, a small-cap shopping center REIT which fell 34.5%.
With the sharp increase in the 10-Year Treasury Note yield in First Quarter and conservative guidance proffered by the various REITs for 2018, established patterns of relative performance by property type reasserted itself. Supply is an issue for almost all of the different property types, particularly in the gateway cities that REITs have their portfolios; however, investors chose to see the glass half full for those sectors that have the shortest lease durations like Storage, Manufactured Housing, Hotels and Apartments while eschewing sectors with longer lease durations like Office; interest rate sensitivity was a headwind for Health Care REITs as well but tenant viability and rent coverage was the real issue for senior housing and skill nursing. Real estate benefitting from secular demand like Industrial and Data Centers outperformed.
The bounce in retail real estate proved short-lived as the realities of operating in an environment of secular decline overwhelmed the short-term positives of visits by tourist investors like Third Point LLC. The cynical bid by Brookfield Property Partners LP for two-thirds of GGP that they do not own suggested limited options and investor interest for regional malls, even of the highest quality, and the entire retail sector was dragged down as a result.