The US economy is still expanding albeit at a slower rate. The third estimate of Third Quarter GDP growth came in at 3.4%, compared to 2.8% for Third Quarter 2017, and the latest estimate for Fourth Quarter GDP growth from the Federal Reserve Bank of Atlanta is 2.8%. According to the Bureau of Labor Statistics, changes in total nonfarm payroll in the past three months were 312,000, 176,000 and 274,000, respectively, an average of 254,000, better than the average of 211,500 for the 12 months prior. Despite the positive GDP and job growth the long end of the yield curve actually declined as the yield on the 10-Year Treasury Note went from 3.056% on September 30 to 2.686% on December 31 and the yield curve flattened with the spread between the 3 Month Treasury Bill and the 10 Year Treasury Note (identified by recent research from the Federal Reserve Bank of San Francisco as the “best summary measure” of the potential for a recession in the US economy) tightened in Fourth Quarter from to 86 bps to only 31 bps.
The Wilshire US REIT Index (“Index”) was down -6.9% in Fourth Quarter, providing a bit more safety in a risk-off environment than both the S&P 500 and Russell 2000 Indices which declined -13.5% and -20.2%, respectively; while this is nominally the third consecutive year of underperformance vs. the S&P 500 Index, subsequent to the sharp sell-off at the start the year, REITs have consistently outperformed the broader equity indices. For the year, only about a third of the Index produced positive returns. Aside from M&A targets like LaSalle Hotel Properties and DCT Industrial Trust, not surprisingly, it was the various constituents of the four sectors that produced positive returns that populated the leaderboard, including Omega Healthcare Investors, the best performing REIT for the year (+39.9%); B-mall REIT, CBL & Associates posted the worst returns for two years in a row (-60.0%).
It is clear that both Fed Chairman Jerome Powell and President Donald Trump were touting economic progress based on lagging indicators while the financial markets were painting a very different picture, one of a global synchronized slowdown. Even in a small GICS sector like Real Estate, the relative performance of the various sectors/property types was telling investors that something was wrong.
For the Fourth Quarter (and for the year), property types which are cyclical: Hotels, Office, Industrial and Retail, all underperformed the Index while property types which are protected from the vagaries of the economic cycle: Health Care, Storage, Apartments and Manufactured Housing, all outperformed. And, unlike in past real estate cycles, it seems that the demand side of the equation was having a bigger effect on relative performance than supply, most likely because supply has been subdued; new construction of commercial real estate in the US, as a percentage of total stock remains below historical averages at below 1.5%. Ironically, supply of new Senior Housing, Storage and Apartments are all above historical averages whereas only Industrial is seeing a modicum of supply among the cyclical property types.