Realist Real Estate Roundup, November 11–15 (Part 5 of 7)
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).
Bonds rally on Janet Yellen’s testimony
Last week was relatively data-light, so Janet Yellen’s testimony took center stage. She is perceived as a dove in the mode of Ben Bernanke or Alan Greenspan. Bonds took comfort in her views, especially since she intends to increase communication to the market. The bond market took this to mean that there should be no further surprises with the end of QE.
Last week, we heard from jumbo mortgage originator Redwood Trust (RWT). Its earnings were generally good, but it’s more of a niche player than some of the other REITs that focus on origination like PennyMac (PMT) or the bigger banks.
Homebuilder earnings and M&A
We’re starting to see mergers and acquisition activity in the homebuilding space, with two deals. First, Tri Pointe Homes (TPH) is buying Weyerhaeuser’s homebuilding unit, and 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 being thrown at them by the Street. Smaller builders, however, are stuck dealing with the banks, and credit is much tighter for them.
We got earnings from Tri Pointe Homes last week, and it’s growing very rapidly. It helps that it’s concentrated in the fastest-growing West Coast markets. We also heard from DR Horton, which noted a big increase in average selling prices
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). Friday’s jobs report was probably strong enough to bring a December tapering back into the picture, but it is a long shot.
Implications for homebuilders
Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. The ISM report certainly was a positive for them, as was the jobs report, although it wasn’t that great. Earnings season for the builders is winding up and we’re heading into a seasonally slow time for the builders. It’s too early to tell if the recent decline in rates (notwithstanding Friday’s report) has had any effect on traffic.
Browse this series on Market Realist:
- Part 1 - Bonds rally slightly on a light data week and Yellen’s testimony
- Part 2 - Why Fannie Mae TBAs reacted constructively to Yellen’s testimony
- Part 3 - Must-know: Ginnie Mae TBAs rallied on very little economic data
- quantitative easing