“These are not the droids you’re looking for.”
– Obi-Wan Kenobi
Man, I love that movie, and I know that Hedgeye Nation has heard the quote many times before. It was the first thing I thought of when I read the CPI report on Wednesday.
My sector deals in the realm of commercial landlords and tenants, lessors and lessees. “REIT” is sometimes viewed as somewhat black-boxy, but in the end it is just an IRS classification allowing a company to function as a pass-through entity. Most if not all REIT taxes are assessed at the individual level on shareholder dividends and gains/losses, as opposed to double taxation through corporate taxes (statutory federal rate is 21% for now) and individual taxes for a typical “C-Corp” corporation.
One of the requirements to maintain REIT status is that 75% of gross income must be in the form of rent or other real estate income. So naturally, my eye goes straight to the rent component of each CPI report.
Specifically, this is the “Rent of Primary Residence” or “true” rent that tenants pay to occupy a multifamily or single-family unit, typically over a 12-month term. It receives a 7.6% weighting in the overall CPI calculation, or about a quarter of the overall “Shelter” component of CPI which is one-third of the index.
The remainder is “Owners’ Equivalent Rent” or “OER,” which is meant to capture the impact of house price inflation. If you believe the numbers the BLS is handing is, “true” rent increased +0.2% sequentially or +1.9% y/y, building up to the overall +5.4% annual CPI increase.
But let’s dissect the numbers a bit…
Back to the REITS Grind…
First, the U.S. Census Bureau tells us that roughly ~35% of all occupied housing units in the U.S. are renter occupied. So we have one bureau telling us it receives a ~25% weighting in CPI, and another telling it should be 35%. Well, which one is it? My money would be on the higher figure…
Second, and the Macro Team has done a fantastic job talking about this, it is important to think about the lag effect. If you assume a ~12 month average lease term for residential leases, the July national rent figure includes lease rates transacted from the July 2020 – December 2020 period when rental rates were dropping so dramatically (particularly in major Coastal Gateway markets) that the overall rent inflation plummeted. The second derivative of that number just recently inflected in April/May 2021.
Consider instead the y/y change in actual transacted lease rates on a “same store” basis from Apartment List. This would represent the y/y change in the price you would pay to re-lease your apartment or SFR unit today. Looks a lot higher than +1.9%...
These are not the droids you’re looking for…
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Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 1.17-1.41% (neutral)
UST 2yr Yield 0.18-0.27% (bullish)
SPX 4 (bullish)
RUT 2182-2279 (neutral)
NASDAQ 14,660-14,966 (bullish)
REITS (XLRE) 45.93-47.09 (bullish)
Tech (XLK) 152.28-155.53 (bullish)
Utilities (XLU) 66.34-68.57 (bullish)
Energy (XLE) 48.20-51.44 (bullish)
Shanghai Comp 3 (bearish)
Nikkei 27,320-28,225 (bearish)
DAX 15,592-15,997 (bullish)
VIX 14.43-19.51 (bearish)
USD 91.70-93.21 (bearish)
Oil (WTI) 65.96-74.12 (bullish)
Nat Gas 3.88-4.28 (bullish)
Gold 1 (neutral)
Copper 4.26-4.53 (bullish)
Have a great weekend,
Rob Simone, CFA
REITs Analyst
