Does the pain get worse?

Homebuilders and residential real estate stocks fall – Photo credit: Shutter Stock

Rising interest rates are likely to slow down the housing market and dry up the sources of income for real estate investors. However, if inflation cools, the sector is likely to pick up, making stocks worth monitoring right now.

Real estate development ground to a halt early in the pandemic as labor shortages slowed construction and complicated supply chains. For real estate stock investors, this resulted in a significant drop in dividend income.

Invesco (IVZ), Hammerson (HMSO) and Landsec (LANDI) all cut their dividend payments during this period.

Invesco (IVZ) price chart

Hammerson (HMSO)

As dividend payouts recover, they face a period of high interest rates. This will reduce the level of financing available in the industry for land development and hamper revenue streams.

This situation leads to an increasing demand for rental properties, which allows real estate companies to maintain a certain level of income, albeit lower than in non-inflationary periods.

Eventually, this should lead to a fall in inflation, which will lead to a recovery in the sector. For now, analysts say the situation will get worse before it improves, potentially creating short selling opportunities for keen investors.

rising costs

Labor shortages due to lockdown restrictions meant construction work was halted for most of 2020 and 2021. In addition, it also affected supply chains as companies’ normal access to materials was disrupted.

While some companies like Great Portland Estates (GPORgb), Big Yellow (BYG) and Land Securities (BLND) have been able to maintain relatively stable levels of dividend payouts during the pandemic, Invesco (IVZ) and Landsec (LANDI) have made cuts halved its dividend payments at the time, while Hammerson (HMSO) cut its dividend per share to 0.2p from 14.8p per share.

Laith Khalaf, head of investment analysis at AJ Bells, told Capital.com that while we can expect payout levels to decrease during a downturn, “many of the FTSE 350 homebuilders offer attractive dividend yields that are generally good. covered”

Land Securities (BLND) price chart.

Rising interest rates

When inflation is a threat to an economy, central banks generally raise interest rates to discourage borrowing and this slows the economy, which should reduce inflation over a period of time.

Currently, both the UK and US economies are experiencing multi-year high rates of inflation, and both the Federal Reserve and Bank of England are set to hike interest rates throughout 2022.

For the real estate sector, this means that borrowing is now becoming more expensive, making new construction more difficult, while retail sales are also falling sharply as homebuyers would be reluctant to pay higher mortgage rates. This will result in the industry suffering a drop in earnings for the coming period.

As Khalaf puts it, “Interest rates and a slowing economy pose headwinds for builders, but the sector is generally at a fairly low valuation, meaning the price is causing a lot of pain.”

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Nancy Vanden Houten, senior US economist at Oxford Economics, said in a note to investors that home sales fell for the fourth consecutive quarter in May. She adds: “Looking ahead, we expect existing home sales to continue to lose momentum as severe erosion of home affordability weighs on sales. Robust demand – including from investors – and strong income growth could prevent home sales from collapsing too much when home price growth slows.”

rental income

As both investors and homebuyers turn away from borrowing, they are instead turning to renting properties and waiting to buy them once interest rates fall. This means companies with large rental property portfolios can maintain healthy income and dividend levels.

For these companies, rental income rather than capital appreciation would be a key success factor.

outlook

Obviously, the prospects for the industry are heavily dependent on the economy. For now, house prices continue to rise, keeping prices low, according to Savills.

A 2022 real estate outlook from PwC states that it’s difficult to predict the direction of real estate right now as this downturn is quite unique. They point to a potential risk in the industry: “A key difference this time is that the industry may also have to contend with the consequences of a very rapid shift in government spending in favor of defense and energy policies and away from areas that are changing properties such as infrastructure and living space have a direct impact on Real.”

Khalaf believes so for now: “It’s probably decent territory to fish for value hunters, but as always, this strategy requires investors to accept that things will get worse before they get better.”

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