As recent signals that the Fed’s “soft landing” recession isn’t going to come to fruition, financial markets responded accordingly. In addition to covering financial markets impact, we’re going to look into real estate. The DOW Jones and S&P 500 both dropped steadily Friday 10/7. The S&P has been on such a steady decline, the last 12 months of gains have officially completely canceled out. While some have speculated that we’re at a “bottoming out” in the equities market, which is supported by historic S&P 500 trends, market participants don’t seem to fully buy in. In fact, quantitatively the Top 5 stocks by market cap in the S&P 500 (Apple, Microsoft, Amazon, Tesla, and Alphabet Inc/Google, i.e., “Big Tech”) have been overpriced for years, compared to S&P 500 P/E [Price-to-Earnings] averages.
Either way, turmoil is very likely to continue for capital markets and equities investors. Even if the net result is positive, there will be a lot of sleepless nights in the process. Let’s shift gears and take a look at a completely different, but critical (remember 2008) market: real estate.
The Real Estate Market was Effectively COVID-proof; is it Recession-proof?
This is the ultimate question for investors will look at real estate – both passive and active investments – in the longer-term. Foreign investors are already starting to see massive benefits to American real estate investments. That’s certainly one of the primary catalysts for steadily high real estate prices, while other assets are devalued. While we’re going to address the current and future state of the real estate market, the heading was rhetorical. Never forget 2008. That’s going to be a critical lesson investors takeaway from this coming recession, as well.
Real estate and related assets are certainly not recession, or even depression proof. It’s always good to be reminded of this fact: real estate is the world’s largest asset class. That means the most money (in all forms of currency, worldwide) is being spent in this market, as compared to any other segment in global finance. With real estate-related securities, we now know we must pay extra close attention to the value of the underlying assets. That goes back to a key differentiator when you’re discussing real estate in the context of an investment strategy. People and families will always need shelter. The landscape may have been altered due to COVID-19, but corporations still need office buildings.
Physical Real Estate Will Always Have Some Value
The critical point is real estate will continue to have some value, regardless of what happens in financial markets. Moving away from the combination of greed – both on the part of homeowners and lenders – that led up to the 2008 financial crisis, real estate is still something society will always need. Remember how truly heartbreaking some of the stories of families losing their homes during that 2008 recession was? When tangible assets that we get daily utility from as in the equation, it’s an entirely different scenario from an illiquid financial asset. The types of investors are different, their goals are different, their interests vary, etc. This is all to say that while there’s no doubt there’s a level of positive correlation between financial markets and real estate prices, by no means is it absolute. The dynamics are far too dissimilar.
However, not being recession-proof is actually one of the common denominators that always holds true for the pair.
The Pandemic Housing Boom
As we’ve recently shared, experts started questioning how long this “seller’s market” we’ve seen explode since COVID-19 will last. Since then, there have been major developments. First and foremost, from the Fed. In late September 2022, the Fed announced they are going to “reset” the real estate market through a ‘difficult’ correction. In June 2022, Fed Chair Jerome Powell said he sees spiking mortgages rates fizzling out the Pandemic Housing Boom as a “good thing”. During what’s referred to as the Pandemic Housing Boom, housing prices soared in growth by 42%. We’ll now certainly see some of those gains erased.
With increased rates, we should expect to see a diminished potential buyer pool. In April 2022, prices peaked at 21% – according to Zillow’s home value index – however by this fall they fell to just 14%. According to Zillow senior economist Jeff Tucker, “it’s too soon to tell” how big of an impact the reset will have on home prices. In July 2022, the S&P Case-Shiller index, which measures house prices in 20 US cities, recorded its first monthly decline in a decade, dropping by 0.44%. Mortgage rates (30-year, fixed rate) are currently sitting at roughly 6.7%, according to guarantor Freddie Mae. Just a year ago however, the same 30-year, fixed rate mortgage was 2.99%.
The Impact of the Current Correction in Housing Market Prices
“The market is shifting, but a correction was needed”, said real estate agent Junior Torres. “It was not a sane market, what we were having in the pandemic”. This is causing sellers, who were driving the early 2020s pandemic market, to face a new reality. Fewer properties are receiving fewer offers. Sellers are going to continue getting more and more ‘desperate’ the longer the correction lasts. In other words, until we’ve reached a point where supply and demand is back at an equilibrium price, median selling prices will continue to decrease.
Additionally, a correction in the housing market typically incentivizes homeowners to ‘stay put’. Investors and home flippers might feel pressure to sell quickly, however homeowners will simply keep their house. If we do reach that point sometime in 2023 – but more likely 2024 – they will then reassess their situation. However, when the Fed is verbally communicating that rates aren’t down – the opposite – homeowners have frankly no incentive to sell. According to the latest numbers from Zillow, the median stay in a US home is 12 years.
Concisely, housing market prices are going to continue decreasing while rates remain at this level. From Fed statements, this is expected to continue through 2023. This should result in housing market prices continuing on the same trajectory. Committed sellers and investors will feel pressure to act quicker. Those not ‘forced’ to sell for unexpected reasons (new job, for example) will very likely remain in their homes. This will obviously decrease supply, but again primarily due to the current and expected mortgage rates in the short-term, we should expect to see below average demand.