Investing in Real Estate in the Context of a Declining Economy
Nowadays, economic cycles, especially recessions, are receiving a significant amount of attention in discussions. It has come to my attention that many people have the fixed idea that when there is a downturn in the economy, the real estate market would be negatively affected to the same level as the overall economy and other asset classes.
Most people are under the wrong idea that there is a strong link between real estate and the overall economy. While it is true that the real estate market can be negatively affected by recessions sometimes, there is a much weaker connection between the two.
In fact, throughout more than half of the previous 34 recessions over the last 150 years, real estate has either not been impacted at all or hasn’t been affected nearly as badly as other asset classes like equities. This statistic can be found by looking back throughout the previous 34 recessions.
Why is real estate not affected to the same level as other industries?
Here are a few explanations
There are various types of investments, but real estate is not one of them. Because real estate assets come with their own objective value, they are often less vulnerable to the influence of economic factors.
In general, economic downturns follow prolonged periods of rising inflation. Where do you recommend individuals keep their money in an inflationary environment? Real estate. Real estate is a fantastic hedge against inflation because of the value of the underlying asset and the debt that could be related to it.
Some investors seek property investment to protect their money if the share market or other types of assets are experiencing a downturn. In contrast to investments in a number of other asset types, real estate value rarely goes to zero or even gets close.
Due to these factors, the real estate market often demonstrates performance that is anti-cyclical in comparison to that of the overall economy.
What Economists are saying
An American economist by the name of Henry George published a paper in the late 19th century explaining why our economy fluctuates in waves at regular intervals (remember, this was before the Federal Reserve existed). In contrast to modern economists who think that fluctuations in interest rates and inflation cause cycles, George argued that the primary factor underlying these cycles was an investment in land prices.
The following is George’s view on how the boom-and-bust cycle that we observe in the economy was produced by land speculation:
First, we must acknowledge that the available land area is limited and cannot be increased in any way. This phenomenon is referred to as inelastic supply in economics. When the supply of a good or service is inelastic and demand for that good or service grows, the cost of that good or service also increases. The value of land goes up in direct proportion to the level of market demand for it.
Next, we are going to assume that real estate developers, overall, buy property to develop it right now and then resell it in the not-too-distant future. The costs developers are prepared to pay for raw land indicate how much they believe they will be able to sell the building in a year or two if they begin developing the site right away. However, when the economy is booming, investors (people like you and me) will continue to acquire land on speculation. This means that they won’t develop the property right away; rather, they will keep it as an investment with the expectation that the price will rise in the future. Because of these speculative acquisitions, land prices have increased, so developers can no longer generate a profit. As a result, developers have been forced to cease purchasing property.
History of Real Estate During Economic Downturns
When real estate developers stop purchasing land, they also stop constructing buildings. And when they stop constructing, this generates an economic wave that spreads across the economy, impacting businesses such as construction, production of heavy machinery, and manufacturing of building materials. This leads to a decline in economic activity, particularly in those sectors of the economy.
Ultimately, land speculators realize that they will not be able to earn a profit from their property acquisitions. As a result, they begin selling off their inventory at discounted rates, which stimulates the activity of land developers once again. The process starts again with developers developing and manufacturers selling, then goes through the whole cycle again.
In the past 160 years, this real estate market cycle has behaved in a highly reliable way. This cycle has its unique timeline and happens less often than the overall economic cycle, commonly referred to as the “business cycle.” Throughout history, it has happened on average once every 18 years. This 18-year cycle has been surprisingly continuous, creating real estate market downturns irrespective of the larger economic downturns that are often discussed. The only exception to this remarkable consistency came during the few decades that followed the Great Depression.
Final Remarks
Generally, I am of the viewpoint that both the economic and real estate cycles exist and that they are influenced by distinct economic factors, although they are frequently connected.
I believe that the depth of the Great Recession in 2008 was compounded by the fact that the economic and property investment cycles both entered a downturn at the same time. The downfall of the real estate market occurred precisely as predicted, approximately 18 years after the beginning of the previous significant real estate crisis in 1989, which resulted in a correction of more than 25 percent in several areas. In addition, we were around six years into the economic cycle following the 2001 downturns, which is the average amount of time between business cycles over the last 150 years. Therefore, 2008 might not have been essential; yet, for those who pay attention to cycles, the date wasn’t all that shocking.
While I won’t pretend to have any strong understanding regarding whether or not the real estate market will be affected by the impending recession or, if it is, to what extent it will be affected, I will clarify that I don’t believe it won’t be affected at all. Anyone who assumes that the real estate market will inevitably experience a recession as severe as the general economy or other asset classes should be wary of making that assumption. The real estate market could take a knock. However, if previous experience indicates, it’s unlikely that anything substantial is on the horizon.
If you have confidence in the historical patterns of cycles, you need to be more concerned about the status of the real estate market in 2026, which will be 18 years after the most recent significant fall in the real estate market.
Real Estate Opportunities During Slowing Economies
When the economy dips so do real estate values presenting opportunities for the savvy investor as well as new real estate investors. What’s more important is having a real estate investment property lender that can quickly deliver the right financing amounts and terms to make it more the worthwhile to invest in such recessive markets.
New City Financial has over 20 years of real estate funding experience funding from as little as $75,000 to over $50 Million in real estate investments. Get a quick real estate investment financing or refinance quote here: or call 855-848-2862.
