Real Estate in Bear Markets. How residential real Estate has performed historically versus the stock market in different periods can give us some clues as to whether real estate will help during the next bear market. Planning to Wealth looked at residential real estate as opposed to publicly traded real estate, since returns for publicly traded real estate investments like Real Estate Investment Trusts (REITs) are more correlated to the stock markets than actual real estate. During the eight bear markets since 1960, the Case-Schiller Home Price Index only had negative returns during one bear market period: the 2007-2009 housing/credit crisis. It’s interesting to note that home prices even went up during periods of high inflation, like the 1980-1982 bear market and 1973-1974 bear market, when the Consumer Price Index (CPI) went up 14% and 20%, respectively.
Stock Market Versus Real Estate Returns. Over long periods of time, home prices have tended to follow a relatively predictable return pattern of increasing about 1% more per year than CPI with the Case-Schiller returning 4.1% annually since 1980 versus 3.1% for CPI. While the stock market has done much better returning 8.7% per year since 1980, its performance has varied dramatically. The annual return for the S&P 500 was 4.4%, 1.7%, 12.5%, 15.1%, and -2.5% in the 1970’s, 1980’s, 1990’s and 2000’s, versus annual home price growth of 8.7%, 5.9%, 2.7%, and 3.9%. Home price growth has had significantly lower standard deviation of returns with the Case-Shiller having less than 20% of the standard deviation of the S&P 500.
Problems with the Historical Data. While the data shows us that real estate still performs well in stock bear markets and has less volatility of returns, drawing conclusions from S&P 500 and Case-Schiller Home Index presents some issues though. The housing return data doesn’t include rent on a home, so total return comparisons between the S&P 500 and Case-Shiller aren’t apples to apples.
Real Estate Volatility. As well, real estate’s low return volatility properties may be overstated. We would argue that real estate’s higher transaction costs and the period of time it takes to convert a property into cash contributes to the lower volatility we see in the data. Since buying and selling real estate costs so much in terms of time and transaction costs, investors don’t trade as often as stock investors do, and real estate investors are less likely to engage in irrational and impulsive buy and sell decisions than stock investors.
Stock investors have the ability to sell their securities with the click of a button and at the cost of a few dollars, therefore stock investors can more easily fall victim to behavioral finance tendencies that lead investors to invest emotionally by buying at market tops due to greed, or selling at the market bottoms due to fear. This emotion driven market timing causes investors to dramatically underperform the indexes, as the 2017 Dalbar study concluded that equity investors underperform stock indexes by 2.9% annually over a 20-year period. If we were able to buy and sell individual real estate properties on a public exchange without high transaction costs, we’d argue that you’d see much higher volatility in returns.
Price Anchoring. Moreover, we are skeptical of the return data for the real estate indexes over short periods. For example, there’s a tendency for some investors that may want to sell in a down market to “anchor” the price they want to sell at above their original purchase price. They try to avoid “taking a loss” by delaying selling until the recessionary period is over when they are more likely to sell their property above what they bought it at. This can create an artificial floor in real estate prices and skew the return data. Since the Schiller-Case data is based on only actual sales, a real estate downturn and lower housing demand will not show up in the data unless a sale is actually made. Anecdotally, we hear with greater frequency real estate investors wanting to wait until the market goes back up to sell a home, than stock investors waiting for a change in the market to sell their stock positions.
Scenarios When Real Estate and Bear Markets Work Best. While we don’t believe real estate overall will sidestep an entire bear market, real estate investing can definitely benefit many investors during a prolonged bear market under certain scenarios. If a bear market coincides with a period of a high inflation, like it did in the 1970’s, real estate is probably a good bet. Bonds, what most people use as a hedge against a bear market, performed very poorly during the 1970’s. As well, if you’re the type of person that will react emotionally during a market downturn, resulting in poor market timing and underperformance, then real estate may make sense for you. The high transaction costs and barriers to selling would help you stay invested and help you earn better returns over the long run.
Maximizing your Real Estate Returns. When it comes to real estate investing, it’s important to really articulate your investment thesis and understand the competitive advantage you have to execute that investment thesis. There are a lot of ways to make money in real estate, and we’ve found that the most successful investors know what their edge is and maximize it. For some investors, their edge could be a lower cost of financing, while for others it could be the ability to identify areas with surging demographic trends before other investors drive up prices. For example, your investment thesis may be investing to take advantage of positive demographic trends: an area with a lot of new businesses starting and job creation can help the real estate market in the short and long term. Markets like Denver, Nashville and Austin come to mind. And while real estate has performed well during recessions in the past, prices and valuation matter. The Case-Shiller Home Index is now 10% higher than its pre housing-crisis peak in July 2006, so finding a property that has good growth potential and a high level of income relative to price is increasingly important at market peaks like this.
Location. Location. Location. We must keep in mind that real estate performance is local, so it can be difficult to forecast overall trends and returns for real estate. There’s wide dispersion for real estate returns, depending on the area, property type, neighborhood, etc. For example, the DC residential real estate market continued to expand in the years after the 2008 financial crisis due to massive government spending and strong job growth in the government sector. On the other hand, the Miami condo market contracted sharply during this time. Property types react very differently to a bear market. For example, vacation homes and the ultra luxury sectors are likely to contract greater than the typical residential property. A shrewd real estate investor can increase his or her chances of side stepping a bear market by picking the right properties.
A Word of Caution. Before doing something drastic to your financial planning, like re-allocating the bulk of your investment portfolio into real estate to try and time the next bear market, it’s important to recognize that market corrections and bear markets are normal. There have been 29 market corrections (declines of 10%) and bear markets (declines of 20%) since 1960. In other words, we can expect a 10% selloff every 2.8 years and a 20% selloff every 7.3 years, historically. And while we’ve had five market corrections since the last bear market of 2007 to 2009, bear markets should not be overly feared. The patient investor will continue to make money in the market over long periods of time. For example, the S&P 500 is up around 70% since its peak in October 2007, right before the market went into a 517-day bear market. The key is that patience is a better indicator of stock market success than market timing.
David Flores Wilson, CFP®, CFA, CDFA®, CCFC is a New York City-based CERTIFIED FINANCIAL PLANNER™ Practitioner & Wealth Advisor at Watts Capital. He can be reached at [email protected].
