When you hear talk of real estate bubbles, the messenger is typically not referring to the real estate market as a whole but to only one specific asset class: Housing.
Take, for instance, some recent headlines:
“The Housing Market Looks Like a Bubble. It’s Time for the Fed to Worry.” –Barron’s
“U.S. Home Sales Are Surging. When Does the Music Stop?”
“. . . Profit Off the Looming Housing Market Crash.”
The tendency to lump all classes of real estate in with the housing market skews investors’ perceptions of the real estate market as a whole when housing enters bubble territory.
This makes investors cautious about investing in real estate in general when they don’t have to be. That’s not to say a housing bubble burst won’t impact other real estate classes – only that not every class will be impacted the same. In other words, investors should not be deterred from investing in real estate in general in light of concerns about a housing bubble.
In order to understand the effect of a housing bubble on other classes of real estate, particularly commercial real estate (CRE), it’s important to clarify some common myths.
A housing downturn will lead to a downturn in a recession and vice versa.
Housing prices and the economy are not always correlated. You only have to look to last year and the pandemic-induced downturn for evidence. Even as unemployment reached levels not seen since the Great Depression, housing prices surged at a record pace. The point is: Even if housing experiences a downturn, this will not necessarily lead to an economic downturn and, in turn, drag other classes of real estate down with it.
While it’s true that certain segments of CRE are more correlated to the economy as a whole – like retail and office – investors shouldn’t necessarily be turned off from investing as a whole simply because of economic fears from a housing bubble.
The Great Recession was a peculiar case of the economy tanking with the housing market because of the intricate interplay between the financial markets and real estate market due to the surge in subprime loans and the packaging of these loans into mortgage-backed securities (MBS’s) for sale on Wall Street. So naturally, banks and hedge funds made a killing selling these mortgage-backed securities.
Adding fuel to the fire were the insurance companies who backed these securities with credit default swaps – resulting in bond-level grades for securities that paid much higher rates than treasuries. No wonder investors snapped up MBS’s.
The voracious demand for MBS’s drove mortgage lenders to loosen more and more their lending criteria to originate more and more subprime loans. The problem is most of these subprime mortgages were adjustable-rate mortgages, and when the Fed raised interest rates, the whole house of cards came crashing down when borrowers started to default in droves as their payments surged. As a result, the subprime debacle took down both the real estate and financial markets.
The circumstances surrounding the Great Recession will likely never happen again. The likelihood that a real estate bubble like the one in 2008 will take down the entire economy is unlikely. So concerns about a housing bubble bursting shouldn’t deter investors from holding out from investing in CRE over concerns about the overall economy.
All real estate segments are impacted equally in a downturn.
Even if a housing bubble leads to an economic downturn, not all CRE segments will be impacted equally. As alluded to above, while some segments such as office and retail are more correlated to the broader economy than others – taking bigger hits and taking longer to recover – there are segments more recession-resistant than others.
Both The Great Recession and the COVID-induced downturn proved the resilience of affordable housing – both in the multifamily and mobile home sectors – and other sectors, including self-storage and senior housing. These segments not only experienced the lowest dips from the initial shocks of a downturn but were also quicker to recover – with some even thriving while the economy recovered.
All geographic markets are equally affected by an economic downturn.
With hindsight and backing data, The Great Recession demonstrated that not all states or regions were impacted equally by the economic downturn. Some states and regions fared better than others – with some experiencing only minor effects and others recovering quickly.
For example, Nevada saw a more than 13% drop in employment on opposite ends of the economic spectrum. In comparison, North Dakota saw a net gain of more than 2% in 2009 – in the aftermath of the real estate crash.
Don’t let the fear of a housing bubble stop you in your investment tracks.
The Great Recession was the result of a unique set of circumstances not likely to be repeated.
So, even as the housing segment goes, the economy won’t necessarily go with it. And even if it does, there will always be opportunities in CRE segments and geographic locations that are more recession-resistant and resilient than others.