Is now the right time to invest in real estate?
The goal of investing is to seek out underestimated assets and acquire them for less than their intrinsic value. A market downturn presents a prime opportunity to do this. However, certain factors need to be considered before you go on a buying spree.
As a rule, home prices tend to fall during a recession. The 2008 recession saw property valuations crash, leaving 10.7 million homeowners in America with underwater mortgages which, in most cases, led to foreclosed homes and depressed home values.
The current COVID-19 pandemic has had an unprecedented impact on world economies, with major industries suffering losses as movement and productivity ground to a halt. Governments have clamored to launch bailout initiatives in a bid to stave off bankruptcies and bolster flagging industries. Wall Street has seen stocks plummet to record lows as worries over the coronavirus and its effect on the economy continue to plague the market.
Comparisons have been drawn between the current economic downturn and the 2008 recession. In terms of real estate, both instances have seen lenders tighten their criteria for home purchases and the likelihood of securing bank financing drop – this is especially true for individuals working in industries that are vulnerable to recessions.
One thing to remember, however, is that despite its current state, the nature of the real estate market is cyclical. During recessions, property valuations decline, developers cease building new houses in response to a dearth in demand, and properties tend to sit longer on the market, making sellers more willing to make concessions and lower prices.
At the moment, many sellers have pulled out of the market, preferring to wait for things to get back to normal. During this time of unprecedented duress, only the most motivated sellers remain. These are the sellers who cannot afford to wait out the recession and would rather opt for a quick settlement than a high sales price. In the coming months, many sellers will find themselves in the position of accepting lower offers due to scarce demand. Banks selling foreclosed homes for below its market value will also compete in this low-demand market.
When a period of recovery inevitably follows, supply will initially outpace demand before buyers – as their purchasing power stabilizes and then grows – begin to acquire homes, driving prices up to pre-recession level or even higher. The golden time to invest is the moment just at the cusp of recovery, when the number of properties for sale begin to rise, but just before prices surge as investor resurgence drives up demand.
How to spot the signs of recovery before investing
The duration of economic downturns vary and just because the market is down and prices are low doesn’t mean it’s a good time to buy. Consider your budget and if you can afford to invest in the medium- to long-term. The Great Depression lasted for ten years and those who invested poorly and didn’t have enough of a financial cushion lost out in the end.
At the moment, companies in the healthcare industry are engaged in a race against time to see which one can put out an effective vaccine against COVID-19. The expectation is that once a vaccine hits the market, recovery can begin. But true economic recovery is signified by the presence of certain factors, and once you identify them and learn to track their progress, the easier it will be for you to spot the moment when you should begin investing.
The following are markers of economic growth:
- Positive change in GDP growth rate
- Decreasing unemployment rate
- Uptick in consumer spending
- State of bank lending
- Rise of freight transport
Gross Domestic Product (GDP) growth rate
The change in a nation’s GDP over time is a good indicator of economic growth. According to the U.S. Bureau of Economic Analysis, the country’s real GDP, which has been adjusted for inflation, decreased at an annual rate of 5% in the first quarter of 2020. This is the first decline since 2014.
The Bureau noted that the drop in the quarter’s real GDP reflects the response to the spread of COVID-19 and the government’s stay-at-home order in March. In the previous quarter, before the pandemic hit, real GDP was up 2.1%. Monitoring the movement of GDP will give you an idea of how the economy is doing and if a recovery is at hand.
Decreasing unemployment rate
Unemployment rate is a lagging indicator that changes in reaction to the state of economies. When an economy is healthy, there are plenty of jobs to be found. When a downturn occurs, jobs then become scarce.
According to the Bureau of Labor Statistics, unemployment rate in May was at 13.3%, down from the previous month’s 14.7%. This is an early sign that, perhaps, we are on a path of recovery. We will continue watching this indicator closely.
May also saw total nonfarm payroll employment climb by 2.5 million. The improvement reflects the easing of restrictions and the gradual resumption of economic activity, which had all but ceased during the months of March and April, due to the lockdown.
Nonfarm payroll tracks the number of paid employees in the U.S., with the exclusion of those in the farming industry, some government employees, proprietors, as well as those working for private households and non-profit organizations. It represents about 80% of the U.S. workforce.
The employment situation reflects the current state of the economy and can be used to gauge future economic activity as it correlates with the financial state of citizens and their ability to avail of goods and services. It also shows the state of certain sectors and whether or not they are expanding or downsizing in reaction to market conditions.
Uptick in consumer spending
Consumer spending is a driving force in the economy and an important indicator of consumer demand and economic performance. It is also the largest component of GDP. The Department of Commerce releases estimates, called Personal Consumption Expenditures (PCE), per month as well as quarterly and annually. As of April 2020, the country’s real PCE dropped 13.2% or about $1.66 trillion, reflecting a $758.3 billion decline in spending for goods and a $943.3 billion decrease in spending for services.
Consumer spending is crucial for businesses because patronage drives revenues and when businesses perform well, they may eventually expand and hire more workers and introduce more products and/or services. Among the factors that drive consumer spending are consumer confidence and the ease or difficulty with which money can be borrowed from financial institutions.
State of bank lending
Funding is necessary for businesses to expand and grow. It is also needed for individuals to procure goods and services. The Federal Reserve’s April 2020 loan officer opinion survey on bank lending found that during the first quarter of the year, banks tightened their loan standards across the board in response to the pandemic and its ensuing economic repercussions.
In terms of commercial and industrial (C&I) loans, banks noted that they were “focused on existing clients rather than granting loans to new clients.” Specifically, banks mentioned their clients’ “liquidity needs and actions to mitigate the effect of the crisis on their clients who are experiencing strains.”
Banks also tightened their standards for household loans “across all three consumer loan categories – credit card loans, auto loans, and other consumer loans… while a moderate fractions of banks tightened their lending standards on most categories of residential real estate loans.”
In written comments on the Fed survey, banks said the changes in standards and demand across loan categories in the first quarter occurred in March, as the economic outlook shifted due to the pandemic. Things will take a turn again once an improved economic outlook heralds more robust bank lending.
Rise in Freight Transport
Freight transport is considered to be the primary component of the supply chain. It pertains to the transport of goods and commodities via road, rail, air or sea. The country’s highly developed transportation system plays an important part in economic growth and connectivity. However, due to restrictions set in place in response to the pandemic, the movement of goods and commodities from country to country and across state lines have tapered, or in some cases, been stalled altogether.
The Shanghai Containerized Freight Index (SCFI) is a much cited metric used to gauge the state of global trade. The Index keeps track of the freight rates that container shipping lines charge. Closer to home, the Cass Freight Index measures the monthly aggregate deliveries of the North American freight market. Automated payment systems provider Cass Information Systems compiles the Index.
The Cass Freight Index showed this year’s April shipment volumes drop 22.7% year on year as “March consumer panic buying subsided, leaving us with just the negative impact of shut-in orders and rising unemployment levels.” For the month, the overall index for both shipments and expenditures plummeted on year to recessionary levels, the report said.
“This is concerning but would be more concerning if it weren’t a self-inflicted wound. Businesses and mobility were severely limited by unprecedented governmental restrictions in April, and those are loosening … and should further loosen on their way back to “normal” in June.” It would be interesting to see if the Index’s May report will reflect its April projections.
Real estate prices tend to depend on the state of the economy. Economic indicators show that right now may still be too early to invest. Most economic indicators are still not showing a robust and sustained recovery. However, certain indicators are already showing positive dynamics and if they continue going upwards, it may give us enough confidence to update our investment outlook. It is a good idea to keep track of market movements in the upcoming months and start researching markets and properties for investment. Please read our analysis on which markets in the US may be the most attractive to invest post COVID.
Smart Capital Center tracks economic markers of recovery and issues a weekly perspective report. Subscribe to our blog to get direct updates to your inbox. You may also follow us on LinkedIn or Facebook to get updates on the state of the economy and the real estate market.
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