How Will The Next Economic Recession Impact Your Home’s Value?
“If we had no winter, the spring would not be so pleasant: if we did not sometimes taste of adversity, prosperity would not be so welcome.”
― Anne Bradstreet, The Works of Anne Bradstreet
“Spring passes and one remembers one’s innocence.
Summer passes and one remembers one’s exuberance.
Autumn passes and one remembers one’s reverence.
Winter passes and one remembers one’s perseverance.”
― Yoko Ono
Blossoms in the spring are followed by summer’s heat, which give way to fall colors, and eventually winter finishes the yearly cycle and makes way for the next.
Many things in life follow a similar pattern or cycle, economic patterns are no different.
Economies don’t expand forever — eventually every economic expansion is followed by an economic consolidation and contraction, called a recession. A recession is defined as two consecutive quarters of economic contraction and should not be feared, but rather planned for. Similarly one plans for winter by building up supplies of wood, food and substance to survive until spring arrives.
Starting in June 2009, the current economic expansion has been the longest ever on record (assuming the official data for June 2019 doesn’t show we are already in a recession when the data is released).
Said another way, the current spring and summer economic season has been exceptionally long and it appears we are getting closer and closer to fall — possibly winter.
Most of us vividly remember how painful the Great Recession was, we either lost jobs and homes, or knew someone who did at that time. What might surprise you is that most recessions are not nearly as painful as the Great Recession and real estate has typically done quite well (more on that later).
Eighty six percent of economists agree that a recession is highly likely between now and 2021.
The economists and business professionals polled for this survey are forecasting a rapidly approaching recession for various reasons. One of the primary indicators of a tiring economy is when short term bonds are suddenly paying bond owners less than longer dated bonds.
In a young, healthy and expanding economy, investors are paid higher returns for the longer they are willing to tie up their money in bonds (longer term bonds pay more than short term bonds).
When there is fear in the market, investors who are buying bonds believe that inflation will be low and the return they will get from bonds in the future is likely going to be lower than the return they can lock in today, which gives them reason to invest longer term bonds. This is a defensive play, the thought here is how do we lose as little as possible, not how do we seek the greatest gain.
If investors believe market conditions are worsening — they are likely to lock in longer term rates of returns at lower profit because they believe the returns they will likely get next year will be worse.
Pictured below, the gray bars represent times of economic recession (the economy is contracting — fall and winter season for the economy), you likely remember the 2001 Tech Crash and the 2008 Great Recession very well.
The red lines show us periods in time when the 2-Year Treasury Yield (rate of return for investors in those bonds) paid investors less than 10-Year Treasury Yields. As you will see, the red lines nearly always proceed the gray bars (times of economic recession) — and today we are ominously close to the 10- Year yielding less than the 2- Year again.
As of today, the 2Y and 5Y-Treasury Bonds already pay investors less than the 1-Year Treasury (giving us hints we are well into the fall season). This is called an inverted yield curve — and the 2Y and 5Y-Treasury bonds are already inverted (paying investors less) to the 1Y-Treasury.
An even more accurate economic indicator can be found by watching the Civilian Unemployment Rate (chart below). Again the gray bars represent times of recession and the blue line represents the percentage of civilian unemployment.
Going back over seventy years, every time the unemployment rate bottoms out and starts to turn higher, we enter a recession within twelve months. Currently the unemployment rate has not started to tick up just yet, but with the unemployment rate at 3.6%, there is a high probability we will see that number tick up in the coming months. When it does, history tells us there is a one hundred percent chance that the economy is entering a recession.
Thus far we know eighty six percent of economists believe — and several reliable indicators are telling us a recession is probable within the next few years. So what now, should we hide under a rock, sell everything and decide to rent for the next few years?
The data below might thoroughly surprise you — I know it surprised me.
Looking at housing data going back nearly forty years and spanning the last five economic recessions, we see that housing actually appreciated throughout most recessions.
This was clearly not the case during the Great Recession of 2008, but that recession was unique. The cause of that recession was a bubble in housing that was caused by buyers (many of them real estate investors) who did not qualify to make the payments on the mortgages that eventually went into default and created a banking crisis.
Mortgage underwriting standards had deteriorated to a point that virtually anyone could qualify for a one hundred percent loan, with no documentation of income, assets, and very low credit score requirements. The industry fell asleep at the wheel and believed that housing could only go up forever and thus there was no reason to verify buyers were qualified to pay back the loans.
When the cheap and easy credit dried up, buyers disappeared — homebuilders and investors were left holding hundreds of thousands of homes they could not debt service and the entire industry imploded.
A very painful lesson was learned. Over the last 10 years, mortgage credit standards have been significantly tighter and as a result of mortgage underwriting discipline, mortgage delinquency and default rates are near all-time lows.
Looking at the most recent data from CoreLogic for the month of March 2019, we see that 0.4% of homes are currently in foreclosure — said another way, one in four hundred homes are currently at risk for foreclosure. Keep in mind that includes homes damaged by flooding, hurricane, and or wildfire.
The mortgage industry learned a very valuable lesson and thus far have not repeated the mistakes that caused the last housing crisis — tighter underwriting standards have ensured borrowers over the last decade were well qualified and the low default rates are a direct result.
Looking all the way back to the recession of 1973 to 1975, we see real estate has weathered the last six recessions quite well and the Great Recession is the clear outlier that impacted housing so severely. Throughout those six recessions and nearly fifty years, housing appreciation has continued in a clear uptrend at approximately five percent per year.
The data tells us that housing does surprisingly well throughout recessions. One of the main reasons housing is so resilient is because of what happens to mortgage rates during those times. As you can see going back to 1980, interest rates have fallen in each of the last five recessions.
Housing gets significantly more affordable during times of recession, incentivizing both first time buyers and existing homeowners to move up. This is exactly what we are seeing thus far in 2019, interest rates have moved down from the five percent to the four percent range — encouraging buyers with more affordable payments.
Interest rates are likely going even lower from here. If we take a look at 10-Year Government Bonds from across the world, we see that the U.S. 10-Year is clearly higher than most, giving plenty of room to go lower when the next recession hits.
We can also see that the downtrend in yield (the rate of interest paid to a bond investor) has been steadily dropping since the eighties and has not broken out of its downward trend yet. As we enter the next recession, the Fed will likely reduce short term rates, further influencing both Treasury Bonds and mortgage rates lower.
Don’t allow fear to govern your decisions — yes an economic recession is likely approaching, but history teaches us that housing does quite well during recessions due to lower interest rates that incentivize buyers on the sidelines to take action. And that trend has already begun, lower rates thus far in 2019 have brought buyers to the housing market and are likely to keep the fifty year history of real estate appreciation going strong in most areas of the United States.
