When Should I Buy a House? How Stock Market and Real Estate Cycles Relate.
"When is the right time to buy a house? When will the bottom be in housing vs the stock market?" - my brilliant mentee
Me: "It depends."
Longer answer? This email!
Here's a secret. Contrary to popular belief, I don't have all the answers. But I'm a good researcher. My newsletters to you drive me to do deeper research than if I was just answering a question off the cuff.
Here's how I research:
Follow advice from my first "real" finance boss, the (pardoned) felon and billionaire Michael Milken. (correlation? ... maybe in another newsletter!)
"Emmy, whenever you enter a new area, the thing you lack is historical perspective. Build that fast in order to compete." - Michael Milken
He was right, and even better? Many others don't do the work, so once I built historical perspective, I wasn't just competing on even footing, I was ahead.
That's what I'm going to do today with you: build historical perspective on the relationship between stock markets and real estate markets.
History is always different... but rhymes.
Real estate prices are often (but not always) a delayed reaction to stock market prices.
You feel your stock portfolio go down, but (hopefully) that is not the cash flow you live on day-to-day. You still need somewhere to live. You keep your house and keep paying your mortgage. You hope stock prices will bounce back soon.
But on the margin, you aren't going to sell your house and get a bigger more expensive one. So on the margin, upward pricing of houses slows.
Not all real estate cycles are born equal.
Therefore... not all real estate cycles act the same. And most importantly, not all real estate cycles are predicted by stock market cycles or even economic cycles.
3 Cycles, 3 Outcomes
1990 stock market bottom. Real estate? Cities vs Country.
The S&P closed down 19.9% from all time highs by December 1990 (not even considered a bear market in stocks). However, risk assets collapsed, specifically biotech had a meltdown trading down 50% from all time highs. And we went into a recession. Why?
Super high interest rates caused a hard crash in spending, investing, and asset prices... recession.
In last week's newsletter, I shared how Paul Volker had fought inflation getting interest rates up to 20.5% in 1980 AND that I had a savings account paying me 22%. Well, a Savings & Loan had to pay that, but when lending rates went down their income went down, but they still had to pay my long-term CD (certificate of deposit) rate of 22%.
8 years after Volker peaked interest rates at 20%+, S&Ls were paying out savings CDs at high rates but lending (their income) at far lower rates.
8 years of paying out more than you take in is not a good way to stay solvent. Indeed 30% of Savings & Loans were technically bankrupt by 1987-88.
So, like any good government, the US regulators went for a delay-and-pray strategy of dealing with the impending doom (bankruptcy) one THIRD of the nations Savings & Loans.
Enter my first boss, Michael Milken, billionaire junk bond king and pardoned felon.
The government increased interest rates to help the S&Ls again make loans at higher rates, and they relaxed rules to let the S&Ls make more aggressive investments. Mike Milken was happy to provide them with those investments (junk bonds).
Greedy CEOs and opportunistic investment bankers, combined with relaxed regulations... what could possibly go wrong?
Charles Keating paid $51 million financed through Michael Milken's "junk bond" operation, for his Lincoln Savings and Loan Association which at the time had a negative net worth exceeding $100 million.
When Lincoln failed in 1989 it cost the federal government over $3 billion and about 23,000 customers were left with worthless bonds. High interest rates and loose regulations created the Savings & Loan crisis which accelerated the recession and the nearly 20% decline in the stock market.
After losing money in "safe" bonds, investors lost their risk appetite and dumped biotechs (highest risk assets), thus biotech was down more than the general market.
In the 1990 recession, real estate in the cities went down the most as cities' housing prices had moved up the most due to loose lending from S&Ls, and people in cities were more directly affected by the S&L collapse.
But every city was different. NYC peaked in 1988 around the Milken insider trading trial and following a massive increase in real estate prices after the city's effort in that city to clean it up and make it safer.
Los Angeles was home to Milken and many of these Savings & Loans, thus the timing of the peak and decline were closer to the timing of the S&L crisis (Lincoln Financial failed in 1989, and Los Angeles real estate peaked 6-9 months later).
Just like the recent NFT frenzy of 2021, in 1999 everyone owned an internet stock. Cab drivers told me which ones I should buy. Oh the stories I could tell...
But 2001-2003 was not nearly as fun.
Global Recession, tech stocks down 80% peak to trough, with retail investors taking the absolute brunt of it (personal accounts obliterated plus their retirement accounts down massively)
The absolute disdain for investing in stocks became as widespread as the internet frenzy before it.
With short memories, and the fact that only the cities had experienced real estate price declines in the 1990 cycle, it was a fair assumption that:
Real estate prices never go down nationwide.
We were diversified enough. Proof was the 1990 cycle driven by the S&L crisis. And when stocks go down, no one is safe.
So people invested in real estate and stayed out of stocks.
One thing that's always true about rules and investing: use the word always or never, and you will definitely live to regret it.
Low interest rates, economic recovery, and retail investors taking all their extra money to buy houses instead of stocks drove the biggest rally in real estate I'd seen in my lifetime.
2008: Never say Never
All the fancy financial products that were originally created for diversification and hedging became ways to add yield/returns for insurers, retirement funds and university foundations.
If housing prices never went down nationwide, then you could put that in your model and create derivatives on derivatives and all kinds of fancy ways to slice and dice bets investors wanted to take. With that huge rally in real estate, financial investors felt emboldened to take more risk, and buy more of these derivatives.
What goes up too far too fast must come down.
Although housing prices had indeed receded after the 1990 stock market crash, they were NOT down in every market. They were down in the cities.
Real estate prices in cities are more sensitive to stock market and economic cycles.
City populations are more white collar, high income, and in the case of NYC, likely to be working in the stock market.
White collar workers have bigger swings in their bonuses and assets during recessions and bear markets.
You would expect a 9-12 month lag as families see the market isn't bouncing back and they need to reset spending, including moving into a smaller home.
If you compare the USA chart vs the City Chart, you can see that for cities the bottom in real estate prices was around the same time as the bottom in stock market prices, but stayed low for several years following the stock market bottom.
Quick summary:
1990-1991 recession followed the S&L crisis which impacted the cities the most, because their real estate prices had benefitted the most, so they were hurt the most. Stock market prices and real estate prices peaked simultaneously, but real estate took longer to decline, thus the bottom in real estate, even for the cities, was 3 years after the bottom in stock prices.
2001-2003 recession only saw certain real estate markets pull back, but that time was FAR more about rotating out of the stock market and into real estate, thus overall real estate prices went up nationwide.
2008-2009 recession was real estate driven. Although nationwide prices didn't bottom for 3 years (Jan 2012), the cities' real estate prices bottomed right along with the stock market, then bounced around at those levels for several years.
Bottom line: When Should I Buy a House?
1. First decide if you should buy or rent, based on your own lifestyle and personality.
Even though I lived my longest stint in one city for 14 years, the longest I ever owned a house was 4 years.
Typical wisdom says if you are NOT a realtor (ie you pay commission) and you are not buying at a great price (bottom of the market) to flip the house, you should plan on owning the house more than 7 years to make a profit after commissions and minor renovations.
What this means for me is I am better off renting in most markets.
2. Next, figure out if we have hit the bottom in the stock market.
If you are trying to "time" the real estate market with the stock market, you have to know we hit a bottom in the stock market. Have we?
Given the impending layoffs coming in tech in the rest of 2022 along with secondary impacts of higher interest rates, I think we likely haven't seen the stock market lows of this year.
Additionally, while some of us may have enjoyed the fruits of the strong dollar (ie buying things in Europe, and feeling less of sting from inflation), massive currency movements are not without negative consequences (potential repeat of 1998's Asia financial crisis is starting to be floated), and spiking inflation in emerging markets.
On the other hand, we are an innovative, resilient, and diversified economy, so once we hit bottom, there are many reasons to be optimistic (after that bottom).
Watch for when bad news becomes good news, ie bad news comes out and markets go up in relief, and markets start to climb a wall of worry. If bad news comes out and markets go up, that means more people are switching from bears to bulls, day by day. This is one sign we have put in a bottom.
3. Finally, decide how stock markets and real estate markets will interact this cycle.
Remember, in 1990, it was the cities because the S&L crisis that caused the recession was more of a city issue, and it drove up the cities' real estate prices before the crisis.
In 2003 investors rotated into real estate, so nationwide real estate prices went up. That stock market decline stayed in the stock market.
In 2008 it was all about real estate, so pricing in cities bottomed at the same time as the stock market, then stayed at that level.
One similarity in all real estate cycles: You Have Time
Real estate doesn't bounce back in price quickly the way stock markets do. This makes sense. People have to move. And the commitment is longer in real estate, ie if you miss the bottom in stocks, you can sell and come back a few months later.
Yes, prices bottomed in March 2009, but they bounced around at that level for 3 more years.
In the the stock market, bottoms can be quick.
2008 saw a double-bottom, October 2008, then a rally, then decline in March 2009 to just below October lows.
Once FASB (Financial Accounting Standards Board) relaxed banking regulations in March 2009, buying the banks time by not making them admit they were insolvent in that moment, the stock market went back to the races, rallying 240% from $683 to $1,465 in 3.5 years.
If you look back at the real estate charts, the mistake was buying too early after the stock market peak and first decline in real estate pricing. But you had years after the prices declined to make your move and get into real estate.
Finally, the most important factor is what works for you in your life.
Perhaps you are planning a family and want stability. Perhaps having a home and working on it over the weekends would bring great joy. Why put that off for years? Short answer is you don't have to. Long answer is this email, but the net of it is you might only need to wait till next summer.