"Stock market volatility may not directly affect your business, but it will affect consumer sentiment and the national economy, which do."
Last week, Wall Street went a little crazy. After more than a year of steady growth, the time was certainly ripe for a correction in the market, and that is what the market gave investors last week. February started off with some turbulence, with the Dow closing on February 2, 2018, down 2.5 percent. That is the largest percentage decline since June 2016, when it appeared the United Kingdom would exit the European Union and possibly send the global economy (or at least the European one) into turmoil.
By February 5, after spending all weekend stewing over the closing numbers on Friday, investors were ready to sell. Meaning the Dow fell nearly 1,600 points, the most ever in a single trading day. Although the market had already “bounced” by the end of the day, recovering about 400 points, it was still the biggest single-day point drop in Dow history, reported CNN Money.
But What Do All These Numbers Mean?
To really get a firm grasp on what we’re talking about when we start bandying about terms like “Dow” and “market correction,” let’s take a quick step back and look at the bigger picture.
“The Dow” is the Dow Jones Industrial Average (DJIA). It is a conglomeration of 30 significant stocks traded on the New York Stock Exchange (NYSE), and it is intended to help analysts evaluate the state of the stock market without having to track every single individual stock all at once. It is one of the oldest, most-watched indices in the world, invented by Charles Dow in 1896 and named after Dow and his business partner, Edward Jones. Because the Dow is comprised of 30 solid, significant stocks and is adjusted periodically when a company becomes less representative of the market, watching the progress of that group of stocks enables any analyst, amateur or professional, to have a feel for the overall tenor of a market. When Jones invented the index, he included railroads, cotton companies, sugar companies, tobacco companies, and oil companies. Now, it includes, among others, Walt Disney, Microsoft, Apple, Nike, and General Electric Company, the sole remnant of the original 30 companies.
The other index you often hear about in discussions about Wall Street is the S&P 500. This index, the Standard & Poor’s (S&P) 500 Index, is an index of 505 stocks issued by 500 large companies with market capitalizations (a value derived by multiplying the value of a single share by the total number of shares in existence), of at least $6.1 billion. The S&P 500 is another benchmark indicator for the stock market, and many analysts prefer to cite its movement over that of the Dow because there are more stocks involved and the companies in the index are weighted differently. For our purposes, however, the main point of understanding a little bit about the Dow and the S&P 500 (also occasionally referred to, incorrectly, as just the S&P, which is wrong because Standard & Poor has 1,200 indices), is to understand and be able to participate in the conversation about the financial markets.
Now, let’s talk about “market corrections.” We’ve all heard analysts and economists say things like, “The market is due for a correction” when referring to basically any positive economic trend. It sounds like a real downer! However, market corrections are part of every market cycle, and the only way to avoid them is to either redefine how economic cycles work (unlikely) or bury your head in the sand. For real estate investors (really, for any savvy investor), the market correction is the time when opportunity for profits and creativity is greatest because a market correction involves price declines of at least 10 percent according to most common definitions.
It is important to note that market corrections are usually defined post-event, meaning that only after a market has headed up, taken a dive, and then stabilized, and that the term may be used to describe any market or even an individual asset’s trajectory. However, market correction is most commonly used to described stock market movements, including a downward trend while that movement is still in process.
What’s Happened Since the Stock Market Correction Last Week?
Now that we’re speaking the same language when it comes to the stock market, let’s take a look at what has happened since the initial “freefall” on Monday and how that might affect the national housing market and real estate investors (not necessarily the same thing).
For a little perspective, note that on January 26, 2018, the S&P 500 hit a record high. By February 8, 2018, it was down 10.16 percent, which placed it in official, by-the-definition market correction territory. Given that in the wake of such drops, markets tend to ultimately fall further as demonstrated by seven similarly sharp drops occurring between 1987 and the present, a number of economists warned late last week that just because the market had “bounced,” meaning the Dow closed up 330 points on Friday, February 9, did not mean that the correction was over. “If the Down had slid at all on Friday, it would have made for its worst week since the 2008 financial crisis,” noted CNN Money reporters Julia Horowitz and Matt Egan.
Over the weekend, speculation ran wild over what Monday would bring. This type of environment can represent a great opportunity for a clear-sighted investor to act and “buy low” in hopes of stock prices rising in the wake of a tumble, but most analysts waited with baited breath to see how stocks would perform yesterday. As it turned out, the S&P 500 and the Dow both rose just over one percent (1.1 percent and 1.3 percent, respectively), and only one Dow stock “traded down” on Monday. Tech stocks like Apple, Amazon, and Netflix all made small gains, with Apple posting a 2.5 percent gain on Monday, Amazon gaining 1.5 percent, and Netflix gaining 2.1 percent. By comparison, Netflix lost seven percent last week. Also of note, Facebook foundered a bit, losing nearly one percent yesterday.
So, What Does This Have to Do with Real Estate?
We’ve spent a fair amount of time picking apart the stock market, so now let’s dive into how its most recent movement affects real estate. Last week was a banner week for many real estate investors and real estate educators, who spent a great deal of time somewhat smugly pointing out that real estate is one of the best, most stable investments you can make (infer: far better than your tanking stock portfolio). That is indisputably true insofar as the caliber of a sound real estate investment. In nearly every circumstance, there are few, if any, sounder investments an investor can make than a solid, well-researched real estate deal. Therefore, let us begin this portion of the market analysis by concluding that real estate is a solid, responsible, relatively safe and predictable investment.
The question then becomes: What should real estate investors take away from the stock market correction and how, if at all, should they adjust their investment strategies in the wake of Wall Street’s volatility?
Perhaps the broadest-reaching fallout from the correction last week will lie in its effect on consumer sentiment. Although relatively few Americans (fewer than seven in every 50 adults) actively trade or own stocks, most view the stock market as an indicator of how things are going. This is largely due to the fact that when you factor in how stocks affect our retirement plans (more than half of us are invested in a company plan that actively owns or trades stocks on our behalf), we start to feel some pressure when the market starts to look shaky. Whether you, personally, own any stocks or trade actively or passively, this means about half of your buyers and sellers do, which will affect how they save and spend money in the wake of this highly publicized market movement.
“Real estate professionals and potential homebuyers and sellers are not immune to the fears that reverberated across trading floors,” observed Inman staff writer Jotham Sederstrom. However, most housing analysts agree that the real estate market operates on a lag, making immediate, emotion-based reactions, such as those that often govern financial market swings, less likely and less intense.
“Nothing changed between last week and this week, in my opinion, in those [Dow] companies,” noted Michael Hoffman, president and CEO of Texas-based Longhorn Investments III, a hard-money lender working directly with real estate investors on both short- and long-term financing. “The stock market is run on emotion, and this correction is purely emotion based. That’s why we like real estate. It’s comp-based and has actual value. I think more people will want to invest in real estate and, at least in the short term, you will see more people attending real estate investor clubs and those clubs doing more marketing,” he added.
For investors tracking real estate stocks like Zillow, Redfin, or Re/Max, it is worth noting that these companies posted losses last week, just like most other publicly traded companies. However, even in that situation, real estate is likely to temper the costs of last week’s correction for these companies because they stand to gain a measure of perceived stability (and, by extension, real stability in the emotion-governed market) thanks to their association with real property.
In fact, the most immediate effect on real estate will likely be in markets saturated with stock owners and Wall Street investors, said National Association of Realtors (NAR) chief economist Lawrence Yun, as in areas with large populations of employees who are paid, in part, with stock options. Yun cited “thriving technology hubs across California” as well as Austin, Texas, and Seattle, Washington, as areas in which this type of market reaction might occur. Overall, however, the general consensus is that the stock market correction will not likely negatively impact the housing market unless, as Realtor.com senior economist Joseph Kirchner put it, “current volatility causes the market to significantly fall below normal levels.” Kirchner went on to point out that the housing market is “still 15 percent above a year ago and economic fundamentals remain strong.”
The Real Question for Real Estate: What Will This Do to The Conversation About Mortgage Rates?
The stock market correction has had one direct, immediate effect on real estate: It has changed the conversation. While analysts have been looking for signs and monitoring indicators that might mean a shift in the housing market is coming, most investors have been primarily focused on making hay while the sun shines. Although some, such as Boston-based Dave Seymour of Garmour Multifamily, note that they are shortening the timelines on some of their short-term investing strategies, such as fix-and-flips, in order to allow for some wiggle room if the local market does start to level off or even trend downward.
The real issue, analysts insist, is mortgage rates. Now that one market has corrected to a degree, the conversation is shifting, naturally, to the next market correction. For many, that correction will be in housing and due to rising mortgage rates.
“Mortgage rates are now at their highest level in four years and poised to move even higher. The timing couldn’t be worse,” wrote CNBC’s Diana Olick. She noted that rising mortgage rates will negatively impact housing affordability, something that most local markets are struggling with to one degree or another already. This may increase buying activity in the short term, particularly in conjunction with the stock market correction, because homebuyers may feel that their “last chance” to own a home is looming nearer. Redfin recently reported that five percent mortgage interest rates would cause about 25 percent of today’s homebuyers to “slow their plans” and about six percent to abandon the idea of buying completely. One-fifth of consumers said that this type of mortgage rate, inconceivably low in most buyers’ minds even in an adjustable rate mortgage (ARM) as recently as 2000, said they would move “urgently” to purchase a home before rates rose even higher.
Interestingly, the same respondents said that they would likely “consider more affordable areas or just buy a smaller home” if they saw interest rates start to rise, indicating that the current shortage of affordable, smaller homes in many markets is likely to continue. As Svenja Gudell, chief economist at Zillow, noted in a recent interview with Think Realty Magazine, real estate investors usually find the best opportunities when they identify what she described as “market inefficiencies” that lead to “gaps” in what is needed and what is available. “There are a lot of markets that are unaffordable because of limited inventory, so an investor who can access or create inventory is filling a need,” she said.
The takeaway from the stock market’s recent volatility, for real estate investors, should be relatively simple: Monitor your market for opportunities and potential shifts. Since every local market is different and unique, it will be important to watch closely and not react emotionally (take a lesson from last week’s stock market losses). The housing market is not directly linked, in most cases, to stock market performance unless the markets fall so far that employment rates are affected, and even then, this result is usually regional.
“The [housing] boom of the last five years is built on a much more solid foundation [than the one in the early 2000s],” said ATTOM Data Solutions’ Senior Vice President Daren Blomquist. “The more likely threat to any housing boom today is some external shock.” This most recent stock market volatility is not yet anywhere near “external shock” level; Blomquist described such shocks as “economic recession or global geopolitical instability.” What the stock market has done, however, is bring the fact that no market can trend upward forever to the forefront of our consciousness, where it should remain. Invest responsibly, research thoroughly, remain informed, and react calmly and strategically when signs indicate a shift could be occurring in your local market and should, as a result, manifest in your investment strategy as well.
Stock market volatility may not directly affect your business, but it will affect consumer sentiment and the national economy, which do.