Hard times come for us all, and that includes everyone and everything in real estate.
Despite being the market best known for its stability and predictability, when the whole economy takes a hit; real estate doesn’t come out unscathed.
The following post will cover the fundamentals of how real estate and those in real estate are affected by the undesirable manifestation of an economic crisis.
What Is An Economic Crisis In Real Estate?
An economic crisis is an undesired situation in a country where its economy experiences a sudden and normally drastic downturn in financial performance.
Countries can experience economic crises for multiple reasons, including the following:
- Inflation and Hyperinflation,
- Epidemics and Pandemics,
- Natural Disasters.
A country experiencing an economic crisis will usually suffer from a fall in GDP, the income of its citizens, and price uncertainties.
Who’s affected In Real Estate During An Economic Crisis And How?
For the sake of this post, economic crises have to justifiably prove that they; in some way or form have an impactful influence of either one or both of the following real estate investors:
- Real estate Buyers (Buying, Renting, Leasing)
- Real estate Sellers (Flipping and Renting out)
1. Real estate Buyers.
Investors involved with real estate for the sake of occupation (business or dwelling) through buying or constructing any real estate property for the sake of commercial use or personal residency.
2. Real estate Sellers.
Investors involved with real estate for the sake of income generation through buying or constructing any real estate property for the sake of flipping or renting out for profit.
How Does An Economic Crisis Affect Real Estate?
The occurrence of any of the above economic crises will have an impact and influence and impact on the current state of real estate through the following channels:
- Affecting Property.
- Affecting People.
1. Affecting Property.
The most concrete influence that an economic disaster could have in the real estate market is if the crisis were to physically lead to damage or destruction of the actual property.
This will typically only be the case in situations where natural disasters such as earthquakes, floods, and tornados, or people-to-property damage such as with looting, riots, and revolts take place.
Depending on the severity by which the economic crisis affects property, the influence on real estate would involve the following:
How long will the influence on property disrupt the ability to effectively use the property for its intended value/income generating purpose – To live in, to rent out, to sell.
This can, on the low end be for very small periods (weeks to a few months) for minor repairs and renovations as a result of small to average property damage such as break-ins and minuscule damage.
Or can scale up to very long periods (multiple months to years) for complete reconstructions of property in the event of destructive natural disasters such as earthquakes.
The necessary financial investment needed to effectively return the property to its intended value/income generating purpose.
From small investments for minor repairs and renovations to huge investments for complete reconstructions.
*As you can expect, influences on property have by far the most potential to greatly and permanently influence real estate.
Small property damage is often negligible in the grand scheme of things but when the damage leads to the destruction of all the property in a neighborhood or city; the influence can permanently disrupt real estate there for years to come if not forever.
2. Affecting People.
There are 2 elements for consideration when It comes to how an economic crisis can affect the real estate market:
a. Peoples’ capabilities.
Concerning capabilities, I’m referring to limitations imposed on people that somehow or someway influence their usual ability to interact with real estate in a way they normally would.
Consider economic crises in the form of recessions, pandemics, epidemics, or any other crises that could potentially lead to interruptions over an individuals’ income to the state of not being able to pay rent, their mortgage, or down-payment on the purchase of a new property.
With special consideration to epidemics, pandemics, revolts, or any crises that may lead to government-imposed capability restrictions; restrictions on the physical or financial movement of people will also influence real estate.
b. Peoples’ perceptions.
The real estate market, like all other markets, is influenced by both practice and emotions.
Both People and Property factors will influence the physical (property damage or peoples’ capabilities) and the mental through perceptions of what to do and not do in the future.
A natural disaster will physically damage the property of the area but the perceptions of the natural disaster will influence peoples’ investment perceptions of that area. In the case of an earthquake – some people may choose to reinvest in the same way they did before or construct more resilient properties or won’t invest at all in the area.
In the case of epidemics or pandemics that would influence people’s health; people may have perceptions to reduce their interactions with other people in real estate for some time.
All in all, when an economic crisis affects people, it is rarely ever to the degree of long-lasting or permanent effect; except in the case of expected repeat crises such as with extreme property damage from natural disasters.
But it does still affect the same 2 categories of money and time concerning areas of damage
In how the crisis-affected people’s capability to generate or use money.
Epidemics and pandemics influence how people can generate income for real estate use.
Recessions, depressions, and hyper-inflation influence the value and capabilities of the money they currently have and earn.
How long are people’s capabilities to interact with real estate affected?
How long will people be restricted from going to work to earn an income from pandemic and epidemic lockdowns and how long will they be out of work or will their money have little to no value because of depressions and hyper-inflation.
What Happens In General To Real Estate During An Economic Crisis?
There are a few routine responses that will directly influence the real estate market and that those in real estate can expect in the event of economic crises.
In this section, I will give brief definitions, reasons, and desired outcomes from each response.
The following are the 5 routine responses to real estate during an economic crisis:
- Government Oversight.
- Movement or lack of it in buyers and sellers (Fewer sellers and fewer buyers.)
- Administration of Law – Forbearance and Force Majeure.
- Movement of Lifestyle.
1. Government Oversight.
Any engagement of the government in factors that affect the real estate industry over and above what was enforced before the economic crisis makes up government oversight.
Oversight can include
- Financial Grants and Bailouts to companies as a whole (lending institutions).
- Stimulus Checks to business owners and individuals.
- Enforcing limitations on businesses – force closing businesses or placing special regulations on them.
- Enforcing limitations on people – lockdown that limits movement and earning potential of individuals for a specified time.
- Enacting laws that disrupt contractual real estate obligations (further discussed in point 3).
Government oversight can be confusing and different from state to state. The most important fact is to pay attention to the decisions they make and enforce and being knowledgeable about how those specific decisions will influence your specific market in real estate.
2. Movement or lack thereof in buyers and sellers.
Some economic issues can lead to an ‘on mass’ movement of individuals from one location to another for haven or improved situations such as in the case of natural disasters or in times of depression or hyperinflation.
In terms of real estate, this transfers into a large injection of real estate buyers who are looking for accommodation in one area and a large detraction of potential buyers in another area.
You should note that in the area where individuals are moving out of; the loss of people is only “potentially” a detraction of buyers as these individuals were not guaranteed buyers where they were because they may have already been accommodating a unit.
Where individuals leave an area in mass without the occurrence of a property damaging crisis (natural disaster); there will be a large spike of homes on the market for real estate sellers to invest in.
In other cases, the opposite happens and both buyers and sellers of real estate have their movement ability restricted as would be the case for epidemics, pandemics, and wars.
In such a situation, government influence or personal choice may limit the amount of viable real estate transactions.
*When individuals have their movement restricted. it will normally result in a temporary dip in real estate transactions that will steadily or rapidly return to normal. Mass movements of individuals out of a market has more potentially long-lasting effects.
3. Administration of Law – Forbearance and Force Majeure.
Forbearance and Force Majeure when contextually brought up in real estate are different means to achieving the same position whereby debtors for a short time are not liable to the reimbursement and backlash of not reimbursing of creditors.
That is to say, borrowers in a mortgage or renters of a property do not have to make their obligated payments to landlords and lenders.
In the case of forbearance, the agreement is solely between the creditor (money lender or landlord) and the indebted (money borrower or tenant). The government is not involved in the agreement. The 2 parties agree amongst themselves to delay the consequences of the indebted not fulfilling their obligation.
The creditor will not kick out the tenant or foreclose the property if the indebted justifiably proves that it is for good reason. Their obligations for the period of forbearance are not erased but are simply pushed back to be fulfilled at a later date.
In the event of force majeure; the government enacts this legal mechanism to take precedence over all or specified legal agreements between contractually obligated debtors and creditors. The force majeure temporarily or permanently voids a contract and frees both parties from their obligations to one another.
*In real estate, for the enactment of the force majeure; as mentioned above; the government may not allow the enforcement of obligations to parties in real estate but will not allow creditors (money landlords) to make tenants or money borrowers homeless.
It will strictly stop debtors from paying and creditors from doing contractual duties like repairs and renovations.
4. Movement of Lifestyle.
In most economic crises that don’t involve the destruction of property (natural disasters); the market usually evens itself in the middle and only drastically suffers at the lifestyle and income extremes of the spectrum.
That is to say, in the context of real estate when an economic crisis takes effect; most people move a step or several steps down from their usual way of living which still generates business in the market.
Buyers are going to continue buying but the majority of transactions will be downsizing and sellers will still be selling to brackets of individuals who were previously above that lifestyle.
In such a case, only the extremes of the spectrum (Those selling or renting super high properties) will suffer greatly as that demographic diminishes without a source of renewal.
*Aside from in cases where there was mass destruction of property, in situations of restricted movement (government control or for self-preservation) the real estate market suffers the most because the economic crisis reduces both sellers and buyers from the market such as when an epidemic, pandemic or war takes effect.
Far fewer people are willing to sell their properties and far fewer people are willing to go out and buy properties (+ the fact that most sellers usually become buyers) to feed the real estate buying and selling cycle.
Depending on the severity of the situation, the majority of properties that will be on the market – will be properties that have no other choice than to be there (Foreclosures, distressed properties, distressed units, trust sales, and probate sales).
I’ve covered some pretty grim and disheartening facts of what happens to real estate during an economic crisis and so I’ve decided to end on a light note as possible.
There will always be opportunities in real estate in one form or another. Because of the multiple avenues and tiers in those avenues in real estate; for as many avenues and tiers an economic crisis affects negatively – the shift of people from that area; becomes an opportunity injection in another area.
Not always but in most economic crises, an economic crisis is just a transfer of opportunity and income.
Conclusion – Real Estate and Economic Crisis Frequently Asked Questions.
1. Do housing prices go down during an economic recession?
Answer- Because most economic crises result in a degree of recession; prices of homes do usually drop because of the laws of supply and demand.
There will usually be a rise in supply – real estate inventory on the market (properties to sell) and a drop in demand – individuals willing and able to purchase them.
The degree of the price drop depends on the overall stability of the economy and the damage of the crisis.
All in all, real estate is a very slow shifting market when it comes to price drops due to any economic crisis.
2. Should you buy real estate in a recession?
Answer – Following up on the above question, if prices usually lower during periods of economic crises that cause recession; are recessions the best periods to invest in real estate?
Typically yes, you are more likely to score a better deal with regard to home prices and mortgage interest rates during periods of recession and hardship.
The issue is usually that investments in real estate are always large obligations that have greater risks during economic crises.
Though the deal will likely be cheaper, you will still have to pay a large down payment, go into debt and be liable to consequences of not meeting contractual obligations – this is now added to dealing with the current environment of the economic crisis such as job loss and unpredictability.
3. What caused the real estate crash?
Answer- That my dear reader, is a story worthy of its own post; which you can read (HERE).