April 1, 2020

Historic Turmoil and US Residential Real Estate Performance

Brian Tesch and Harrison Tateosian

The recent eruption of the Coronavirus (COVID-19) onto the world stage has brought about significant turmoil within financial markets, as well as other asset classes traditionally deemed to be non-correlated. While the effects on financial markets are felt almost immediately, the impact can be muted when examining the performance of residential real estate over a similar timeframe. Residential real estate can provide a repository of shelter for investors due to the low correlation exhibited by this asset class, especially during market corrections when the general level of correlation between asset classes rises. Exploring this idea, Unison has examined four historical scenarios when there was significant market disruption to gauge the impact that those events had on residential real estate at the time and to offer as a roadmap for the current crisis.

Four periods were chosen that contain significant market dislocation over the past four decades, ranging from the culmination of the Vietnam War and the Oil Crisis, Black Monday and the Iraqi invasion of Kuwait, the Dot-com Bubble, and the Great Financial Crisis of 2008. Each of these market dislocation events occured at significant points of economic and social impact. Much like those events, the ramifications from COVID-19 on present day society will have meaningful and lasting impacts.

To test these relationships, national home sales data was used to compute an aggregate value for the median home sale price along with the home sales values of the 25th and 75th percentiles. These values are not measured through sales pairs but are instead the ordinal values of those respective percentiles. The home sales metrics were then compared to the performance of the S&P 500, a proxy for the performance of public equities. These two metrics were then indexed to provide an accurate view of the relative performance of each asset across the historical timeframes.

Historical Scenarios

End of the Vietnam War and the Oil Crisis

The 1970’s were highlighted by the ending of the Vietnam War in 1975, a period that coincided with the Oil Crisis from 1973-1975, and the abandonment of the Bretton Woods System. This period was also punctuated by the first bout of stagflation, high rates of inflation coupled with low economic growth. All of these events rippled through financial markets with the biggest drawdown in public markets occurring from 1973-1975. While the decade resulted in a greater than 40% return for the S&P 500, this return was achieved within the first 18 months of the decade. Residential real estate on the other hand, continued to perform in a stable and consistent manner throughout the decade as seen in Figure 1. As denoted by a correlation of just 0.06, each of the major political and economic events from above appeared to have little material effect on residential home prices during the decade.

Figure 1

Percentiles consolidated from the 2018 CoreLogic, Inc OLB Database. Monthly S&P 500 is the average of all weekday market close values inside each month.

Black Monday and the Invasion of Kuwait

Figure 2 follows the performance of the S&P 500 and the aggregate home sales percentiles from 1987-1991. This timespan covers both the 1987 crash as well as the Iraqi invasion of Kuwait in 1990. Not to be confused with Black Tuesday, the focal point of the 1929 Market Crash, Black Monday in 1987 resulted in a loss of nearly one-third of the value in the S&P 500. During this four-year period, the S&P 500 climbed nearly 35%, although also experiencing multiple drawdowns of greater than 15%. While residential real estate did not perform as well as the S&P 500, it also featured significantly lower levels of volatility. More importantly, during periods of the greatest drawdown, residential real estate experienced only minor depreciation, exemplifying residential real estate as a source of stability within a portfolio. This period saw a slightly increased level of correlation (0.26 vs 0.06) than the 70s. This is likely due to the impact these events had on mortgage interest rates.

Figure 2

Percentiles consolidated from the 2018 CoreLogic, Inc OLB Database. Monthly S&P 500 is the average of all weekday market close values inside each month.

The Dot-Com Bubble

The late 1990’s culminated in the Dot-Com Bubble and subsequent bust. Throughout the late 1990’s and early 2000’s, public markets experienced high levels of volatility as the excess of the bubble was dissipated. However, the effect of this decline and subsequent volatility had a muted effect on residential real estate. Until 2005, real estate prices continued to perform exceptionally well relative to public equities as seen in Figure 3. Even after topping in 2005, the magnitude of drawdown in the home price index was significantly less than that experienced by public markets only a few years prior. While this boom could be partly placed on the mass loosening of financial standards for real estate transactions during this period, residential real estate performed as an ideal non-correlated asset to public markets as there was minimal fallout experienced from the drawdown in public markets.

Figure 3

Percentiles consolidated from the 2018 CoreLogic, Inc OLB Database. Monthly S&P 500 is the average of all weekday market close values inside each month.

Great Financial Crisis

The Financial Crisis of 2008 was the product of the bursting of the housing market bubble and the loose financial standards that had accompanied it. Figure 4 shows that unlike the prior historical examples, both residential real estate and public markets experienced significant drawdowns. However, even during the decline, the level of volatility exhibited by residential real estate was much lower than that of the S&P 500. Despite public equities recovering their previous highs at a much faster pace than real estate, a potential investor would have been required to undergo a significantly higher level of volatility than an investor holding residential real estate. This lower level of volatility becomes even more remarkable when factoring in that residential real estate was the source of the decline. With the denoted correlation of 0.61 this time period is relatively unique in that it saw the highest correlation between the S&P 500 and Real Estate Sale percentiles in history.

Figure 4

Percentiles consolidated from the 2018 CoreLogic, Inc OLB Database. Monthly S&P 500 is the average of all weekday market close values inside each month.

The Current Environment

Following the Financial Crisis, performance of both public equities and residential real estate has been robust. Both assets have been increasing in near lockstep, yet the distinctions in volatility remain. Similar to prior periods, the level of volatility experienced by residential real estate remains well below that of public equities. Public equities experienced a near one-fifth drop in value in the latter months of 2018, however, real estate prices were nearly unchanged during this period.

Unprecedented government support has been unleashed following the widespread impact of COVID-19 across the world. As public equities have dramatically fallen, the United States Government and Federal Reserve have taken steps to limit the fallout on the surrounding economy and financial wellbeing of consumers. For example, landlords and mortgage servicers have been told to abstain from conducting any evictions and foreclosure proceedings[1]. In addition, fiscal stimulus currently being discussed by the government could help to further curtail the impact on individual households.

Figure 5

Percentiles consolidated from the 2018 CoreLogic, Inc OLB Database. Monthly S&P 500 is the average of all weekday market close values inside each month.

The impact that COVID-19 will have on residential real estate is not yet known. Unlike the Financial Crisis, residential real estate is being actively supported by the government almost immediately, along with the scale of support reaching a significantly higher level than seen before. Based on historical context, residential real estate is likely to exhibit much lower levels of volatility than what has already been experienced by public equities. While home turnover volume may be impacted in the near term, it will likely take a longer and more protracted economic crisis event to impact real estate prices. During these uncertain times, residential real estate can provide the ideal safe haven of lower volatility without having to materially sacrifice the potential for performance.

[1]Payment Relief actions by government and GSE’s https://www.bankrate.com/mortgages/programs-to-freeze-foreclosures-evictions-from-coronavirus-disruptions/