Introduction
In this article, we will explore the relationship between price growth and housing market downturns, focusing on the concept of relative change. By analyzing how different local housing economies performed before, during, and after the Great Recession, we can gain valuable insights into the indicators of a severe downturn and identify regions that are more resilient to market fluctuations. Understanding this phenomenon can help real estate investors make informed decisions and mitigate potential risks. Let's delve into the details and unravel the significance of price appreciation in predicting housing downturns.
Examining Housing Price Appreciation
During my research on home prices leading up to the Great Recession, I divided regions into two distinct categories based on their housing market performance from 2000 to 2007. The first category comprised regions that experienced slower-than-average home price appreciation, while the second category consisted of regions with faster-than-average growth. Analyzing the price appreciation trends in these regions provides valuable insights into their respective performances before, during, and after the recession.
The Role of Pre-Downturn Price Appreciation
The extent of housing downturn in a specific region is strongly correlated with the degree of price appreciation it experienced prior to the downturn. To illustrate this, let's consider the example of the Great Recession on a national scale. Home prices peaked in Q2 2007 before beginning their decline until reaching their lowest point in Q2 2012. If one had purchased a property at its peak and sold it at the bottom, on average, they would have incurred a capital loss of 19%, highlighting the severity of the downturn.
However, it is crucial to note that certain locales exhibited above-average home price appreciation compared to the national average. These regions experienced price declines starting in Q1 2007, preceding the broader market downturn. Locations like coastal California, Las Vegas, and Phoenix were among the early indicators of the impending recession. If an investor had bought at the top and sold at the bottom in these locales, they would have suffered a substantial loss of 30% on average during the recessionary period.
Resilient Locales: Slow and Steady Price Appreciation
In contrast, locales that demonstrated slower-than-average price appreciation before the recession followed a different trajectory. These regions did not experience price declines until Q1 2008, a year or more after the nation as a whole had entered a housing downturn. The downturn in these locales bottomed out in Q2 2011, a full year before the greater nation.
If an investor had purchased a property at the peak and sold it at the bottom in these resilient locales, their loss would have been limited to 7.5%. This suggests that buying real estate in regions with a history of slow and steady price appreciation compared to the national average significantly reduces the likelihood of a severe downturn or, in some cases, entirely avoids it.
Consistency in Behavior: Before, During, and After the Recession
Interestingly, the same resilient locales that exhibited slow price growth during the Great Recession continued to display similar trends after the recession. As the housing economy started to recover in 2012, these regions demonstrated consistent, gradual price appreciation. They behaved in a manner reminiscent of their pre-recession performance. Consequently, it is reasonable to expect these locales to exhibit similar resilience during future downturns, experiencing mild to no negative price appreciation.
The Statistical Measure of Relative Change
A technical look at the statistical analysis reveals that relative change accounts for 68% of a housing downturn in any given locale. This means that when a housing downturn occurs, 68% of the collapse in real estate prices can be attributed to how
prices behaved leading up to the downturn. In other words, regions that consistently exhibit slow and steady price increases during stable market conditions are 68% more likely to experience milder downturns when faced with nationwide housing challenges.
Conclusion
Understanding the relationship between price growth and housing market downturns is invaluable for real estate investors seeking to make informed decisions. By analyzing the extent of price appreciation before a downturn, we can gauge the potential severity of a housing crisis in a particular region. Regions with slower-than-average price growth tend to be more resilient, experiencing milder downturns or even avoiding them altogether. This knowledge empowers investors to navigate the real estate market with greater confidence and adapt their strategies to minimize risks.
