What is a Bear Market in Real Estate?
With the stock market in retreat in 2022, the concept of a bear market has been very much on the minds of investors. While a bear market in equities is well defined, the concept is not so clear for commercial real estate. In fact, the phrase ‘bear market’ is not typically used to describe a decrease in commercial real estate values. Investors more commonly refer to a ‘downturn’ in property values, or to the end of a real estate bubble.
For the equities or stock market, the generally accepted definition of a bear market is the decline by more than 20% from recent highs in broad market indices, such as the S&P 500. There can be types of bear markets also in some of the narrower indices, such as tech-centric Nasdaq Composite or small-cap Russell 2000. For example, in mid-year 2022, the Nasdaq Composite was off about 24% year-to-date, thus meeting the definition of a bear market.
Since 1928, by one of the broadest measures of U.S. stocks, the S&P 500, there have been 26 stock market bear markets. Thus, the rough math suggests investors should expect an ursine cast to the stock market every four years or so.
But real estate, especially privately owned property, is a horse (or bear) of different color.
Read on to learn more about real estate bear markets and listen in as I discuss this topic with Paul Fiorilla, Director of US Research at Yardi Matrix, in the latest GowerCrowd podcast.
Listen to the full podcast here:
What is a bear market in stocks?
A bear market in stocks is a period characterized by a sustained decline in equity prices. The conventional definition of a stock market correction is a 20% drop in valuations from cyclical highs. In recent memory, bear markets have followed the dot-com bust of the early 2000s and the global financial crisis of 2008 and 2009.
A bear market typically follows a bull market, which is a period of rising equity prices and investor optimism. After a brief stock market downturn at the start of the coronavirus pandemic, the Federal Reserve moved aggressively, cutting interest rates to zero. The stock market quickly recovered, soaring to record highs. However, the U.S. economy and equities markets were running so hot that inflation ensued. The Fed responded in 2022 with rate increases, and stock returns have cooled.
It is worth noting a distinction between equities markets and real estate markets: Stock values are completely transparent and are, in most cases, completely liquid meaning they can be traded at a moment’s notice. Real estate values are less transparent, has a long sales cycle, and is generally considered to be highly illiquid.
Stocks are valued and revalued every moment of every trading day, with the prices readily available for all to see, and are subject to the whims of the news cycle that can trigger near instantaneous trading and balancing of supply and demand leading to considerable volatility.
In real estate, on the other hand, the vast majority of commercial properties are privately owned, and are not priced based on a given moment’s precise balance between demand and supply. Consequently, it can be difficult to point to a particular index and determine whether real estate values are in a bull market or a bear market.
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Real Estate Downturns Are Uncommon
For better-or-worse, generally accepted U.S. commercial property indexes do not reach back as many years as stock market averages, but there are approximate indices going back 25 years and 50 years.
In the last near quarter-century there have been two real estate downturns for U.S. commercial real estate. The first was the Global Financial Crisis, 2007 to 2009, which bottomed out in two years and then took until 2014 for full recovery.
The second U.S. commercial real estate downtown was in response to the COVID-19 pandemic, and was brief, and lasted under a year, and then bounced back to historical highs, according to Yardi data (see chart below).
In the last half-century, there has been only three major declines in the FTSE Nareit All-Equity REIT Index—the early 1970s, the 1990s, and the 2007-2009 Global Financial Crisis. The aforementioned Nareit Index, which pertains to U.S. listed REIT stocks, is not a perfect proxy for privately held U.S. commercial real estate, but nevertheless is suggestive of general real estate values.
The short story is that it takes some serious bad news to send U.S. general commercial real estate values lower for any length of time. But aside from worldwide financial crises or pandemics, general U.S. commercial property values have been steady or gaining for at least a half-century.
How does a bear market (in stocks) affect real estate?
This is a complicated question. Sometimes a bear market in stocks drags down real estate values, other times it does not. The mere fact that the stock market has gone down does not necessarily affect demand for offices or industrial space or apartments. If it turns out that the bear market of 2022 was just a return to reality after a period of optimism, then falling equity prices would deal only a glancing blow to the real estate market.
On the other hand, if the bear market portends a protracted recession and job growth turns negative, then that reality could put a damper on the commercial real estate boom. But moves on Wall Street do not always reflect the reality on Main Street. There is an old saw that goes: ;The stock market has predicted nine of the last five recessions.’ In other words, a bear market in stocks might be more about the intricacies of equities markets and less about other parts of the economy, including commercial real estate.
The stock market can have some effect on real estate demand, however. During the dot-com bubble, tech firms snapped up offices and distribution space. Then the crash came, and the companies that had been in such dire need of space no longer occupied offices and warehouses.
A similar phenomenon played out during the housing bubble that preceded the global financial crisis of 2007-2009. With mortgage firms, builders and real estate brokers making record profits, those industries snapped up commercial space to support their operations. When the bubble burst, they no longer could pay the rent.
Broadly, though, commercial real estate values are driven by supply and demand and as sales cycles tend to be weeks if not months, values tend to remain stable over time. As long as demand outpaces supply for a given property type, values will continue to rise, even during a bear market in equities. As of mid-2022, demand for commercial properties remains robust. Job growth is strong, and consumer balance sheets are still solid. In short, it is quite possible that the bear market in stocks will not translate to a downturn in commercial real estate values – or, at least, be a precursor to one.
Of course, as history shows, if there is a macroeconomic calamity, such as the Global Financial Crisis or sustained recessions, you will see real estate values follow the stock market lower.
But in general, commercial real estate values are determined by interest rates and rents collected, and commercial property is not priced daily so is illiquid than stocks. This results in much less volatility in commercial real estate than on the New York exchanges—indeed, considering the large swath of “tech” issues, IPOs, or other prospective shares trading on Wall Street, it would defy all sensible expectation if listed companies were not more volatile than commercial real estate, the latter with its manifest features of generally predictable rent rolls, income streams and costs.
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Is it Good to Buy (or sell) real estate in a bear market?
For equities investors, the mantra to “buy the dip” has proven a profitable directive. With stocks trending ever higher, a downturn in prices is sort of like a brief sale. The same mindset applies to real estate. Despite painful episodes of price corrections, real estate values have trended up over the long term. That means savvy investors are more likely to buy than to sell in a bear market.
That said, property prices may soften on the margins during turmoil in the stock market. If investors are chary of current market or economic conditions, that may carry over into property markets.
The 50-year track record of the FTSE Nareit All-Equity REIT Index does suggest that buying during the rare real estate downturns is a very good investment strategy—and just as strongly suggest that a very poor strategy is to sell during a property downturn. Patience rewards the property owner.
When was the last real estate bear market?
The most recent downturn in real estate values followed the global financial crisis of 2007-2009 and the ensuing Great Recession. The crash was precipitated by a run-up in residential real estate values. Mortgage lenders dramatically loosened underwriting standards and engaged in frenzied securitization of mortgages, leading to a global contagion when housing values stopped rising and borrowers began defaulting. Commercial real estate was a casualty of that crash.
The unemployment rate soared in 2009 and 2010, which reduced demand for offices. Consumer balance sheets suffered, resulting in less demand for retail real estate. The bearish conditions led to a decline in commercial real estate values and a wave of foreclosures on commercial mortgages.
Over the past decade, however, commercial real estate has experienced a pronounced upward trend. Demand for apartments, distribution space, grocery-anchored retail and self-storage has been robust. A few property types, including office, shopping malls and hotels, struggled at the beginning of the COVID-19 pandemic, but even those sectors have avoided the sort of dramatic downturn that affected the broader commercial real estate market during the Great Recession.
The Yardi data in the graph above shows the overall stability of private property values relative to the S&P REIT index and the S&P 500. The black line running through the middle of the graph is the NCREIF Property Index that shows how much private real estate has fluctuated in value since the late 1990’s. As you can see, with only two exceptions, private real estate is a stalwart of consistency versus the extreme volatility of REIT and the S&P 500 performance.
The two dips in private real estate were paralleled by extreme drops in the other two indexes values; the first during the global financial crisis of 2007-2008 and the second, harder to discern, during the onset of the coronavirus pandemic in early 2020.
Even in these instances, however, private real estate suffered considerably less than the other two investment indexes shown. For example, the REIT index fell almost 40% during the Global Financial Crisis, while the S&P 500 fell almost 30%. By comparison, however, private real estate only dropped 9% or so.
Almost forgotten today is that the Nasdaq index had actually peaked at more than 5,000 in 2000 but lost 75.6% of its value in the famed dot.com meltdown, eventually regaining 5,000 in 2015, a decade-and-a-half later.
The more recent and brief commercial real estate decline in 2020-2021, and perhaps even the new record summits reached thereafter, should probably be marked with an asterisk.
The COVID-19 pandemic was an unusual event, first shuttering economies and then triggering a wave of central-bank easing and fiscal outlays. True, through concerted efforts, governments can induce volatility in commercial property markets, but it is a major undertaking.
How can you profit from a bear market?
At the risk of being obvious, the ‘buy low, sell high’ maxim succeeds in every market, including commercial real estate. There are no guarantees in any investment, but the half-century track record is that general U.S. commercial real estate downturns are rare, and last at most a couple of years.
For buy-and-hold investors, a bear market is a painful period but one that will soon appear in the rear-view mirror. However, opportunistic investors look to take advantage of a bear market. Those who anticipate a bear market can profit by selling short – that is, betting that values will fall in the future and selling their real estate before that happens with the intent of buying back in again when the market bounces back. Profitably timing a bear market in advance is no easy task and tax implications alone can make such a strategy ineffective for the real estate investor.
A safer bet is to keep access to cash liquid and buy on the dip and the best way to do this is to expand your list of individual investors. That way, when discounted real estate opportunities start showing on your radar, you have a source for capital and can act decisively. If you can buy assets at a discount from their true value, you can profit when the long-term uptrend resumes.
To be sure, there are geographic exceptions, such as poorly placed property in Rust Belt cities, or some “overbuilt” housing markets after the 2007-2009 Global Financial Crisis. Another example is the impact on specific real estate asset classes. The hospitality industry tends to perform exceptionally badly during economic downturns as disposable income drops and travelers curtail their discretionary spending. During the Global Financial Crisis and during the height of the coronavirus pandemic in 2020-2021 hotels suffered the impact of travel restrictions particularly badly.
Indeed, in general, commercial property is considered a solid asset enough that gimlet-eyed banks are willing to lend 65% to 75% of the value of a real estate acquisition, also known as the loan-to-value (LTV) ratio, and sometimes even more.
Moreover, investors buying in real estate downturns have fared well thereafter. Property buyers who braved the nadir of the Global Financial Crisis in 2009 saw asset values double within six years, even as they collected income. Of course, leveraged property investors who bought in 2009 saw returns at many multiples of equity invested.
Watch the June 2, 2022, roundtable discussion as Dr. Adam Gower asks 'What is a bear market in real estate and are we in one?' with special guest Orest Mandzy, Managing Editor at Commercial Real Estate Direct (CRENews.com), featuring appearances from Chris Finlay, Founder and CEO at Lloyd Jones in Florida, Chris Rising, Founder and CEO of Rising Realty Partners in Los Angeles, Paul Fiorilla, Director of US Research at Yardi Matrix and other contributors from the live audience.
How Long Can a Real Estate Bear Market Last?
The duration of a bear market depends on how long supply and demand are out of balance. Run-ups in real estate values are marked by a shortage of supply and an excess of demand. When prices fall, on the other hand, it is because the supply of commercial property outpaces demand. The most recent bear market in commercial real estate lasted more than two years, according to data from the International Monetary Fund. U.S. property values peaked in the fourth quarter of 2007, then fell sharply through the third quarter of 2009.
The period from the third quarter of 2008 through the third quarter of 2009 was the worst of the crash – values fell 30% for the year, according to IMF data. Year-over year price trends remained negative into 2010, finally inching up in the third quarter of that year.
But as major global central banks tighten up monetary policies, and thus raise interest rates, could the 2020s usher in a new, but less exuberant era, for real estate?
To be sure, there was a 40-year-run from 1980 to 2020 of disinflation and generally lower interest rates across the developed world. At times this disinflation coincided with capital gluts, perhaps caused by stratified incomes in the West (the financial elites made more money than they could spend) and forced or promoted savings across the Asian Pacific.
In any event, “too much money chasing too few deals” has been a perennial complaint in institutional investor markets for a generation. Particularly since the Global Financial Crisis in the United States there has been an excess of capital and this was exacerbated by the economic stimuli the government used to limit the impact of the pandemic.
While pandemic and war has marred recent economic outlooks, broadly speaking the long run is likely a replay of the recent past: A lot of capital, globally, looking for secure investments that can generate stable, predictable sources of income and real estate offers these characteristics better than most other investment options.
Predicting interest rates is usually a mug’s game, nevertheless major central banks in North America and Europe are discussing maximum rate hikes in modest ranges, such as 2% to 3% higher.
While the 20%+gains in commercial real estate values seen in 2021 are not likely to be annual recurrences, sustained property declines have proved rare in the last 50 years. A pause, or some declines in less well-situated properties, is certainly possible in the 2020s, but with mounting tides of capital every year looking to be placed, any property pullbacks will likely be short-lived.
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Real estate bear market - conclusion
As widely noted, real estate is regarded as a hedge against higher rates of inflation, as inflation generally also boosts rents, and thus operating incomes, while debt service can remain fixed or lagging (depending on loan structures).
Tighter monetary policies may slow macroeconomic growth, but higher rates will also limit new construction, eventually constraining supply—especially if the general economy does not enter a recession.
Any widespread weaknesses in property value should be monitored carefully by investors, but potential property buyers may also wish to ponder if a short “bear market” in property is a buying opportunity.
Not all geographies or real estate sectors will fare equally going forward, and many observers have noted the uncertain prospects for lodging, retail, and office markets—although investors have also priced in the perceived risks.
Despite troubled global outlooks in the early 2020s, the half-century record of U.S. commercial real estate is that downturns are hurdled, and long, moderate rallies are the norm. Not a bad market to be in, in a world troubled by pandemics and geopolitical tensions.