Real Estate in Recessions: How Do Rents & Home Values Perform?

As we round the corner to the last half of 2020, the United States continues to fight against the spread of the coronavirus. Unemployment rates are at all-time highs and the economy is knocking on the door of a recession.

Because we’ve experienced many recessions in the past, we have a pretty good understanding of what to expect – generally. However, as we’ve seen with the arrival of the novel coronavirus, the causes and effects of one recession compared to another can vary greatly.

A recession is when the overall economy in a specific area experiences a significant decline. By definition, recessions mean at least two quarters of economic shrinkage. A recession turns into a depression if the economy continues to decline for multiple years.

There are several key economic factors of recessions. The health of the economy is based on the performance of 1) gross domestic product (GDP), 2) personal income, 3) employment, 4) manufacturing, and 5) retail sales. While no one indicator is entirely dependent on another, when one gets wobbly it can cause a domino effect causing the other indicators to do the same.

Recessions can cause unemployment rates to skyrocket and personal incomes to decrease. Naturally, this puts even more financial pressure on many homeowners and renters, as we’ve seen since the COVID-19 outbreak.

As we begin to adapt to our “new normal,” it’s important to understand what to expect from real estate during the recession at hand. What happens to real estate in a recession? How do rents and home values typically move in recessions, and will rents and home prices go down in 2020?

What Happens to Real Estate in a Recession?

When the overall economy is suffering, more people lose their jobs which cause some to pull out of the house hunting game. In past recessions, we’ve seen certain markets experience a drop in demand for homes and a rise in supply. When this happens, home prices will typically dip, adjusting to market conditions. But not all recessions are the same, and this one is definitely different than any other we’ve seen in history. Let’s take a look at how real estate has been affected thus far.

What Happens to Real Estate Values in a Recession?

We know that recessions can be caused by a variety of factors and last for varying periods of time.

Many of us remember the most recent recession caused by a mortgage meltdown, the Great Recession. This particular recession greatly impacted the value of homes. In fact, the 2008 recession was actually centered around the real estate industry, and even caused by it.

Loose lending practices allowed more people to qualify for homes, driving home prices up to inflated levels. Easy lending also allowed more builders to create more inventory, flooding the market with new homes. When adjustable rate mortgages reset to a higher rate in 2006 and 2007, many borrowers were unable to make the new payment. Mortgage defaults started to soar, as people who had put no money down on their homes simply walked away from the new, higher payments.

The real estate market soon became inundated with overpriced, empty homes that eventually were taken back by the banks. The housing bubble popped, and home prices came crashing down. The Great Recession lasted over two years and forced millions of people to become renters, as they lost their homes to foreclosure.

The Great Recession is unique because it was triggered by easy lending standards, including no down payment requirements, low or no documentation requirements, and qualification based on a teaser rate versus the actual rate – on both primary and investment properties. Literally anyone could qualify for a mortgage, whether they could afford it or not. It should have been no surprise that that house of cards would eventually fall.

However, not all recessions are caused by loose lending. In the ‘70s, it was caused by the oil embargo. In the 80’s, it was caused by junk bonds. In the ‘90s, it was oil again. And in the early 2000’s it was speculation in the tech industry. These recessions didn’t always have an impact on the value of homes, and if they did, it was market specific. In fact, in several past recessions, the price of homes actually went up.

Brian’s Note: Take a look at median US home prices since the ‘60s, with recessions highlighted in gray:

Home values will likely decline in some markets during a recession, but not always. Home prices were also less impacted during recessions that didn’t last as long.

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What Happens to Rents in a Recession?

Rents can go both up and down in a recession. The location of a rental property and how hard the local economy is hit by a recession will dictate whether rents go up, down or stay the same.

For example, a working-class housing market that experiences huge job losses during a recession will likely see an increase in vacancies, forcing rents down. This happened in North Dakota in 2015 when oil prices plunged, as the economy in North Dakota was highly dependent on high oil prices.

On the other hand, if a property is located in a less vulnerable area and/or occupied by a tenant with more resources, rents may generally stay the same during a recession.

Houston, Texas serves as a great example of this. Even though oil prices plunged in 2015, home prices increased in Houston, mainly because the metro area has a diverse economy that is no longer reliant primarily on oil production.

Brian’s Note: Rents tend to remain more resilient than property values in a recession. At worst, nationwide rents tend to flatten out during recessions – see this chart:

But as Kathy points out, nationwide averages can conceal some markets rising while other markets fall in recessions.

What’s Happening to Real Estate Right Now?

The biggest crisis in real estate today is not vacancies or delinquencies. It’s a lack of supply. There doesn’t seem to be an end in sight to the affordable housing shortage across in the U.S. In many cities, income is not keeping up with increasing rents or home prices, adding even more financial strain to renters and home buyers.

According to the State of the Nation’s 2019 Housing Market report by Harvard University, 50 percent of renters spend more than 30 percent of their monthly income on rent. Which eliminates a large portion of people that can’t afford to keep up with rising rents.

And sure enough, we’re seeing more tenants planning to non-renew higher rent lease agreements than more affordable rentals. See this data from HousingWire:

To solve this issue, more affordable low-income and middle-income housing needs to be built to meet the demand of buyers and renters. Unfortunately, building costs have increased substantially over the years, making it virtually impossible for builders to provide affordable housing. Most of the new inventory that has been built over the past decade has been on the higher end, as it’s the only way for builders to make a profit.

COVID-19 has caused major slowdowns in both manufacturing and construction, which is further exacerbating the problem. Some builders have stopped building entirely, while others have slowed down substantially. According to the US Census Bureau, in April and May, there were fewer building permits issued, housing starts and completions, compared to a year ago. This trend tells us that this lack of supply may continue for the foreseeable future.

Will Rents Go Down This Year?

Apartment rents in some areas around the country have started to decrease, but only slightly. March through June is normally the busiest season for rental activity, but with the Coronavirus shutting down the economy during those months, many people just stayed put.

However, single family rental rates have stayed consistent and even increased in some areas. There is a new de-urbanization trend emerging of people moving out of the cities and into the suburbs, in search of more space in order to practice better social distancing.

According to a recent report by Apartment List, the national rent index fell by 0.3 percent from March to June. To put this seemingly nominal number into perspective, since 2014 rents grew between 1.0 percent and 1.7 percent (from March to June). This “Pandemic Pricing” shows us how COVID-19 has impacted people financially and even shifted what renters may now be looking for in a place to live.

The cities with the largest decline in rent prices fall into two categories:

1. Expensive markets with already high pre-pandemic rents.
2. Markets where the local economy relies heavily on service and tourism sectors.

The following 10 cities are experiencing the biggest drops in rent, while the suburbs are gaining speed:

1. San Francisco, CA
2. Orlando, FL
3. New York, NY
4. San Jose, CA
5. Miami, FL
6. Charlotte, NC
7. Austin TX
8. Houston, TX
9. Washington, DC
10. Tampa, FL

At a national level, we have yet to see significant drops in rent since the pandemic began. But certain markets that were highly impacted by shelter-in-place orders are seeing a more rapid decline in rents – especially in large, expensive metros where most people lived in condos or apartments. Today, many of the desirable amenities that attracted residents are now closed – including swimming pools, gyms and even restaurants.

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Will Home Prices Go Down This Year?

It’s still hard to say whether home prices will go down this year as markets will be affected differently. The COVID-19 outbreak and subsequent “shut-down” slowed real estate activity for a brief time, mainly due to a lack of inventory as more people stayed put and few people wanted strangers walking through their homes.

Even though home sales declined for this reason, home prices held relatively steady. “Safer at home” guidelines have elevated the home to a whole new level of importance, along with a new set of needs – like home offices, better kitchens, and a yard for outdoor privacy.

In April and May, we began seeing existing home sales decline nationwide. There were 17% fewer existing homes sold in April 2020 compared to a year ago. In May, the number of existing home sales dropped 26.6 percent, year-over-year.

Even with the recent drop in home sales, the sales price of existing single-family homes is still holding up, particularly in the Northeast (up 9.2% year-over-year). In May, the NAR reported that the average price of single-family homes nationwide went up 2.4 percent compared to 2019.

The pandemic has slowed price gains in certain regions around the country, which is actually a positive outcome for homebuyers struggling to afford a home. Low interest rates also help. However, the lack of affordable, low-to-mid-priced homes, coupled with high demand is driving home prices up in some areas.

We are already seeing a leveling out or drop in markets where household incomes have failed to keep pace with the increasing price of homes. The question is, which markets will meet the demand for affordable housing?

The shortage of affordable housing has translated to a shortage of affordable rental housing as well, all the while, rental demand remains strong. This is good news for real estate investors.

Should You Buy a Home During a Recession?

In the past, recessions can bring a buyer’s market. In a buyer’s market, there will be less competition and more houses on the market. Buyer’s carry the power and are less likely to compete with multiple offers. Depending on the market and your resources, a recession may be a great time to invest in real estate, especially if rents continue to rise. Even if home prices stay steady, there may be some opportunity to find motivated sellers and distressed properties at a discount.

Additionally, it’s important to note that some industries actually thrive during recessions or remain relatively unaffected. In today’s environment, economies based on healthcare, biotech or high-tech are booming. Real estate markets may well hold strong in these “recession-proof” areas.

And finally, follow is the money supply as a critical metric. In the past several months, over $3 trillion dollars have been created by the Federal Reserve to buy bonds and to keep the banks solvent. When these funds circulate, asset prices tend to increase as more dollars chase a limited supply of goods (read: inflation). Generally, real estate and stock prices increase when the money supply increases, making them great hedges against inflation. We have never seen a monetary stimulus quite like this, so I do expect to see inflation in real estate and stocks over the coming years, even while unemployment is high. Unfortunately for renters, this also means rents will likely increase, and the affordable housing crisis will continue.

Real estate can be a safe haven for investors during tough economic times. Depending on your goals and tolerance for risk, recession-busting investments can protect your money, grow your money or do both. It is our mission at RealWealth to help as many people as we can acquire recession-proof and inflation-proof assets during these uncertain times.

What are your thoughts on real estate investing in a recession? Are you planning to build your rental portfolio, or stay on the sidelines to see what happens?

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About the Author

Kathy Fettke, the Co-Founder & Co-CEO of RealWealth®, specializes in teaching people how to build multi-million dollar real estate portfolios through creative finance and planning. She is passionate about researching and then sharing the most important information about real estate, market cycles and the economy. Author of the #1 best seller, Retire Rich with Rentals, Kathy is a frequent guest expert on such media as CNN, CNBC, Fox News, NPR and CBS MarketWatch.

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