House Prices vs. Stock Market: Which Has Better Historic ROI?

Could stock market volatility cause house prices to fall
Share on facebook
Share on twitter
Share on linkedin
Share on reddit
Share on whatsapp

The housing market has been booming in recent years. Prices for homes have increased at a healthy pace and the stock market is at an all-time high. The problem with this situation is that it’s not sustainable. There will eventually be a major correction in the housing market. So, we will have to make sure we’re prepared for a correction in the housing market when it happens.

Article Overview

Is the housing market tied to the stock market?

We know that home prices and Share prices are closely tied together, but is there a direct connection between the two?

Yes, there is a strong correlation between stocks and the real estate market. Whether it’s a residential property or a commercial property this relation will be reflected by certain key factors that you can use to track over time.

It may seem like they’re separate entities. However, real estate prices are tied to the stock market in three main ways:

Interest rates:

First of all, interest rates are very important in determining real estate prices because they determine how much money is available to borrow for home purchases and at what cost that borrowed amount will be.

The low-interest rates will make it cheaper to borrow, and this will lead to more price appreciation in the real estate industry.

The same thing goes for the Stock market. For example, if the interest rate decreases stock investors will be encouraged to take loans to invest in the stock market.

Housing Sector Index Vs Dow

Investor sentiment regarding stocks and real estate:

If the market as a whole is optimistic about real estate and stocks, then buyers will make their investment decisions upon overbought/oversold conditions or upon return on Investment.

For real estate, the price-to-rent ratio is an important factor. These reflect how much rental property costs against the rental income it generates. This indicator helps investors to determine an overpriced or undervalued space.

On the other hand for stocks, the Intrinsic value of shares and EPS determines investor sentiment for investing in stocks.

By inflation rate:

Here the correlation between real estate and the stock market is inverse. Because a higher rate of inflation may cause a hike in the price of asset classes. On the other hand, a higher rate of inflation reduces earning growth expectations. This is bad for the stock price.

If there is a recession or depression, then both markets will drop in value and it usually takes two years for them to recover. During the bubble, institutional investors reduce their investments, and on the other hand, people sell their houses quickly for cash flow.

But we have seen some exceptions between these two sectors during the 2001 financial crisis. In that period of time, both of them showed an inverse correlation.

Perhaps the only time in history, we have seen a perfect negative correlation between both markets. Moreover, in 2008 the housing bubble was the only reason for the stock market crash.

Could stock market volatility cause house prices to fall?

A new study by the Federal Reserve Bank of New York finds that a rise in stock market volatility can lead to lower housing demand and price declines.

The Fed researchers found that when stocks are volatile, people tend to sell their homes more often than they would otherwise. That leads them to believe that home sales will decline if the markets continue to be volatile.

In fact, the research shows that even small increases in stock-market volatility have an impact on real estate activity. Because this is the moment when buyers prefer stock equity investment over real estate investment for short term gains. 

 “The results suggest that higher levels of stock market volatility may reduce property investment,” says economist Andrew Levin at the bank’s Research Department. He adds that this is because investors who buy houses as investments also use some of those funds for other purposes such as paying down debt or saving for retirement.

But keep that also in mind that the dot-com bubble had no impact on the real estate market but it affected the financial market very badly. Thus you can term the dot-com bubble as a stock market bubble.

Why is investing in real estate better than stocks?

The stock market has been around for centuries but real estate only recently became popular as a way to invest money in something tangible that would grow over time. During this time period, people started buying houses instead of stocks because they were more stable than the stock market.

However, there are many advantages to owning a property rather than investing in the stock market. Here are some reasons why homeownership might be better than the stock market:

Your home appreciates in value every year. When you purchase a share of Apple, Google, Amazon, or Netflix, you don’t know what its future earnings potential could be! You get immediate access to rental cash flow when you buy a home, and like shares, you don’t have to worry about selling first. On the other hand, your home will appreciate in value each year.

It’s easier to diversify your assets. Stocks are highly concentrated so most people end up holding very few different companies. On average, Americans hold less than 10 different stocks.

By comparison, almost half of all U.S. households own multiple properties. So while you’ll never own 100% of one company, you do own part of several others. And since these properties aren’t related to each other, you won’t experience losses due to unexpected events affecting one business sector.

Capital gain taxes are much lower than income tax rates. While you must pay capital gains taxes, you generally avoid sales taxes. For example, California residents pay 1% to 12.3%, Massachusetts residents pay a capital gain tax of about 5%. Meanwhile, federal income tax rates range between 15%-39.6% depending upon how high your taxable income is.

There are no fees associated with real estate transactions. Buying and selling stocks requires brokers’ commissions, legal costs, accounting fees, and more. These expenses add up quickly and eat into profits.

Homeowner insurance premiums are cheaper than mutual fund management fees. Mutual fund managers charge 1/20th of 1% annually whereas homeowner’s insurance policies cost anywhere from $10-$100 per month.

A house usually lasts longer than a company. According to data compiled by the National Association of Realtors, the median age of existing single-family homes sold in 2016 was 8.8 years old compared to 4.9 years for newly constructed homes.

How Stock Market Crashes Impact the Housing Market?

A recent article by The Wall Street Journal reported that home sales could be impacted negatively if there is another major crash in the U.S. economy. This would occur because many people who are looking to buy homes have their finances tied up with stocks or other investments which may lose value during this time. If this happens then those individuals will not be able to afford to buy a new home as well.

S&P 500 Dropped 50 Percent

The housing industry has been on an upward trend over the past decade but experts believe that we should expect a downturn soon. Many economists predict that interest rate hikes will cause inflation to rise significantly and therefore lead to higher mortgage interest payments.

As such, fewer buyers can qualify for mortgages at current low levels. Additionally, rising unemployment numbers also indicate that job growth will slow down. All of these factors combined mean that demand for houses will decrease.

Are houses cheaper in a recession?

Yes! A recent statistic showed houses were 20% cheaper in 2008 than they were in 2007. House price decreases due to a lack of demand caused by people in fear of depression. This means people are less likely to buy. They hold on to their money and wait until the market is more stable.

Another reason that houses may be cheaper in a recession is because of a surplus in supply, meaning there are more houses than people buy them. If the demand decreases then the price will decrease dramatically due to a lack of interest from buyers.

With that being said, apart from the recession factor according to Zillow, the national median price of a single-family home dropped -0.4 percent year-over-year in January 2018.

However, some areas saw even greater declines. For example, San Francisco experienced a decline of 2.7 percent; Los Angeles had a drop of 3.1 percent.

Final Thought

Financial markets have traditionally been a good indicator of the mood and sentiment of consumers, but property prices are also telling an interesting story.

The Department of Economic Advisers in their report in December 2017 found evidence that home affordability is improving and this may be linked to an increase in real estate transactions.

One hypothesis for why we’ve seen such a large uptick in demand is because borrowing rates remain near historic lows.

Finally, a recession or a stock market crash can have unpredictable consequences on the housing market. Housing prices may fall, but they could also stay steady as people are less likely to buy houses during economic difficulties.

The best way to protect your investment in real estate from volatile markets is by diversifying your portfolio with tangible assets like gold and silver that hold their value over time. If you’re not sure how this all works together, you can consult with a financial advisor for further assistance.