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How the Real Estate Market Dictates the State of the Economy

The 2008 recession was one of the worst economic crises in recent history, and while there were many independent factors at play to influence it, one of the biggest motivators was the collapse of the housing market. With home prices currently rising and the Fed raising rates incrementally, 58 percent of Americans believe another housing market crash is on the horizon. But are they right to be concerned?

The real estate market and the economy at large share an interesting and complicated relationship, and the better we understand it, the more power we have to prevent the next major economic recession—or at least see it coming in enough time to prepare for it.

Real Estate Construction

The only element of the real estate market that’s calculated as part of our gross domestic product (GDP) is real estate construction, which contributed $935 billion in 2017 (and supported 7.6 new and existing jobs). That makes real estate construction about 5 percent of our total GDP. When demand falls and construction slows to a crawl, we lose that economic productivity, and millions of jobs are threatened to be cut or lost.

Still, this isn’t the only way—or even the most significant way—real estate affects the economy.

Housing and Job Opportunities

For the most part, people need to live close to where they work. Having access to public transportation or a personal vehicle can overcome some distance, but most people still want to live within 30 minutes of their place of employment. The relationship here is complicated; if housing prices rise too far, people can’t afford to move to a city, which results in a dearth of workers, and in some cases, economic decline. Economic decline tends to lower real estate prices, which may, in turn, attract more people to the city, but in the meantime will create economic hardship for current real estate owners (more on that in the next section).

Demand and Home Prices

The nature between real estate demand and real estate prices creates a kind of feedback loop that has the power to boost or crush the economy. Let’s say there’s a steady rise in the demand for housing, with supply remaining the same. In response, housing prices steadily rise, and the market remains more or less at equilibrium. But let’s say an economic crisis is starting to unfold, and consumers are reluctant to move or buy housing. In this scenario, housing prices crash, and existing homeowners may see a decline on their biggest monetary investment, or even become underwater on their mortgage. This, in turn, brings consumer spending to a halt, which affects practically every business in the United States economy. And when the U.S. economy suffers, the global economy suffers.

The Federal Reserve

The Federal Reserve uses interest rates to try and mitigate the influences here. In general, when the Fed raises interest rates, mortgage rates and other loan rates rise (and vice versa). Accordingly, in anticipation of a recession or in response to lower demand, the Fed can lower rates (as it has in the past), driving consumer spending, housing demand, and home prices up to keep the economy from crashing too hard. Unfortunately, there’s only so much this can do.

The Great Recession

We can examine all of these influences collectively, using the Great Recession of 2008 as an example. Experts trace the beginnings of the crisis back to the early 2000s, when banks started irresponsibly offering subprime mortgages to homebuyers with little to no credit. In 2006, home prices started to fall in response to decreased demand, and as a result, consumers started losing value on their homes, in some cases foreclosing, and in other cases getting stuck in an underwater mortgage. Over the next few years, consumer spending slowed to a crawl, and both home prices and GDP shrank significantly.

The Real Estate Market Today

As mentioned earlier, the majority of Americans feel that there’s a real estate market bubble forming, in large part because of rising prices. But in many areas, those rising prices are a sign of recovery, and a positive trend of growth.

In 2018, experts anticipate that supply will finally catch up to demand, which means home prices will finally stabilize, and the market may level off without experiencing a correction, or worse, a major crash. If that’s the case, the real estate market and the economy overall can continue enjoying a harmonious feedback loop of growth.

Of course, high-level outlooks view the real estate market in terms of a national average. There are some areas where real estate prices are skyrocketing higher than residents can afford to pay, and they may be subject to more volatility than the nation at large.

The economy is far too complicated to depend entirely on one variable, but the real estate market is a major contributor to the health and growth of our nation. While even top experts can’t predict what might happen next to the real estate market, stock market, or our position in the international economy, we can work to understand the influential factors at play between these areas.

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