How Can You Prepare for a Real Estate Market Downturn?

Homeownership By Noah - March 26, 2020

The stock market is down, various industries are struggling, and layoffs seem to threaten in the near future. March 2020’s coronavirus-related financial headlines bear a certain resemblance to similar headlines from the 2008 financial crisis and Great Recession. Is a housing crash on the horizon now, too?

Probably not. The 2008 crash was the result of years of instability, not an acute, external crisis like a disease. News is developing quickly, so it’s hard to say exactly what the next months of 2020 will hold, but there’s no immediate reason to believe the real estate market is at risk. But this is a great time to learn more about what does cause a housing market crash, and how to protect your home.

How Did the Housing Market Crash in 2008 Happen?

The real estate crash of 2008 didn’t happen due to a sudden accident or unpredictable market fluctuation. A combination of factors seriously weakened the housing market and primed it for a crash.

Factors that caused the housing market crash

Major factors that contributed to the real estate crash are:

  1. Subprime lending. In the mid-1990s and early 2000s, there was an increase in subprime lending, or lending to borrowers with lower savings and credit scores than lenders generally require. Subprime lending increased dramatically around 1999.
  2. Predatory lending. A large number of mortgage and home refinancing loans contained predatory terms. Borrowers saw low interest rates and virtually risk-free terms. Lenders may have understood more about the potential downsides than they always made clear to borrowers.
  3. Rising consumer debt and mortgage-backed securities (MBS). Bundling mortgages and selling them as securities was profitable for banks — as long as home prices climbed and homeowners paid the mortgage on time.
  4. Mortgages in default. When homeowners defaulted on their mortgage, financial institutions found themselves in trouble, too. Defaulted mortgages were disproportionately common in areas with high rates of subprime lending, so the connection was clear.
  5. Stock market crash. With widespread mortgage default and foreclosure, collapsing the subprime lending market, the stock market plummeted, sending the country into the Great Recession.

The Dow Jones fell 777.68 points on September 29, 2008, one of the largest single-day drops recorded at the time. (March 2020 currently claims the top two single-day point drops, as coronavirus affects the stock market.) The housing market dropped by as much as 33% during the recession that began in 2008.

How did we get out of the 2008 recession?

The Troubled Asset Relief Program (TARP), which passed in October 2008, bailed out struggling banks and some other companies like Chrysler and GM. This helped keep some major institutions from collapsing.

Shortly after taking office, President Obama passed an economic stimulus package to help restabilize the economy and avoid a global recession. The combination of this measure with programs like TARP helped prevent the recession from even more dire lows.

What Happens When the Housing Market Crashes?

A major crash like the 2008 financial crisis doesn’t happen often, but markets experience fluctuation all the time. So how do you handle the dips when they come to your neighborhood?

What does a recession mean for house prices?

Generally, a weaker economy tends to lead toward a buyer’s market. Fewer buyers may feel ready to take the big step into homeownership during a recession. Those that do may find less competition and have more negotiating power with sellers.

That doesn’t mean your home is doomed to drop in price. According to Redfin data, houses with certain “dream home” characteristics keep their value better than others. Here’s what buyers are looking for:

  • Single-family home (rather than townhouse)
  • Old homes (built before 1940)
  • Multi-story homes (even townhouses keep value well if they have three stories)
  • High number of bedrooms (at least 4)
  • Low-density neighborhood

The more of those factors applies to your home, the better the odds that you’ll get offers at your asking price, even in a recession.

How long does a recession last?

An economic decline doesn’t qualify as a recession unless it lasts for at least 6 months. The National Bureau of Economic Research recorded 12 recessions between 1945 and 2009. The shortest was 6 months, the longest was 18 months, with an average duration of just over 11 months.

If your home’s value dropped due to a recession and you have some flexibility to wait, you may want to hold off on a sale for a year and see if the market swings in your favor again. Not all homeowners have the same financial cushion. If you were hoping to sell your house in the near future, talk to your financial advisor about the most beneficial plan for your home and your savings.

What Is a Housing Bubble?

In finance and economics, when we talk about a bubble, we’re talking about a situation where a certain asset is climbing rapidly in price. The price escalation tends to be based on less-than-plausible projections about the future, so the asset’s value “bursts” and falls rapidly, too.

Why is a housing bubble bad?

Your home has immediate value as the place where you live. Most families hope their home will provide more of an investment than a simple roof over their head, though. The idea is that your home will gain value over time, so that when it comes time to sell, you’ll get back the money you put in and then some.

The housing bubble of 2008 ruined that plan for a lot of homeowners. When the bubble burst, some homeowners found that their inflated mortgages left them owing more than their “burst” home value was worth. The World Economic Outlook[1]  found that equity price busts tended to occur roughly every 13 years, and housing price busts happened somewhat less frequently. A housing bubble burst period can extend for several years.

Will the Housing Market Crash Again?

If you do the math, counting 13 years after 2008, that brings you to 2021. Should you take this as a warning sign for your home’s value?

Is the housing market going to crash in 2020?

The economic crisis in 2008 happened because of serious weaknesses in the structure of how lenders treated loans. Predatory tactics and inflated mortgages destabilized the housing market.

The stock market dip in early 2020 appears to be due to fear surrounding the COVID-19 pandemic. This is a serious event, and more developments are coming out all the time, so it’s still difficult to say what the ultimate economic effects will be. A pandemic is more like a sudden natural disaster than a flaw in the economic infrastructure, though.

Current valuations of the housing market in major U.S. cities show that some areas are overvalued, but not at bubble level, according to the UBS Global Real Estate Bubble Index. Regulations against subprime lending may help avoid the mistakes of the early 2000s.

The takeaway is, while it’s possible that housing market prices may be affected in the next couple years, there isn’t currently clear evidence that this is an imminent outcome.

How can I prepare for a housing market crash?

Staying prepared can help you feel more secure, whether you’re anticipating an economic downturn or not:

  • Build your emergency fund: If you find yourself without income for a few months, would your savings cover your bills? If not, time to stash some cash.
  • Be savvy about home financing: Not all lenders are created equal. If you’re planning to refinance your home, read terms carefully so you don’t fall behind on payments or sign up for more interest than you bargained for. Or schedule a chat with Noah to learn about financing without monthly payments or interest.
  • Read real estate news for your area. Boston’s housing market can be completely different from Chicago or San Francisco’s. Tracking national real estate news is helpful, but don’t neglect the latest for your area to get a more accurate sense of what to expect. 

Will 2020 be a buyer’s market or a seller’s market? Time will tell, and chances are the answer will vary in different parts of the country. When you understand the reasons behind a big housing crash like the one in 2008, it might be easier to see warning signs of another downturn. Or you might find that, while other industries may take a hit, an economic dip doesn’t always mean the slump affects your home’s value.