Implications of a bear market.

[Armando Payano]

Hey BP I'd like to get opinions on what the effects of a bear market in stocks be on real estate investments. Please share your thoughts on what the general effects from small to large SFR markets. What's are some opinions on how it would effect note investments? How would multifamily be effected? Would flips thrive or ease? How would a bear market in stocks effect lending? Would refinancing or HELOCSs become more difficult to attain compared to the cure environment? I'm sure many of the astute investors that are on BP already have plans in place please don't hold back. Thanks in advance.

[Kenneth Reimer]

@Armando Payano Hi Armando, that's a great question. However, the question is almost impossible to answer. Their is a correlation between the two, but not necessarily a causation. The relationship between equities markets and the real estate market are connected, but it is unfortunately not a static situation. 

That being said, investor sentiment undoubtedly has a role to play in the relationship. For example, when the net worth on paper drops due to a softening in the equities markets, people feel like they aren't as well off as they were before. This might change their decision to pull the trigger on moving up to a larger house or an investment property. Across the country, if this movement in the markets pulls enough buyers out of the market, we'll see less transactional volume, and prices could possibly decrease or flatten. However, there are many more factors to consider in this hypothetical situation when trying to find the change in prices. For example, if the equities markets were to dramatically appreciate, people might feel richer and more apt to buy deals. However, if the market was being flooded with new product, the two opposing forces would create a balance. The question would then be, which one will impact the prices that the homes trade for in the markets more?

When you start talking about multifamily, notes, refinancing, flips, and HELOCS, the more important characteristic of the market is interest rates. The interest rates that the market is charging will have a direct impact on these types of investments. The basis of the reason is that different types of investments are evaluated against what is known as the risk-free rate. For example, if your unleveraged return (cap rate) on a stabilized multifamily asset is 5% going in, and a 30-year bond is throwing off 3%, the question would become whether or not it's worth all the work and risk to take on the building for an extra 1% (ignoring other factors such as tax implications etc.). That 1% would be called the risk premium. As interest rates start to increase in the coming years, we'll see a softening of cap rates, which makes sense due to the risk-premium. As interest rates creep up, the spread of the risk premium will either shrink, or it will stay the same and the cap rates will move up. If they do, prices will fall.

Lastly, I would argue that the change in investor sentiment from equity market movements will be different for various major metros/markets. A place like San Francisco which has a lot of security due to job diversity might be different than Detroit which has felt great economic pain due to their previous reliance on one major industry.

This is just the beginning of a very complex conversation that can go deep into economics, but I hope this little bit of information helps you Armando !

Kenny Reimer