Will A Stock Market Crash Hurt Real Estate?

The Real Estate Espresso Podcast

Will A Stock Market Crash Hurt Real Estate?

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Will A Stock Market Crash Hurt Real Estate?

Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce. As real estate investors, we need to be paying attention to many aspects of the economy. After all, we are investors first and real estate investors second. Our investments do not occur in isolation. They’re influenced by the surrounding environment.

If the stock market rises, how does that affect real estate? If the stock market crashes, how does it affect real estate? Well, on today’s show, I’m going to predict a stock market correction using history as a guide and predict the impact on the economy as a whole, and in real estate in particular.

A stock market correction, that is, a decline of 10 percent or more from recent highs, can trigger or accelerate an economic downturn through several key factors. Number one: there’s the wealth effect. When stock prices fall, households with investments feel poorer, and they often reduce consumption. Today, it’s the top 10 percent of households that account for a disproportionate percentage of consumer spending. That’s especially important in places like the U.S., where there’s a high percentage of the population that hold equities. A 10 to 20 percent drop in household wealth could lead to a significant reduction in spending, particularly on durable goods and services.

Number two: it affects the cost of capital and corporate investment. Falling stock prices make it more expensive for companies to raise equity. Investor appetite for declines in initial public offerings and secondary offerings often dry up. As valuations compress, corporate managers cut back on expansion plans and capital investment. It forces them to use more debt which decreases operating profitability. Financial markets act as barometers of future expectations. A sustained correction often signals, or is interpreted as signaling, trouble ahead. Both consumers and businesses become more cautious, which can transform a market correction into a real contraction.

Next is counterparty risk. Financial systems are linked together, like hedge funds, margin accounts, financial institutions, if they face margin calls, they might be forced to liquidate positions. For example, we’ve seen, many times, that after a correction, the price of gold tends to drop, because people liquidate their gold to cover their margin calls.

But not every correction results in a recession. For example, in October 1987, Black Monday saw a huge stock market sell-off, with a loss of 15 percent in a matter of days. Despite the massive volatility, the events in 1987 did not trigger a recession, mainly because the Fed injected a massive amount of liquidity into the system, and banks covered the equity loss with debt.

Then in 2000, the dot com bubble led to a significant collapse in market values, wiping out trillions in market value and severely damaged investor confidence. Several major companies lost large portions of their value over that two-year period. The stock market correction of 2000 is widely credited with precipitating the 2001 recession, which was further amplified by the attacks of 9/11.

So, why the talk of a stock market crash? We’ve heard the argument, “This time it’s different.” But history has shown us that we need to exercise caution whenever massive infrastructure investments outstrip actual revenue, even when there are actual earnings behind the so-called tech boom.

A lot of the revenue we’re seeing associated with artificial intelligence, for example, is from capital investments within the AI economy, not from revenue from the real economy being injected into AI. We need to make that distinction. So, when we tally up the few companies that are actually making money off of AI, the numbers look good, but they’re massively dwarfed by the infrastructure investment that’s already been made, even when you take future growth into account.

What’s even more worrying is that the debt funding is starting to shift towards AI infrastructure, and this is a major warning sign. If there’s a pullback in debt as a result of this heavy emphasis on AI, it could result in a reduction in liquidity that would affect all industries, including real estate. So, as real estate investors, we have to consider the impact of a stock market crash on our investments.

As you think about that, have an awesome rest of your day, go make some great things happen, and we’ll talk to you again tomorrow.