You bet, and I’ll get into what real estate investors need to know shortly, but let’s go through the following first.
We closely follow the real estate markets in the US and Canada. real Inheritance is a very slow-moving asset, and it’s not always that exciting. When we get our monthly rental reviews every month, it’s almost as boring as watching paint dry.
But any savvy investor knows that enduring and sustainable wealth is built over time and has huge payoffs down the road. This means that the rental properties will be paid off by the tenants in 10-20 years. House values will be 1-4x more valuable and it offers cash/income for life.
I invest in real estate and I think it’s one of the best long term investments outperforming the stock market considering the risk/volatility. But there are times when buying property isn’t so great, and 2022 is one of those years.
In a month, real estate fell 14.7% in parts of Canada and the US. In fact, the IYR real estate ETF was also down 15%, confirming this over the same timeframe.
Here’s some evidence from the town where Technical Traders Ltd. is resident.
My question to you is do you think it is wise to pay all time highs for a property or wait for another 15-25% correction before investing in a new home or rental property?
Overview of investments in 2022
The US stock market contracted sharply in early 2022 as traders tried to identify the risks associated with the US Federal Reserve’s rate hike. Behind the scenes, real estate investors and homeowners are under pressure from higher costs for almost everything. Gasoline, groceries, essentials, credit card interest payments—almost everything costs more due to inflation and rising fuel costs.
I remember back in 2007-08 when oil prices hit levels above 140 ppb and the seemingly high cost of everything just before inflation peaked and markets turned bearish. Then, much like now, a period of extreme speculation seemed to permeate buyers and investors across the US.
What broke this trend was the global financial crisis. As the economy began to unravel, excessive levels of credit/debt suddenly became uncontrollable for almost everyone. What seemed like a reasonable and manageable debt load was suddenly exaggerated when the US Federal Reserve hiked interest rates from 1.0% to 5.5% – a 450% hike.
Recently we saw the Federal Reserve raise interest rates from 0.25% to 1.0%. The Fed could soon start raising rates again to tame inflation. I don’t have a crystal ball, but it’s not hard to see how inflation, higher consumer costs, and increased debt service costs will cause many real estate investors to panic, especially after many years of ZIRP and low inflation.
Real estate investors and homeowners are burdened by higher costs & dwindling revenues
US investors are struggling to manage their finances as inflation and higher living costs continue to eat away at their extra cash. Remember what is happening at the consumer/retail level is often the canary in the coal mine type scenario that relates to broader economic trends. As consumers change their spending habits, news spreads quickly to other consumers about how economic conditions are threatening their future.
The extreme measures taken when COVID-19 hit in February 2020 helped many real estate investors and homeowners and consumers survive the extreme economic downturn that took place. Now that we’re past extreme measures, over the last 24+ months prices have increased by more than 25% for almost everything. Investors struggle to manage their monthly expenses while trying to enjoy their lifestyle.
A recent article citing former Federal Reserve Chairman Ben Bernanke suggests that the current Federal Reserve has waited too long to address inflation concerns. The steps needed now to tame inflation could be very painful in the future. I see this as a very clear warning to traders/investors to keep their assets highly liquid and reduce their risk factors.
Demand for new mortgages collapses as most real estate investors are priced out of buying homes
A sharp drop in mortgage demand suggests a collapse in consumer confidence and willingness to believe the economy will continue to grow. Warnings from the US Federal Reserve and signs that international market conditions are deteriorating rapidly are making US consumers and homeowners nervous – waiting for house and home prices to drop the next shoe (again).
Mortgage demand for real estate investments
The US Federal Reserve is on target for a rate hike of over 1100% for more than 4 months – the fastest in recent history
The US Federal Reserve has continued to point out that further rate hikes are needed to tame current inflationary trends. By many conservative estimates, the US Federal Reserve is targeting a level of 2.0% or above. These extremely aggressive targets would represent the fastest and potentially largest rate rise in recent history in percentage terms.
The next time the Federal Reserve hikes rates by 0.50%, that would mean a rate hike of over 1100% in just 90 days. Rates soon moving to 2.0% or higher will represent a rise of over 1500% over 4 to 5+ months.
Source: St Louis Fed
Extreme post-COVID speculation wave can have extreme consequences
Inflation and many other economic problems are suddenly the focus of central banks and real estate investors around the world. News that China’s house price levels are falling further could be a very clear sign that China/Asia has peaked ahead of the US and other global markets. Except for a brief period from 2004 to 2008 (see chart below), we have never seen anything quite like the surge in global house price levels.
Investment property prices
Source: St Louis Fed
This rally ended with the global financial crisis. Home prices fell almost -20% from the peak in Q1 2007 to the low in Q1 2009. If history repeats itself, US home prices for real estate investors will fall more than -20% to -25% as history can repeat itself.
The US stock market may not follow asset prices lower when the economy shifts
I urge you to consider how capital works in a changing global market environment. Capital is always looking for the best and most opportunistic tools for future gains and protection from risk. Even as markets turned down in 2009, the US stock market bottomed well before other assets bottomed. The same type of scenario could play out over the next 12 to 24+ months.
If my reading of market conditions is correct and the Federal Reserve is looking to raise interest rates further to mitigate inflationary tendencies, it is likely that various asset classes including real estate, ETFs and individual sectors will (as we are now seeing) de-risk and will continue to do so may turn into future opportunities. What has been overvalued in the past can turn into an incredible opportunity as capital is reallocated to sectors/trends that offer opportunities for future returns.
Current market trends present incredible opportunities for traders/investors who are able to protect capital, recognize and understand the risks and opportunities that unfold and time their investments/trades in the markets correctly.
In today’s market environment, it is imperative to evaluate your trading plan, portfolio holdings and cash reserves. Experienced traders know their downside risk and adjust when necessary. Successful traders manage risk by using stop-loss orders, rebalancing existing positions, reducing portfolio holdings, liquidating investments, and investing in cash.
Managing risk and expectations in both real estate and stock market investments is key to long-term success. By doing this, you can avoid the rollercoaster of doing nothing to protect your investments.
Successfully managing our drawdowns ensures our trading success. The greater the loss, the more difficult it becomes to make up for it. Consider the following:
- A 10% loss requires an 11% gain to recover
- A 50% loss requires a 100% gain to recover
- A 60% loss requires an even scarier 150% gain to simply break even again.
The recovery time also varies significantly depending on the size of the drawdown. A 10% drawdown can typically be recovered within weeks or months, while a 50% drawdown can take years to recover.
Depending on a trader’s age, they may not have the time to wait for recovery or the patience. Therefore, successful traders know that keeping their drawdowns reasonable is crucial. Most of them learned this principle the hard way.
Editor’s note: The summary points for this article were selected by Seeking Alpha editors.