Whether you’re looking to buy a home or invest in real estate, it’s essential to understand what a recession is and how it could affect the housing market. While it may not be possible to prevent recessions from occurring, there are steps you can take to protect yourself from their effects.
This article will discuss what a recession is and the signs that a recession may be happening. Learn how recessions affect different parts of the economy and gain tips for protecting yourself from financial stress during a downturn. Wrap up with an outlook for the economy in the coming years.
Defining a Recession
A recession is commonly seen as a period of economic activity decline that occurs when the gross domestic product (GDP) falls for two consecutive quarters or more.
However, that definition is not the only measure of a recession. For instance, the National Bureau of Economic Research (NBER) measures a kaleidoscope of macroeconomic factors, from retail sales to industrial production, to decide if the economy is in a recession.
No matter what, to be classified as “in a recession,” the impact must be felt across the economy, not just one sector. For instance, if oil and gas production is down, but retail sales are up and wages are growing, that’s not a recession.
During a recession, businesses often experience decreased demand and profits, leading to layoffs and reduced wages. Consumer spending can decrease as people become less confident in their financial situation. These impacts often last long after the recession is declared over and can have lasting implications for individuals’ finances and decision-making.
Another interesting aspect is that there are different kinds of recessions. When the economy shrinks but prices rise, it’s an inflationary recession. These are tough to handle because interest rates and unemployment often rise. When prices fall as the economy slows, it’s a deflationary recession. These usually have lower interest rates because the government is trying to encourage spending to get the economy to grow again.
Like the real estate market, the economic cycle experiences periods of expansion and retraction. The NBER Business Cycle Dating Committee maintains a chronology of data points measuring the cycles. How long these periods last isn’t set in stone. The previous expansion lasted 128 months, from June 2009 through February 2020.
Various factors, such as a significant drop in the stock market or a banking crisis, can trigger economic contraction. Signs that a recession may be occurring include GDP declines, increased job losses, and declining consumer spending.
We know this from past recessions, like the Great Depression and the Great Recession of 2008. The Great Depression was triggered by economic and banking crises that caused the GDP to drop 10% and unemployment to hit 20%. The Great Recession in 2008 was a global financial crisis where the real GDP fell by 4.3%, and unemployment peaked at 10%. A primary catalyst was the American housing market collapse spurred by predatory lending practices, causing a financial crisis whose impacts on the housing market persisted for a decade.
The most recent recession is unique in that its roots were in a global pandemic, something economists had not experienced before.
Economic watchdogs are constantly scanning key indicators for what is happening in the market to better predict and prepare for the future. One measure that economists tend to rely on is the inverted yield curve, which has signaled ten US recessions since 1955. A normal yield curve has short-term investment yields lower than long-term yields. When the yield on longer-dated bonds decreases and shorter-term bonds go up, the inverted curve is created. However, even this measure isn’t foolproof, as not every period of inverted yields translated to a recession.
Due to the frequent changes in the economy and lags in reporting data, it can be hard to see when a recession has started and when it is over until some time has passed.
Interestingly, the NBER said the economy experienced its shortest recession on record in April 2020. The global pandemic brought on the two-month slump, with international economies hitting the brakes.
How Recessions Impact Our Markets
Understanding how recessions affect different parts of the economy is important so you can prepare yourself financially.
Recessions usually lead to lower personal incomes as more people are out of work and wages decrease. People may work fewer hours due to economic downturns, reducing their incomes even if they are still employed.
Employment is a crucial aspect of how recessions impact the economy. Most recessions see higher unemployment rates, reducing consumer confidence in spending. This is important because lowered spending trickles across the economy. With fewer people at work producing goods and the pullback in personal expenditures, it shrinks the GDP and exacerbates the recession.
Goods and Supply Chain
Reduced production makes goods and services typically more expensive during a recession. People are spending less, so there’s less demand for those goods. Exports decrease. Raw materials tend to increase in cost because of less manufacturing activity.
Businesses incur increased costs associated with unemployment benefits. Additionally, the economic downturn can cause supply chains to be less efficient and more costly as companies try to save money.
When people are less confident about their financial situation, real estate markets can suffer due to decreased demand for homes and other properties. This can make selling a home more challenging because fewer buyers are on the market. Inventory can increase as there’s less buyer demand, which further impacts appreciation gains. Home values often grow less during recessions.
Conversely, buyers can be challenged to purchase a home because the interest rates are too high or there’s not enough inventory at their pricing level. Rising unemployment and stagnant wages often accompany recessions and impact a buyer’s confidence in making a large purchase like a home.
Other aspects of the real estate industry are also affected, such as mortgage originations, new construction, and home renovation.
Investors become more cautious about investing in risky assets like stocks. Companies struggle to maintain profitability, and the pullback in buying drops their stock prices. This impacts portfolios and pension plans heavily invested in the stock market, making them less valuable and profitable.
While stocks may dip during economic downturns, remember that stock markets can also experience periods of economic expansion and recovery from the effects of a recession.
In a deflationary recession, slower economic growth means that the prices of goods and services may not increase as quickly, leading to lower inflation rates. Borrowing interest rates tend to fall in an effort to encourage spending. This can benefit individuals and businesses, as it may mean that prices for some goods and services remain affordable despite a significant decline in production.
However, in an inflationary recession, the opposite is true. Inflation rises, so goods and services become more expensive, resulting in a pullback in spending from businesses and individuals.
Protecting Yourself In A Recession
Economists recommend maintaining an emergency fund, reducing debt, and increasing savings to protect yourself from the effects of a recession. It’s always a wise idea to live within your means. Stay informed on economic trends and monitor changes in interest rates set by the Fed.
Diversify your investments. Consider “recession-proof” assets, which are traditionally stable investments and income-producing during a recession. Real estate tends to be one of the “recession-proof” classes, but only for certain property types. The location also matters in real estate, as properties in areas with stable job growth are more shielded from market swings. Other options historically performing well in recessions include gold, treasury bonds, and annuities.
When you do invest, think about long-term performance rather than short-term gains. Rather than look at your portfolio daily or weekly, review the performance over time, such as monthly or quarterly. Make decisions based on data and not gut feelings.
It is possible to stave off recessions or at least reduce their length and economic impacts, although economists disagree on the best methods. In the US, the Federal Reserve sets the government’s fiscal policy. Some past measures the US government has taken that seem to assist with mitigating the impact include unemployment insurance and dropping the federal interest rate.
Generally, economists suggest that central banks and financial institutions should use expansionary monetary policy by increasing interest rates to control inflation and stabilize the economy.
Additionally, governments can encourage economic growth by investing in infrastructure projects and providing tax relief for businesses that ease their expenses.
Long-term Impacts of Recessions
Even though a recession can be officially over, it can take time for the economy to heal fully. Unemployment rates tend to remain higher for months after the so-called end of the recession because businesses are still conservative about hiring or raising wages. The reduced income can impact a family’s ability to save, provide quality education or healthcare, and prepare for retirement.
The earning power of young professionals entering the workforce during a recession can also be reduced, which impacts when they make major life decisions, such as buying their first home.
Consumer spending often lags as it takes time to rebuild their confidence, which delays the economic recovery.
U.S. Economic Outlook
Usually, the government’s response to a recession is to stimulate investment by cutting interest rates. That hasn’t happened in this most recent recession because of rising inflation, signaling we are in an inflationary recession. Instead, the Federal Reserve raised the interest rates seven times in 2022.
The outlook for the economy in the coming years is ambiguous due to high levels of uncertainty surrounding global trade and political tensions. Overall, experts see the US economy entering a period of economic recession in 2023, with most economic indicators showing that the GDP growth rate is slowing.
As of early 2023, the Federal Reserve is expected to raise its base interest rates again, although many experts believe this strategy is reaching its culmination. The rates are expected to level off or maintain through 2023. What will happen largely depends on if inflation stabilizes.
Some analysts are concerned that the economic recovery could be vulnerable to potential economic shocks, such as increased trade tensions or a long-term financial slowdown.
The real estate market has experienced dramatic impacts from rising inflation and mortgage rates. Buyers put the brakes on their purchasing plans as borrowing and housing prices became more expensive. Homeowners opted to stay in place unless they absolutely needed to move. That further put pressure on the low inventory across the nation—however, the need for housing remains, which is sheltering home values from significant losses in appreciation.
Despite this, economists are generally optimistic about long-term economic prospects as many countries have taken steps to support their economies through government programs and stimulus packages. A stabilizing market should help the housing market, as mortgage interest rates should follow in kind. As buyers and sellers adjust to the new normal of higher lending costs, inventory and sales pace should increase.
Diversifying into real estate can shore up your financial future against recessions, as it tends to perform better in the long term than other markets. With data-backed decisions and careful planning, it is possible to weather a recession successfully. And real estate investors can find opportunities during recessions with great deals on properties owners need to offload.
Understanding how recessions work can help you protect your finances and prepare for the future. By keeping informed of economic trends, maintaining an emergency fund, and reducing debt, you can ensure that you are financially prepared for periods of economic downturn.