Blue Paper – The Correlation between the Stock Market and the Real Estate Market

Between 1990 and 2000 many schools of thought cited that real estate market was neither positively nor negatively correlated and in fact had little or no effect on the US economy. The premise of this theory did have merit as during the 90’s many claimed it was the manufacturing sector which was the main driver for economic growth during the period.

However we disagree strongly. In essence we examined why both must be related especially in such a heavily invested market as the USA real estate market. Mortgage related companies that are listed on the stock exchange NYSE or are in the DJIA (Dow Jones Index) are not the only companies that feel the pinch of a weakening real estate market. But it does signal some trouble on the market. It must be said however that a deeper analysis on the incomes of these companies must be done to truly see a correlation. This leads us to believe that though both are positively correlated, one is a trigger.

First the real estate market is typically reactive and the stock market proactive. When the New York Stock Exchange or the Dow Jones Industrial Averages are booming then many investors turn to the mortgages market to park their hefty returns. This leads to increased demand and invariably an increase in the cost of properties. This phenomenon is evidenced even in the UK as property prices continue to steadily rise. However when the market comes crashing down then investors who were in real estate begin to cover their losses by liquidating real estate and property held mortgages and liens driving the prices down.

Empirical evidence can be found in the Japanese stock market and the Japanese real estate market where once the stock market crashed in 1985 and the real estate market followed unwinding by more than 60% in values and 23 years later in 2008 can still not fully recover. Even closer to home is the 2001 NASDAQ crash in the stock market led to a drop in real estate values by twenty to thirty (20% – 30%). Yet during this time not many investors threaded carefully. However many US based investors and European investors bought into UK mortgage companies, lending them money through Mutual Fund companies and collecting hefty returns.

Again the bottom of this market fell out as it began to unwind in July 2007 in the sub-prime mortgage crisis and to date the fully consequence of that dilemma has not been brought to book for many companies. To be fair however there are other factors that can precipitate a real estate market crash:

• The Federal reserves move to tighten liquidity increasing interest rates led to parking and a slow down in the building market without reaching any market equilibrium. Leading to higher mortgage rates and more foreclosures.
• Rising petrol costs and other inflationary pressures postponed the middle class man from purchasing property whittling demand
• Lack of Government regulatory legislation allowed collusion between property developers to price each other out of the market driving down prices of existing homes.

The stock market unwinding is just a trigger, real estate vales would have passed sustainable levels based on speculative demand and now the real estate market has collapsed under its own weight.

[tags]correlation between real estate and stock market,stock market crash,Masdaq crash 2001,Japanese stock market[/tags]