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]

Real estate investment in 2008 in the USA seems bleak at first look. However the scenario will not play out as long as players in the market stick to their core business. It is imperative that real estate and property investors begin to become cognizant of the fact that land and building investments are not for the short term. These are long term investments for much more reasons than one.

Primarily it seems that there might be an increase in capital gains taxes; this could surely prevent the quick sale of property and hence force investors to hold on to real estate for longer than one year. As the demand for property remains at a virtual standstill, the supply continues to increase as investors scramble to sell properties before they incur losses. This coupled with record setting foreclosures in most states in the USA leads to a major downturn in prices.

A bump up in capital gains taxes would alleviate this ongoing pressure on supply. That being said many real estate agents still see this as a buyers market. Though many investors get caught up in the jargon of when the market will bottom out, there is a clear difference between capital gains and cost to replace. If you can find the cost to replace a property, then you have an idea of what is its bottom price. Capital gain really is just your profit, which is the difference between what you sold the property for and what you paid for it.

A simple explain is your profit and or loss in the transaction. Once you can ascertain the replacement cost and match that to the sale price then you can actually find what the bottom price is. This means if you find a property that the sale price is below the replacement value then it’s a sure buy and hold.

California real estate had recently faced a major problem as it pertained to actual replacement values and sale prices. As real estate prices in California plummeted it seemed that there would be no end in sight as foreclosed property prices fell below replacement value.

Yet it seemed strange that no buyers were snapping up the market. The problem of draw downs had reared its ugly head. The draw down in real estate is really how low the investor can go. Lets take for example a property is purchased for USD$250,000 and within 6 months the property falls to USD$175,000 due to the sup prime mortgage crisis. The investor might be inclined to sell and cut his/her losses. However if the investor holds the draw down of USD$75,000 remains and when the price begins to go up then they continue to hold recover the losses and wait until they begin to see a substantial profit.

Hence real estate in the USA is now a buyers market – the key equation is sale price = < replacement value.