The housing crisis that began in 2008 was a perfect storm for the economy that resulted in the greatest financial dislocation since the Great Depression. However, many safeguards have been put in place to keep this from happening again. Here is why real estate investors can invest in the market with confidence.
The crisis was caused by real estate overextension, but it’s not quite that simple. Banks lent too much money to risky borrowers. Everyone had an incentive to keep pushing these loans out the door without too much scrutiny of whether the borrowers could pay the money back. When housing prices started to drop, it accelerated the damage because much of the market was predicated on the assumption that prices would continue to rise. The more borrowers defaulted, the worse the crisis became.
The economy goes in cycles. There are times of boom that are followed by times of bust. This makes recessions inevitable and part of the business cycle. However, the long-term growth of the economy has been stable and steady. The job market, which is an indicator of a coming downturn, has remained strong. Other leading indicators, such as the stock market, do not show that a recession is on the way.
New standards were put in place after the housing crisis to prevent a repeat from happening. Current Expected Credit Losses is a standard that changes how losses are accounted for by requiring losses to be estimated over the course of the loan. Changes to the individual review process under CECL should help lenders more accurately judge whether or not a loan is likely to go bad. This will lead to more conservative accounting by lenders that should prevent a recurrence of the sudden deterioration that sparked the last credit crunch.
While real estate has its ups and downs, the decline last decade was an extreme anomaly. The steady population growth in this country, combined with a limited amount of space and housing stock means that there will always be some demand for real estate. Commercial and residential real estate have been shown to slightly outperform the rate of return that you can get by investing in stocks.
While the real estate bust in the Great Recession scared many investors, it should be viewed as an opportunity to get into an underappreciated market. There are new safeguards in the marketplace and enduring demand that will keep the market steady.