If California slid into the sea, would it take the U.S. housing market with it?
After a few years of real estate boom, which spread dramatically higher prices to many (though not all) parts of the U.S., the market has recently seemed to change course. On Thursday, the U.S. Census Bureau reported that housing starts were down 7.9 percent from January to February and had declined 4.8 percent from February 2005, indicating less demand for new construction. That came three days after the National Association of Realtors predicted that this year would bring "a more level playing field for buyers and sellers on the heels of a five-year sellers market."
This won't be a crash, but a soft landing for the real estate market, it appears. But that made us wonder: What would it take to make things really go off the rails?
War, pestilence and natural disaster have always been bad news for human civilization; that would seem to suggest that they are bad for home sales as well. While conflagrations like World War II and economic declines like the Depression are rare, they do happen — as do lesser versions of conflict and crisis.
We talked to a number of experts about hypothetical events that could send the U.S. real estate market into a skid, from highly unlikely scenarios such as a military confrontation with China, to the types of predicaments we have faced in recent years, like natural disasters and terrorist attacks.
Turns out, there are lots of ways to hit the housing market.
"Prices will certainly plummet if we have significant loss of house buying power," says James W. Hughes, dean of the Edward J. Bloustein School of Planning and Public Policy at Rutgers University.
Higher interest rates that make mortgages more expensive, an employment decline that results in loss of income, or an increase in the costs of other goods (think oil) can all divert money from real estate.
"Anything that throws the economy into recession will throw the real estate market into recession," says Susan M. Wachter, professor of real estate, finance and city and regional planning at the Wharton School of the University of Pennsylvania.
A truly dramatic plunge in the real estate market could be precipitated by a crisis, whether economic, natural or, as in the case of war, man-made, that lasted.
"It's the long-term impact stuff we have to worry about," says Delores Conway, director of the Casden Real Estate Economics Forecast at the University of Southern California Lusk Center for Real Estate. An earthquake may be devastating, but if it only lasts a day the market can recover. A prolonged economic crisis can have a far more profound effect.
What about wars abroad, or concerns like bird flu, nuclear ambitions in Iran or conflict in Israel? In some cases, such as with Hurricane Katrina, what can be devastating to one region will have no impact — if not even a positive effect — on other areas.
"SARS in Asia is very negative for the Asian market and real estate in the markets where it occurs," she points out. "But it has no negative impact on the U.S. A beneficial impact is that it might, if anything, draw capital to the U.S. and lower interest rates." An increase in the threat of war could have the same result, as investors seek a safe harbor for their money.
On the other hand, a meaningful outbreak of avian flu in the U.S. would probably have a strongly adverse impact on the housing market, especially if it struck a major population center. Robert J. Shiller, an economist at Yale University and author of the book "Irrational Exuberance", which predicted the 2001 stock market bust and was recently updated to include real estate bubbles, notes that housing prices in the U.S. were on the decline in 1916. But a serious drop took place at the same time as the 1918 flu epidemic. "World War I and the flu were kind of coincided," he says. "It looks like that had a huge hit on housing prices — they were down 40 percent in real terms from 1912 to 1920."
But Shiller believes that the biggest potential market shifter is far less tangible than a tsunami, interest rate spike or other newsworthy event. "I think that most likely what would cause a big drop in real estate would be a change in public thinking," he says.
In October 1987, when the Dow Jones Industrial Index fell more than 22 percent in one day, nothing in particular seemed to be happening, he says. But investors had been adopting a new strategy called portfolio insurance, which meant there were large and sudden sell-offs when the market dipped. "It got everyone really primed to sell," he says.
The real estate boom in Florida in the 1920s collapsed partly because of the 1926 hurricane, which killed scores of people — but also because newspapers around the country started describing people who were buying land they had never seen, or that was under water.
Despite potential nightmare scenarios, though, for the most part, the economists and experts we spoke with seemed convinced of the overall resiliency of the U.S. housing market. As Wharton's Wachter points out: "Natural disasters are bad news, but not necessarily for real estate."