“Will Real Estate Prices Drop if the Stock Market Crashes?”

This is a question has been asked a lot lately. There is an online debate titled “Homeowners vs. Renters.”

This debate led to an interesting discovery. Regarding the unprecedented monetary easing which began in 2013, the renters’ side predicted a rise in stock prices, while homeowners, anticipated asset inflation in condominium prices. As someone who wasn’t particularly interested in stocks, the correlation between monetary easing and stock prices was a surprising revelation.

The Long-Term Correlation Between Stocks and Real Estate

There is a clear correlation between the amount of money in the market due to monetary easing and stock prices. Similarly, there is also a correlation between monetary easing and real estate prices. Since surplus funds tend to flow into both stocks and real estate, the two appear to be correlated. However, this may be a case of hindsight bias.

Certainly, there have always been a number of people who aim to buy homes using profits from selling stocks. When stock prices temporarily fall, these individuals may cancel or postpone their home purchases. While this does represent a decrease in buyer demand, its impact on the real estate market is limited. That’s because the number of such buyers is relatively small, and sellers can often respond by simply extending their selling timeline.

At the Tokyo Stock Exchange (TSE), daily trading volume is around 5 trillion yen, with the number of transactions exceeding tens of millions. In contrast, real estate transactions number only in the hundreds of thousands per year. As a result, price fluctuations in real estate are naturally smaller, and short-term volatility like that seen in the stock market doesn’t exist. The correlation between stocks and real estate exists only over the long term—there is no direct or immediate correlation.

Real estate prices only decline when the amount of capital flowing into the real estate market decreases. Since World War II, there have only been three major periods of decline in housing prices: the collapse of the bubble economy, the financial Big Bang, and the Lehman Shock. The reason prices fell during these times is that developers supplying new housing experienced funding shortages and went bankrupt. Stock prices may have also declined during those same periods, but that’s simply because overall capital supply was shrinking.

When a developer goes bankrupt, land under development is sold—under the direction of banks—to other companies in the same industry. At which point, the land is sold at prices low enough to allow the acquiring company to turn a profit. As a result, the prices of new condominiums temporarily fall.

What a Market Downturn Reveals About the Conditions for a Collapse

Incidentally, while the price declines from the post-bubble collapse through the financial Big Bang were significant, the situation during the Lehman Shock was different. New property prices fell by about 20%, and existing property prices dropped by around 10%. In the case of existing properties, prices declined by 10% within a year, but then returned to their original levels in the following year.

What this tells us is that for new property prices to fall significantly, developer bankruptcies are necessary. On the other hand, owners of existing properties are individuals who would have to declare bankruptcy if their mortgage balances exceed the sale prices. Because of this, existing property prices tend to be more resistant to decline.

A broad drop in condominium prices would mean the bankruptcy of many developers and individuals. Unless that happens, prices will not fall below land acquisition costs. It’s important to understand this. And we should ask: who would be in a position to pull that trigger?

After the bubble burst, a widespread sense of falling future property values led corporations to rush to offload large-scale land holdings, such as factory sites. Since they believed prices would only fall further, selling quickly seemed like the smart move to avoid losses.

As a result, land acquisition costs fell, and new property prices declined as well. Falling new property prices then rippled into the existing property market. Owners of existing condominiums facing unrealized losses often choose not to sell in order to avoid bankruptcy. In effect, they become unable to sell.

Looking ahead, a key issue is whether we will see a downturn similar to the post-bubble collapse. There are several conditions that would need to be met for that to happen. First and foremost, there must be a widespread sense that real estate prices will decline in the future. If that sentiment takes hold, the number of land sales may increase.

However, the supply of large plots of land suitable for condominium construction is very limited. As for land for single-family homes, over 60% of vacant houses are effectively being used as storage rather than being sold (according to the 2019 Survey on Vacant Home Ownership by Japan’s Ministry of Land, Infrastructure, Transport and Tourism). Despite the rise in the number of deaths, the amount of land being put up for sale is actually decreasing.

While there is a possibility real estate prices could fall due to a loosening of supply and demand, the probability of that happening is currently low.

Will New Condominium Prices Not Fall?

On the contrary, there is a high possibility where prices will continue to rise going forward. Even amid rising interest rates, the amount of funding supplied to real estate developers is increasing. This is because the real estate business is one of the few industries which requires active borrowing even when interest rates rise. Since developers use these loans as capital to purchase land, land prices are soaring. In addition, construction costs are skyrocketing due to increases in material and labor costs. Since these combined factors determine new condominium prices, price increases are inevitable.

As we have seen so far, condominium prices are driven by new construction prices. With new construction prices rising, existing condominium prices inevitably follow suit. Without being misled by stock market fluctuations, it is essential to carry out a well-planned real estate strategy to avoid mistiming the market.

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