What Is an Economic Downturn?
In addition to GDP, financial institutions (such as the Federal Reserve) and economic analysts recognize economic downturns by watching for the following behaviors in different areas of society:
- Labor market: A rise in the unemployment rate
- Stock market: A consistent fall in Wall Street
- Housing market: An abundance of supply, otherwise known as a buyer’s market
- Government: Increased government borrowing, often caused by more benefits spending and lower tax revenue.
What Causes an Economic Downturn?
To understand what causes an economic crisis, it’s important to examine what determines economic confidence. The subjective nature of economic confidence can make it tricky to pinpoint, but economists try to quantify it by looking at various objective factors, such as:
- Employment and wages: Jobs and pay rates affect people’s discretionary income and therefore influence spending and confidence. Loss of income decreases purchasing power.
- Inflation: Higher prices for goods and services stifle spending and erode confidence.
- Interest rates: Purchases made on credit are especially affected by interest rates. Higher interest rates may cause delays in spending on high-priced items (e.g. houses, cars, luxury goods, travel) which has a trickle-down effect on other goods and services.
- National events: Elections and governmental policy changes can sway confidence and buying habits on both a personal and industrial level.
- Global events: Wars, unrest, health crises, foreign relations, and tariffs all affect confidence and spending as well. For example, a financial crisis within countries that supply oil can cause domestic gas prices to skyrocket, which can then increase the prices of other consumables and decrease overall spending.
What’s the Difference Between an Economic Downturn and a Recession?
In generally-accepted macroeconomic terms, a recession includes two or more consecutive quarters of economic decline. Once that happens, the NBER will label the downturn as an official recession. But because the NBER looks at pinpointed data from many economic indicators, they will sometimes declare a recession before two quarters have passed. Still, to be considered a recession, the nation’s economy must experience a marked decline that can be tracked for more than a few months.
Often, these economic conditions are a precursor to a recession. For example, in the Great Recession (also known in the United States as the 2008 Recession), housing and financial markets started to take a downturn as far back as February 2007 when Freddie Mac announced it would no longer work with risky mortgages. The markets fluctuated over the next months (meaning recession had not set in yet); in fact, the stock market hit an all-time high in October 2007. However, by looking across the various markets mentioned above, economic experts concluded that a long term recession was on the horizon. Eventually, the true recession began in 2008 with American households losing about 20% of their worth.
Recessions can occur on a national or global level. Nations each measure and monitor their own GDP, while the IMF (International Monetary Fund) keeps tabs on the global economy. National recessions, especially those experienced by major world powers, can precipitate global recessions. For instance, the Great Recession in the United States impacted global economies heavily in 2009, though individual nations experienced the downturns to varying degrees.
Will the Coronavirus Pandemic Cause an Economic Downturn?
For more information—and tips for real estate investors—check out our guide to Recession Prep 101: Investing in Real Estate During a Financial Crisis.
What Happens to Real Estate During an Economic Downturn?
Though real estate remains generally stable during downturns, the 2008 financial crisis led to home prices falling 33%, proving that even the housing market is not entirely immune to economic distress. However, experts point to the Great Recession’s direct connection to subprime mortgages and subsequent foreclosures as an explanation for the anomaly.
Great Recession aside, investing in real estate during an economic downturn can be a good strategy if prior economic downturns are any indication. The following investment considerations present a positive scenario regarding real estate investments during an economic downturn:
Investment income: Real estate income in the form of rental payments can provide stability during a season of economic uncertainty. Even during the Great Recession, the single family and multi-family rental sector fared well.
Limited fluctuation: While the stock market may be volatile during an economic downturn, the housing market remains stable for the most part. Investors who rely on dividends may experience hardship due to losses in the stock market, while those who depend on rental income can actually raise rent (during lease renewals) to account for inflation.
Growth over time: Real estate supply will likely grow during an economic downturn, which means that investors have more purchasing options. However, this may not be the season for quick flips. Instead, investors can ride out an economic downturn by focusing on rental income. By waiting to sell until the economy recovers, real estate investors can experience profitable growth over time.
Economic downturns are a natural part of the economic cycle. Because the housing market tends to remain stable in comparison to other markets, vigilant and savvy real estate investors need not worry too much.