Is investment in companies in the real estate sector about to collapse?

The pandemic managed to bring out the best in investing in stocks in the global real estate market. Homeowners with more cash to spend, lower mortgage rates to pay, and a new freedom of remote work lined up to move on to bigger and better things. But there are finally signs that its form is starting to lose steam, as rising interest rates and slowing economic growth drag the market lower. The big question now is how quickly it could start to fall...

What are the signs that investment in real estate stocks is slowing?​

Prices are falling in the hottest markets ​

While housing market prices continue to rise in the US and much of Europe, they have begun to fall in Canada, New Zealand, Australia and Sweden, the countries that have had the most attractive markets in recent years. That suggests that investment in shares of companies in the real estate sector is losing steam as interest rates in those places rise and doubts grow about the health of global real estate markets. Over time, that could make buyers around the world more cautious, spreading the weaknesses more globally.

Indicators point downwards​⤵️​

In most of the world's major industrialized countries, three things have fallen recently: 

• The number of home sales.
• The confidence of the builders.
• Mortgage approvals. 

House prices tend to follow these early or leading indicators with a lag of a few months. Additionally, as we explained last week, weaknesses in the housing sector have a way of spilling over into the broader economy, which could add even more downward pressure on investment prices in real estate companies' stocks.

Investing in shares of companies in the real estate sector is becoming unaffordable羅​

Faced with higher home prices and higher mortgage rates, prospective buyers are finding it more difficult to purchase a home. In fact, many economists point to deteriorating measures of affordability, such as price-to-income and price-to-rent ratios, as evidence that prices have reached the territory of a bubble. In finance, when home prices are out of step with what people earn, we say they have become detached from their fundamentals. And we warn that the further they separate, the more brutal the potential reversal could be.

There is no balance between supply and demand in investing in shares of companies in the real estate sector⚖️​

This post-pandemic moment is a strange moment. High inflation and rising mortgage rates are taking a heavy toll on consumer budgets and slowing interest in investing in real estate stocks. Meanwhile, the pipeline of homes under construction has risen rapidly as supply chain disruptions finally begin to ease. And while there is still a housing shortage in most regions, a faster-than-expected rise in supply, coupled with a drop in demand, could lead investors to reevaluate their view and become more pessimistic about regarding investment in shares of companies in the real estate sector.

It's all part of the Fed's plan​

In the US, the Federal Reserve (Fed) has made it very clear that fighting inflation is its top priority. To achieve this feat, investment in shares of the country's real estate market has to be stopped. Not only because lower housing costs directly influence how inflation is calculated, but also because it will cool the rest of the economy: investing in real estate stocks is not only the largest asset class in the world. world, but also have a direct impact on credit creation.

So, is investing in real estate stocks going to crash?​

Deteriorating fundamentals and sour sentiment will clearly add downward pressure on real estate equity investment over the coming months, particularly in regions that experienced the biggest excesses. But even if prices fall, which most investors still don't expect, a repeat of the 2008 housing crash is unlikely because of three facts: (i) There are still very few homes available right now. Although more homes are being built, there are still fewer homes than buyers, and that should put a floor under prices, even if sentiment worsens. (ii) The housing market is healthier than in 2008. Lending conditions are much stricter, many fewer homeowners have rate-sensitive variable mortgage rates and the recent rise in prices has more to do with an increase of pandemic-era demand than a moment of pure speculation. In other words, no, we are not likely to see a collapse like we saw during the global financial crisis. (iii) Structurally, housing demand remains strong. More millennials are in their prime home-buying years, and permanent changes in working conditions, such as hybrid jobs, have been positive for prices. Furthermore, investing in real estate market shares is a very good hedge against inflation, and that is something that is not so easy to find. If that's not enough to convince potential buyers to buy, it's probably enough to keep some current owners from selling.

So, where is investing in shares of companies in the real estate sector heading?吝​

The most likely scenario for global real estate markets is that prices stagnate, or even decline, in the coming months. But good investors (like us) don't just look at the most likely scenario, we also look at the least likely ones. And if past crises have taught us anything, it is that the links between the real estate market, the economy and financial markets are not always evident. After all, few people expected mortgage-backed securities to wreak so much havoc during the global financial crisis. Today, new players like institutional investors may be the weak link as it is difficult to know how much they have actually borrowed and how deeply they are involved with investing in real estate stocks. So if you're wondering if it's a good time to invest a lot of time in real estate, or even if it's a good time to buy your dream home, our answer remains the same; No. The current downside is that we run the risk of more than offsetting our potential gains, so it's best to wait. We could make an investment in shares of companies in the real estate sector by selling short through an inverse ETF such as the ProShares Short Real Estate (REK) or short selling banks like Commonwealth Bank of Australia (CBA), Westpac (WBC), National Australia Bank (NAB) and Australia and New Zealand Banking Group (ANZ).

The best strategy remains to stay on the sidelines and be ready to shoot if a good opportunity presents itself. Not exactly the excitement of “Big Short,” we know. But as the late business legend Jesse Livermore said: