How Recessions Affect Expensive and Cheaper Houses
Recessions have varying impacts on different segments of the housing market. While it is often believed that cheaper homes are less affected by economic downturns, research and real-world observations suggest that the more expensive housing market can actually suffer more during recessions. This article explores this concept, examining the reasons behind these impacts and providing insights into how recessions differently affect high and low-priced real estate.
The Myth That Cheaper Houses Are More Resilient
It is commonly assumed that cheaper homes, which often cater to a broader range of buyers, are more resistant to economic downturns. However, recent data and historical events challenge this notion. In many instances, the more expensive market is the one that experiences higher volatility during recessions. This is due to the sheer amount of disposable income that is involved in buying luxury properties, which can evaporate with greater ease during tough economic times.
Factors Contributing to the Different Impacts
Several factors contribute to the differential impacts of recessions on different housing price segments:
Economic Savings and Investments
One of the primary reasons is that the purchase of a more expensive house often requires a significant portion of an individual's savings and investments. During a recession, disposable income and the value of investments are likely to decrease. This means that high-end buyers who have allocated more of their assets to real estate may experience higher financial stress as their wealth diminishes.
Mortgage Collateral and Capital Flows
High-end properties often serve as collateral for large mortgages. When the economy falters, these mortgage loans become riskier for lenders, who may call in these loans or make it more difficult for owners to refinance or sell. This effectively reduces the secondary market liquidity for expensive properties, leading to lower prices and increased distress sales.
Consumer Confidence and Luxury Spending
The luxury housing market is significantly influenced by consumer confidence. During recessions, consumer confidence tends to plummet, leading to reduced spending on luxury items, including high-end homes. This can result in a dearth of buyers in the high-end market, driving down prices and increasing vacant inventories.
Examples and Real-world Observations
To illustrate this point, consider the following scenarios:
Less Expensive Homes Are Less Impacted
Take, for example, the analogy of cars. In a recession, it stands to reason that old sedans would be less affected than new luxury cars. The key reason is that sedans, which are often more affordable, can be purchased with a smaller portion of one's disposable income. While people might still drive, they are less likely to purchase new, expensive cars due to economic constraints. This principle applies to housing markets as well: lower-priced homes have built-in buyers, and the primary determinants impact affordability rather than investment or luxury.
Regional Variations and Unique Scenarios
It is important to note that the impact of recessions on the housing market can vary significantly depending on the region and its economic context. For instance, if a local plant closes down and the area becomes economically depressed, higher-end properties may face a more severe decline. Alternatively, in areas with high concentrations of high-income residents or a robust financial services sector, lower-priced homes might be more affected. During the current upturn in my area, low-priced homes have seen a larger percentage increase compared to high-end properties, highlighting the region-specific nature of real estate market dynamics.
Moreover, it is crucial to recognize that some recessions do not significantly impact the real estate market at all. Economic cycles are inherently complex, and the effects can vary greatly based on the unique circumstances of each recession and local market.
Conclusion
The impact of recessions on different segments of the housing market is multifaceted and varies based on the complexity of economic conditions. High-end properties often experience more significant price swings during recessions due to the larger amount of disposable income they represent. However, it is essential to consider regional and economic variations when analyzing the real estate market during an economic downturn.