Since the Global Financial Crisis (GFC) in 2008, one thought came to mind for almost everyone – ‘Can property prices be actually correlated to the stock market?’. This is especially due to the fact that the global stock markets were on a downturn as a result of the subprime mortgage crisis in the United States. As such, that brings us to the purpose of this article: to examine if there is indeed a direct relationship between the stock market and real estate prices.
This issue is one that has been a hot topic and constantly studied by analysts, academics and research institutions alike. Should there be a direct relationship, therein lies the opportunity for investors to actually forecast the outcomes of either factor, should anything happen to them.
However, based on our findings, there are actually several variations on the nature of their relationship, ranging from an insignificant relationship to a rather blatant one. Nevertheless, we have identified and analysed for you the two different theories provided by experts and academics: whether it is minimal or a strong relationship between them.
Theory 1: Minimal relationship between the two
Firstly, we acknowledge the fact that there are several academic journals and researchers who claimed that there is little relationship between the two factors. According to CXO Financial Advisory Group who did a comparative analysis of U.S real estate and stock prices ranging from the mid-1960s through 2011, any changes in home market prices bear no correlation to the changes in stock returns of the Standard & Poor (S&P) 500 Index.
They claimed that over time, even when both factors generally depict an increase in values, the rate of increase for property prices were smoother and steadier than stock market returns, and on that account, bears no direct evidence that there is a correlation. This could perhaps be due to the different mechanisms and operations of how real estate and stock markets work respectively.
Simultaneously, to further investigate the conclusion of CXO’s, we also look into other studies of this topic. A prominent paper titled ‘The Causal Relationship between Real Estate and Stock Markets’ produced by John Okunev, instead claimed that there is a positive correlation between the two. However, seven other studies of the subject which were referenced in the paper were actually found to be divided about whether there was even any correlation at all, and even if there was, it could actually be attributed to the accidental market circumstances for the respective segmented markets.
However, that’s only for the US market!
Graph 1: U.S House Prices vs S&P 500
Graph 2: Singapore House Prices vs Stock Market
As indicated by Graph 1 above, we can indeed make an inference to back the claim of CXO Financial Advisory Group: house prices and the stock market returns depict a general rise in prices, but there is no evidence that there is a direct relationship between the two. However, on a local scale, if we were to look at Graph 2 which actually depicts residential property prices of Singapore and its stock market, we can observe that there is a degree of correlation between the historical trend of the two factors. As such, I bet this pops a question in your mind of ‘Why is there a difference?’
Theory 2: There is a strong relationship between the two
Henceforth, we decided to further look into other research journals and research articles pertaining to this topic. We aimed to find those especially who inferred that there exists a strong direct relationship between property prices and the stock market performances. A study by the University of Piraeus (that studied the US and UK markets), Lund University (that studies this topic but with regards to China), and the National University of Singapore’s Institute of Real Estate Studies (IRES) which studied this relationship on a global level – have all indicated that there is indeed a moderate to strong relationship between the two.
In order to simplify our findings for you, the summarized respective findings based on the research sources are as follows:
• University of Piraeus
The two markets are rather integrated and especially increased when the securitized real estate markets are considered.
• Lund University
The relationship between the two markets in China was weak, but it strengthened during and after the financial crisis. The financial crisis somehow played an important influential role between the two, attributing to governmental policies.
• NUS IRES
There is a moderate correlation between the individual pairs of real estate and stock markets. However, both markets (on an individual basis) become more correlated in times of high volatility (as indicated by the GFC situation and the Asian Crises in 1997 and 1998)
Combined, these findings have attributed their findings of a strong correlation between real estate prices and the stock market due to 4 factors: interest rates, inflation, governmental policies and the growing trend of real estate securitization.
Evaluation of the 4 factors
It is imperative to note that the first two factors are ones that generally affect both stock markets and real estate prices. It is as simple as this: for interest rates and inflation, the higher it is, the higher the costs of purchasing a specific product and vice versa. As such, to say that there is indeed a correlation between the two markets would be a mere superficial assumption.
This applies to governmental policies as well, but there is an extra underlying factor for this – investor sentiments. For instance, in the period of post-financial crisis in China, the government introduced a ‘four trillion’ stimulus package where the biggest portion (about 38%) of the funds was used for public infrastructure, and the second biggest portion was allocated, on a tiered basis, to reconstruction works and rural development as well as technology advancement programmes. This effort did not just make a significant positive influence on housing price, but also to the stock market as investors felt that it was a strong indicator that the economy was bound to pick up.
Notwithstanding that, a similar trend can be seen in the US. During the post-financial crisis, the government’s $700 billion ‘Bailout Plan’ was successful in stimulating its economy. By methods such as lowering the key federal fund’s rates, and purchase of impaired assets from big banks; investors’ sentiments were suddenly optimistic and confidence was regained. As such, the stock markets recovered greatly, as with a surge in demand for housing prices as well. However, still, to say it is correlated would be a weak assumption because the government stimulus package was to help the economy, whatever the sectors, collectively.
However, there is an ever-increasing rise of securitized real estate products such as Real Estate Investment Trusts (REITs) and Mortgage Backed Securities (MBS). Listed on the stock exchanges, in this matter, there is a definite correlation between property prices and these aforesaid securities. The reason being is simple, these securities own and manage a specific portfolio of real estate properties. As such, the performance of their properties, of course, directly affects their returns. In terms of their share prices on the stock market, investors’ sentiments of the real estate market, in turn, affects it as well due the nature of their operations.
Even at this point of time, studies are still ongoing to investigate the relationship between real estate prices and stock market returns, with varying results. However, we believe that there is a weak relationship between the two and that you have to look at them as two different, separate assets. The only time where it is indeed highly proven that they are strongly correlated is when the real estate prices are being compared against a real estate securitized product such as a REIT or MBS.
That is the extent of the correlation between the two factors, although it is important for us to keep our minds open to any further research or studies that can provide a reasonable and sound explanation between them in the future.
Article by Jo’An Tan, Associate Director, Redbrick Mortgage Advisory
Armed with a local degree with a major in Economics, Jo’An embarked her career in the world of secured lending with her previous roles in SME Banking at leading banks for this segment; UOB and OCBC.
Her extensive job scope included commercial and industrial property financing, issuance of LC and business term loans. This has allowed her to confidently embrace the processes involved in the mortgage industry at Redbrick.
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