Wondering when the next recession will arrive?
Recessions don’t come out of the blue. There are a number of signs that signal when the next recession will occur, and learning to watch for these signs is an important part of the successful real estate professional’s job.
Readers of first tuesday have probably heard about the predictive power of the yield spread to forecast recessions one year in advance. A new report from the St. Louis Federal Reserve offers evidence that construction trends can predict yield spread inversions 12 months before they occur, thus giving investors even more advance notice — roughly 24 months — to prepare for the next recession.
The yield spread is a reflection of current economic conditions and future expectations, as interpreted by bond market investors and Federal Reserve economists. Each time this figure dips below zero (inverts), an economic recession is imminent, likely to arrive about 12 months after the yield spread inversion occurs.
Construction starts tend to begin declining roughly one year before a yield spread inversion takes place. The reasoning is that since construction is a long-term investment, investors think ahead several months and even years to what economic conditions will be present when the project will be completed. Therefore, when interest rates begin to rise in anticipation of a yield spread inversion and eventual recession, investors become more reluctant to start new construction projects.
Thus, watching construction trends is useful to real estate investors and professionals alike, as housing conditions tend to deteriorate several months before a recession occurs. In other words, when the yield spread inversion happens 12 months before a recession, important housing conditions have already begun to decline, impacting real estate agents, brokers and mortgage lenders.
For evidence, look no further than California’s declining home sales volume and prices in 2018-2019, a trend which has begun affecting agents and end users of real estate well ahead of the coming recession.
Construction and the economy in 2019
What do today’s construction trends say about the next recession?
Nationally, construction starts peaked in March 2018 and have since experienced a significant decline. The St. Louis Federal Reserve study notes this construction decline “appears to be in line with historical housing trends prior to yield curve inversions.”
In California, residential construction has also declined over the past several months, with single family residential (SFR) construction starts down 17% and multi-family starts down 7% from a year earlier in the six-month phase ending in March 2019.
At the same time, the yield spread began declining in 2017 and is hovering just above zero, at 0.17 as of March 2019. At this rate of decline, the spread will likely invert later this year, forecasting the next recession to arrive 12 months later in mid- to late-2020.
Real estate professionals who track construction trends alongside the yield spread will be given the foresight to shift their advice and business practices before changes in the market actually occur. By doing so they will be able to prepare to survive during the next recession by overproducing and saving earnings now, or seeking out recession-proof niches of real estate (such as real estate owned (REO) sales, or property management) in which to weather the coming economic downturn.