Relationship Between Stock Market & Real Estate Prices

by Patrick Gleeson, Ph. D., Registered Investment Adv

The hardest kind of economic relationship to identify is a causal relationship -- one, for example, in which a rise in the stock market causes a rise in real estate prices. In general, economists content themselves with establishing a correlation -- that a rise in one market correlates with a rise in the other. The exception is the subprime real estate market meltdown in 2007. Most economists agree that a bursting U.S. real estate bubble directly triggered a collapse of the stock market.

A Weak Negative Correlation

CXO Financial Advisory Group did a comparative analysis of U.S. real estate and stock prices from the mid-1960s through 2010. It concluded that changes in home prices prior to 1990 did not generally correlate with contemporaneous changes in stock returns, but that changes since then suggest a negative correlation with a four-year lag -- i.e., that a rise (or fall) in stock prices correlates with a fall (or rise) in real estate prices four years later.

Other Studies

Other studies come to slightly different conclusions. A study of U.S. markets from 1972 to 1998, "The Causal Relationship between Real Estate and Stock Markets," led by John Okunev, found a positive correlation that began with a change in stock market values. Seven other studies of the subject referenced in the Okunev paper were divided as to whether the weak noted correlations originated in an integrated market -- that some sort of causality was involved -- or whether the apparent correlations were accidental phenomena in segmented markets.

Gyourko and Keim

The most influential of the academic articles cited by Okunev is "What Does the Stock Market Tell Us About Real Estate Returns?" by Joseph Gyourko and Donald B. Keim. The authors note that a significant part of the value of corporations in western economies is real estate. They propose that changes in real estate values affect corporate valuations, which are reflected in stock values -- that the markets are integrated.

The Subprime Meltdown

In 2007, a long U.S. real estate boom ended with the abrupt collapse of a $400 billion bond market in subprime real estate mortgages. Banks had made low-interest "teaser rate" loans to under-qualified buyers. When these expired, interest rates on the loans jumped as much as 300 percent. Borrowers defaulted. Investment banks, such as Goldman Sachs, had bundled these loans into groups and sold them to banks, pension funds and foreign investors, both as securitized bonds and as "synthetic" bonds. The latter didn't hold actual mortgages, but simply tied their values to bonds that did -- a legal way of selling the same thing several times over. This multiplied the severity of the collapse, immediately taking down the entire U.S. housing market. The stock market quickly lost about 60 percent of its value, and the Great Recession of 2007 to 2009 followed. In this instance, causation seems clear: A failure in the subprime U.S. real estate market spread to the U.S. stock market and then to the entire economy.

About the Author

Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.

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