Economics
The Problem with REITs
February 7, 2025
The United States of America is one of the most developed countries in the world. It is also known for having the most transparent market system in the world. Since many economies in the world are so integrated with American economies, a movement in the American markets has ripple effects all across the globe.
This fact became more evident in 2007, when a local real estate crisis in the American markets became a crisis of global proportions and threatened to bring the financial system of the world to a grinding halt! The study of real estate markets would therefore not be complete unless the recent history of the American markets is understood.
In this article, we will describe the two major boom bust cycles that the American real estate sector has witnessed since the 1980’s.
Stage 1: The Bust
The American real estate market was witnessing a bust from the 1980’s onwards. This bust was created by the Savings and Loan crisis that was present in the markets during this period. Prior to 1980’s, most of the homes being purchased in the United States were being purchased as a result of money borrowed from these Savings and Loans institutions.
However, in the 1980’s the Fed realized that inflation was slipping out of control. As a result, Paul Volcker who was leading the Fed at that time increased the interest rates to as much as 20%! This interest rate hike almost wiped out the savings and loan industry as they were not able to attract new capital at these rates. Also, the number of people who would borrow at this rate to buy a home went down significantly bringing a crash in the real estate market.
The savings and loans crisis ended up creating what was then what was one of the lowest points in the history of United States real estate. However, by then the people had no idea as to what was in store for them later!
Stage 2: The Manufactured Boom
The 90’s were spent recouping from the savings and loan crisis. The savings and loan institutions had become insolvent. However, some of the other financial institutions were also under severe financial duress. Hence lending activity was low. The government enacted various laws to increase the lending and particularly the lending to the real estate sector.
Legislations like the Communities Reinvestment Act were created with the intention of increasing lending to the minority community. Soon, the political motive of the fulfilling the so called “America Dream” took over all rationality. The politicians were adamant on creating policies that would enable more people to buy homes. The long term implications of these policies were simply not thought through.
What followed is known as one of the largest boom periods in American history. This boom was largely enabled by the rock bottom interest rates i.e. close to 1% that was prevalent in the United States at that time. To add to this, banks were instructed by law to lower their lending standards to ensure that they are able to make as many loans as possible!
As a result of all these activities, the real estate market found itself flooded with buyers who suddenly had a lot of money are were willing to buy properties that always seemed to appreciate in value making their owners rich.
This boom in the American real estate industry lasting from the late 1990’s to 2007 was created as a result of the policies of the American government. As a result, it is often called the manufactured boom.
Stage 3: The Crisis
The year 2007 created one of the biggest financial crises that the world had ever seen. This crisis had its roots in the American real estate industry. The manufactured boom that was created as a result of the government policies soon became a manufactured crisis. This is because once again, fearing inflation, President Alan Greenspan had to raise the interest rates in the economy.
This increase in interest rates created an unprecedented crisis called the subprime mortgage crisis. The increased interest rates led to the monthly payments of mortgages going up. Many homeowners could not afford their increased mortgage.
As a result, the houses had to be foreclosed. The declining value of the houses created a scenario of excess supply wherein the prices were contracting even further.
During this bloodbath, almost all of the markets in the world were adversely affected.
However, the worst hit was the American real estate market which had lost almost half of its value!
Stage 4: The Post-Crisis Market
The United States real estate market has been healing post the depression that hit it in 2008. However, the healing has been slow. The drastic drops that were witnessed by the real estate market are now being replaced by a steady rise.
However, the good news is that this time, the government intervention in the market is minimal and neither is this moderate growth being driven by insanely low interest rates.
There are some critics that point a finger towards the Quantitative Easing policies being followed in the United States for the steady rise. However, nothing can be conclusively said as of now.
To sum it up, the United States real estate sector has a history of ups and downs. Real estate is far from the steadily and predictably rising investment class that many people make it out to be. In fact, it is almost as risky as other investment (if not more)