While the real estate market has been a near sure-fire investment in recent years, rising rates, inflation and recession risks are reshaping the investment landscape. In the latest episode of Exchanges at Goldman Sachs, Jeff Fine, global head of Real Estate Client Solutions and Product Strategy, and Nora Creedon, an investor in our private Real Estate business in Goldman Sachs Asset Management, look at how the new macro realities are creating new risks and opportunities for investors.

Date recorded
August 31, 2022

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How Inflation, Rates, and Recession Are Reshaping the Real Estate Market

The real estate market has always been influenced by various economic factors, but recent trends in inflation, interest rates, and recession have put a significant strain on this sector. These factors are reshaping the landscape as homebuyers, sellers, and investors grapple with changing conditions.

One of the most significant factors impacting the real estate market is inflation. Inflation refers to the general increase in prices over time, reducing the purchasing power of currency. As inflation rises, so do the costs of construction materials, labor, and other resources involved in real estate development. Consequently, the rising costs make it more expensive for developers to build new properties, and these costs are often passed on to the buyers.

Inflation can also affect homeowners and their investment. While rising asset prices in a strong real estate market may initially benefit property owners, inflation erodes the value of fixed-rate mortgages. As the cost of living increases, homeowners may find themselves struggling to keep up with mortgage payments, leading to an increase in defaults and foreclosures.

Another critical factor that is reshaping the real estate market is interest rates. Central banks often adjust interest rates to control the economy’s growth and inflation. When rates are low, borrowing becomes more affordable, increasing the demand for real estate. However, when rates rise, borrowing costs go up, and this can deter potential buyers and investors from entering the market.

Higher interest rates also impact the rental market as landlords may face higher borrowing costs, which can restrict their ability to invest in rental properties or maintain affordable rents. Higher rates can also lead to a shift in the behavior of real estate investors who may turn to other investment options offering higher returns, potentially reducing demand in the real estate market.

Recession, which refers to a significant decline in economic activity, can also have substantial effects on the real estate market. During a recession, job losses and income reduction can lead to a decrease in demand for real estate, particularly in the residential market. Decreased demand can result in a surplus of properties, causing a downward pressure on property prices. Moreover, the uncertain economic environment during a recession often leads consumers to delay home purchases, further dampening the market.

The effects of a recession can also be felt in the commercial real estate sector. Businesses facing financial difficulties or closures may downsize their office spaces or terminate leases altogether. This can lead to higher vacancy rates and decreased rental income for commercial property owners.

In response to these challenging market conditions, both buyers and sellers must adapt their strategies. Potential buyers might need to lower their price expectations or explore different mortgage options to mitigate the impact of rising interest rates. On the other hand, sellers may have to be more flexible in setting their prices to attract buyers in a more competitive market.

Real estate investors need to carefully evaluate their risk appetite and diversify their portfolios to account for the volatility and potential downturns associated with inflation, interest rates, and recession. Exploring alternative investments or geographic areas that may be less influenced by these factors could be a viable option.

In conclusion, inflation, interest rates, and recession are shaping the real estate market in various ways. Higher construction costs, increased borrowing expenses, and reduced demand during recessionary periods are all contributing to a changing landscape. Both buyers and sellers need to be mindful of these factors and adjust their strategies accordingly to navigate the evolving real estate market.