In the past in the mining industry, miners would carry canaries into the mines as an early warning against dangerous deadly gases. Signs of distress from the birds would indicate that conditions within the mine where unsafe. With the current economic expansion in its eighth year, are there early warning signs that the real estate market, particularly for high-end luxury homes, may be in for a correction? This economic expansion is one of the longest on record. Whether you’re buying, selling or developing, timing is everything in the real estate market.

As pointed out in an earlier article, since the Great Recession bottomed in 2009, luxury real estate around the world has experienced a phenomenal increase in value setting all-time records for volume, price per square foot and overall size of transactions. We’ve experienced this in Aspen as prices are again at record levels.  We also speculated that the health of the luxury real estate market may be closely tied to the health of the stock market, particularly for resort markets that seem to thrive during healthy stock markets.

By studying patterns prior to past real estate downturns, we might see signs that are replaying in the current market. Leading up to the Great Recession, the country experienced seven years of economic growth after the Dot.com crash and recession of the early 2000s. During the period from late 2001 too late 2007, there was an exorbitant rise in asset and housing prices. Even though the Great Recession started at the end of 2007, real gross domestic product (GDP) didn’t start contracting until the third quarter of 2008 when the shadow banking system, most notably Bear Sterns and Lehman Brothers, started collapsing as a result of the subprime mortgage crisis, something only a handful of economists and investors foresaw.   

Real estate markets that don’t fare well in a downturn have one thing in common, there is generally no constraint on supply leading up to the point where the demand ceases. Good examples of this in the last recession where Las Vegas, Miami and Phoenix. In all cases, there was a tremendous amount of development to the point of exceeding demand just before the market hit its peak. This led to a huge inventory overhang as the market slowed. The supply and demand equation took over when the demand side of the equation slowed dramatically and real estate prices plummeted.

In the current Aspen luxury home market are we starting to see a similar pattern? There have been roughly 27 sales of luxury homes in the Aspen-Snowmass market over $10 million in value in the past 18 months. Of those sales roughly 8 were spec homes delivered to the market in 2016 and the first half of 2017. Currently, about 120 homes priced over $10 million are listed for sale of which about 29 are new spec homes.

If we stopped delivering new homes to the market right now and absorption continues at its current pace, it could take three or more years for all new spec homes to be sold and four plus years for all homes listed over $10 million to be sold. If for some unforeseen reason, the absorption rate was to decline dramatically like it did in 2008-2009, those time frames could easily double. That could lead to significant downward pressure on prices at least for the over $10 million segment of the market. 

Most real estate market slowdowns start with a decline in overall volume and number of transactions. We observed this in the last recession. In the last quarter of 2007, the Aspen real estate market started to slow. The market continued to slow modestly into 2008 but hit the breaks in the last quarter of 2008 as the stock market started falling and the extent of the mortgage crisis started to show. Currently, the market in Aspen is the reverse of that pattern. In the first half of 2017, the overall market volume has accelerated with the overall volume and transactions running well ahead of 2016 similar to the pattern that unfolded in first half of 2007.

The other factor to keep an eye on for any early warning sign of a shift in the luxury home market is the overall health of the U.S. economy and the stock market. At this time, neither is flashing any obvious warning signs. The U.S. economy continues to grow at a slow but steady pace of 1.5% to 2.5% per quarter producing a respectable 200,000 plus new jobs each quarter. The stock market continues to set new records. However, a key measure of value, the P/E ratio, is also reaching all-time highs which is normally a signal that the stock market may be entering overvalued territory. At this time, there still doesn’t appear to be any obvious negative warnings that could impact the Aspen luxury home market; however, the first signs of a sea change will likely be a correction in the stock market or a slowing of the national economy. If we start to witness either or both of these events unfolding, it could be a warning sign that a decline in sales volume and number of transactions will follow.         

William Small, CCIM is the Founder and CEO of Zenith Realty Advisors, LLC, a commercial-investment real estate advisory and investment firm. If you’re interested in contacting him, you can reach him at (970) 925-3866 or by email at William.Small@ZenithInvestment.com