Understanding consumer financial behavior is essential to any type of business, but even more so to the real estate business, which is the first to drop and the last to grow during economic cycles. The reason behavioral knowledge and insight is so important is because the link between consumer financial anxiety, consumer behavior and the real estate market is very strong and significant.
Research shows that consumers’ financial anxiety fluctuates based on present or anticipated economic conditions. Thus, consumers modify their financial behavior relative to the four stages of an economic cycle: growth, decline and two transitional periods in between. Since the economic cycle repeats itself, and since consumers react to such economic changes in the same basic pattern, we can identify consumers’ specific behavioral orientation during the different stages of the economic cycle. These behavioral orientations are defined as Behavioralogy – the science of financial behavior.
The most relevant and significant behavioral orientation to the real estate market is the “Castle Craze”. As soon as the economy improves and starts to show meaningful signs of growth, consumers return to their favorite “sport” — bigger and better homes. The Castle Craze behavioralogy is about consumer fascination with bigger, better and nicer homes the moment they feel that the economic storm is over. Clearly, real estate, specifically the primary residence property, is very appealing — not just from a practical perspective of a place to live and for investment reasons, but also as a statement of status and achievement.
Many of us are very familiar with the real estate boom and bust that occurred during the early to late 2000s. So I am going to skip the whole story about who did what and why in regards of mortgages, securitizations and everything else that is related to the rise and fall of the real estate market in the last economic cycle. Instead, I would like to focus on the behavioral aspect of the period prior to the collapse of the real estate market to demonstrate the Castle Craze behavioralogy orientation.
The main factor in the Castle Craze behavioral orientation is the amount of money consumers spend on their homes, in terms of building supplies and gardening equipment during good economic times, compared to other types of spending. To demonstrate the Castle Craze behavioral orientation, I selected the four-year period prior to the actual start of the Great Recession, from February 2003 to March 2007. Keep in mind that although the official start date of the Great Recession was December of 2007, the actual decline in the economy started about six months prior to that because it takes two consecutive quarters of negative GDP to declare an official recession. Thus, the actual decline in economic activities started in the second quarter of 2007.
I compared the percentage increase in total retail sales between February 2005 and March of 2007 with the percentage increase in building and gardening supplies during the same time period. I am sure you are familiar with the phrase “high tide lifts all ships,” which is only half true in this case. In this case, the robust economy during the early and mid 2000s lifted the sales of building and gardening supplies much higher than it did other categories of retail sales. While total retail sales during this four-year period increased by a substantial 26.4 percent, the percentage increase in building and gardening suppliers was 37.9 percent — a difference of 11.5 percent.
The enormous increase of nearly 38 percent in retail sales of building and gardening supplies, compared to other retail areas, is a clear indication of consumers’ infatuation with building, improving and enhancing their homes during periods of economic growth and low levels of financial anxiety. Needless to say, this craze died right after the economy started declining in mid 2007, and although the real estate market is showing some signs of recovery at this time, mid 2013, it is very far from where it was during the growth years prior to the Great Recession.
It is also important to indicate that the growth figures in sales of building and gardening supplies are retail figures only and do not include large wholesale purchases of building materials used in the development of large housing and commercial complexes. Thus, the increase in retail sales of building and gardening supplies during the four-year span we discussed earlier accounts for purchase by individual consumers and small contractors working mostly on smaller building or renovating projects.
Will we see another cycle of Castle Craze behavioral orientation down the road? Yes, of course. This was not the first, nor is it the last, economic cycle we are going to experience, and once the economy starts growing again, we will witness the same type of behavioral orientation repeating itself. Why? Because, as we discussed earlier in the book, human nature never changes, only circumstances do. Just as soon as the level of financial anxiety decreases and consumers feel more confident about the economy, they will be thrown back to building and remodeling their castle that was “neglected” in the last few years since the beginning of the Great Recession.
The Castle Craze behavioral orientation is a very important indicator for almost any type of business, retail and financial. The reason is that real estate has the highest economic multiplier among all other products and services. This means that when the real estate market starts growing, it impacts a very large number of other products and services associated with homes and gardens such as building materials, furnishings, appliances, gardening equipment and many other products and services related to building and maintaining homes.
The link between a lower level of financial anxiety and a higher level of building materials is very good news for the financial industry, because when the Money Anxiety starts declining, it means that consumers will start seeking mortgages for new homes, refinancing of existing mortgages, or home equity lines of credit or loans to finance the improvements they want to make in their homes. Thus, financial and banking professionals should keep a close eye on the Money Anxiety Index for signs of consistent decline in the level of consumers’ financial anxiety, which is going to trigger the Castle Craze behavioral orientation.
All in all, when the Castle Craze behavioral orientation is taking place, the economy is going to greatly benefit from the financial boost it provides to many industries. As long as the financing side of the Castle Craze is done responsibly, Castle Craze behavioral orientation is highly desirable and a major contributor to economic growth and prosperity.