Written by David Thompson
Real Estate Market Cycles: What are they and how do they work?
Have you ever met someone in the real estate investment business that just seems to have the ‘gift’? They never seem to miss a beat, land all the right deals and are in all the right markets at the best times. There is an aura about these people that we know, and that is what we as investors look to achieve. It is that confidence that we wish to have one day in everything we touch. There is a secret to these investors that I must share. The way they develop this persona is through education! Relentless dedication to educating themselves in their chosen field. Two educational aspects that real estate investors need to learn is how to analyze markets and understand real estate market cycles. If you can gain a solid understanding and education through both practical and theoretical learning of these two topics, you will be able to skate to where the puck is going.
What Is the Real Estate Market?
Breaking News “THE REAL ESTATE MARKET HAS JUST CRASHED!!! US HOUSING IS SEEING ITS DARKEST DAYS AND REAL ESTATE OWNERS HAVE LOST IT ALL” (In Bakersfield California). Don’t we hear this type of thing time and time again but fail to read the fine print or are not told the whole story. The first thing that causes chaos in this circumstance is a lack of understanding as to what ‘The Real Estate Market’ means and implies. So, what is the ‘The Real Estate Market’? The ‘Real Estate Market’ is where buildings and land are bought, sold and leased. This all sounds great, but how many niches are there that make up real estate again? Almost endless.
For example, when I refer to the ‘real estate market’ I am talking about B class multi-family apartment properties in A and B areas. This is where I’m focused. Some other investor may be focused on single family rental properties in certain submarkets of their towns that are gentrifying. My point is that everybody’s ‘the real estate market’ is completely different. Along with this, your real estate market depends on where your real estate market is. My real estate market in Dallas, Texas may be booming, but over in other markets they may be in a slow recovery or dipping into a recession if they are dependent on one downtrending industry. So the next time somebody uses those 4 words ‘The Real Estate Market’ ever so loosely, ask them what market they are talking about. You may be surprised ! Now we know what the market represents, let’s dive in a little deeper with reference to cycles within the market.
The Four-Cycle Phases of Real Estate
The real estate market is known to be cyclical, meaning that it flows in cycles. Think of the real estate market like the seasons, where the only difference is the market may go from spring to summer to winter in a month. Winter may be here for Jon Snow, but what if it were to stay winter for the next 5 years. This is what makes the real estate market hard to predict, as consistency can be elusive. Real estate does move through four key phases in its cycle and then repeats again and again. These phases consist of Recovery, Expansion, Hyper Supply and Recession. The graph below depicts the movement of this market cycle but understand that there is no actual starting point in the cycle.
At this stage, the market is in recovery mode, where the market is no longer falling out of the sky. The market is now beginning to move in an upward direction and is where you can really maximize on getting good deals for low prices. Buy low and sell high remember. There are many telltale signs of this phase, such as high yet stabilized unemployment, fear throughout the general population (evident all over the news) and large numbers of home foreclosures. All you will hear is things from most people will be things like “Real estate isn’t safe”, “there is too much risk right now”, “I wouldn’t do that if I were you”, “My friends, brothers, cousins, sister lost it all because of real estate”. Follow your education, be smart and don’t listen to those cynics who know it all because their financial planner is now an expert in the negatives of real estate.
Real estate confidence is back and growing. At this stage you will see many signs of expansions such as; the rise in home prices (due to a decrease in supply and increase in demand), businesses are deciding to expand by buying more commercial real estate and adding employees. As a result, you will see real estate developers building more and more properties to keep up with demand. This will still be a good time to find deals, but you will have to do more work to find them. You will also want to tread with caution during this stage, as investors that are hunting appreciation type investments will be circling like sharks, and inevitably pushing prices higher and higher.
Hyper Supply or ‘the beginning of the end’ is the phase where all you hear on the news or from people that real estate is an investment you should get into. This period is made up of astronomical real estate prices, mass building projects and everyone wants some skin in the real estate game. This phase is all about the domino effect of overpaying for land, buildings, and construction.
During the expansion phase, more construction is seen to accommodate the increase in demand, but once an equilibrium of supply and demand is met the real action begins. Because of the slow nature building takes during the expansion phase, supply will slowly overtake demand, vacancies will rise and the countdown to game over begins. You will hear a lot of people talking about making great fortunes and vast amounts of money during this time, which anyone can do in a bull market. Remember, real money is made at the lowest points, so recognize this phase, do not get tempted in, be patient, stick to your numbers and your real estate education.
And just like that everyone is screaming ‘TIMBERRRR’!!! The large abundance of development projects that were looking prosperous in phase 2 and 3 now vacant and unable to sell, creating a dive in prices. Homeowners are now going under, as are investors finding it difficult to pay off mortgages with a decrease in rent and rises in vacancy.
On the other hand, this can be an exciting time for real estate investors, but caution MUST be taken. Educated investors will be waiting patiently for supply to slip below demand and pounce on great deals, whilst also helping to save their local economy. It was these small and large investors all over America that saw this as an opportunity, where no one else believed in real estate in the Great Recession that played a role in saving the US economy.
It is important to gain a grasp on and learn about the aspects of market analysis and cycles to some extent. Even for me personally where most of my work and business involves syndication, I still take the time and feel confident that I can analyze a market to invest in and understand what is occurring in the current real estate cycle of different markets. I do not believe that anyone can predict 100% what the real estate market or any submarkets will do, but by educating yourself, you will be able to recognize market trends, make choice to minimize your risk and build some incredible wealth. So, let me know what type of market you think we are in right now, and what direction are we going towards? Maybe you are looking to invest in a city or submarket that is going through one of these cycle stages. Leave a comment and let’s discuss your thoughts.