Real estate has always been a profitable investment for people who have long-term plans for wealth generation. Still, as a real estate professional, you need to understand how the economy works and keep a pulse on the real estate cycle. This way, you can help identify possible triggers and make informed decisions to mitigate risks and increase profitability. The goal is to position yourself wisely in whatever phase of the cycle. Knowledge and insight about real estate cycles can help you stay ahead of your competitors. Let’s take a look.
Phase 1: Recovery
The recovery is the initial phase after a market pullback or recession. You can expect high vacancy rates and low demand for housing. Still, it is an excellent opportunity to buy real estate properties because of their low prices. You may find it challenging to identify this phase because it will seem like the real estate market (or the country in general) has not pulled out of recession yet. The most recent recovery phase that you may have experienced was between 2010 and 2015.
Signs of Recovery
- Flat home sales and leasing, and slow upward growth for property sales and rentals
- Fewer construction projects
- Declining or steady at low-interest rates
- Depression, panic, and fear are prevalent emotions but will be more hopeful and decisive as the market recovers
Opportunities During the Recovery Phase
- Investors can borrow to invest or refinance a property because of low-interest rates, but there may be restrictions on bank lending after a recession.
- They can search for value-add real estate investments to sell at a higher price during the next cycle.
- Identifying the recovery stage earlier provides a better chance of earning high profit in the future.
Dangers of the Recovery Cycle
Any market and any investment will have risks, especially when the country is recovering from a recession. However, investors can mitigate the purchasing risk because they can buy properties with hefty discounts. They need to practice due diligence for each acquisition, which means they shouldn’t just purchase real estate just because of its low price. They need to crunch the numbers.
During the recovery phase, rental rates are low, and vacancy rates are high. Current property owners will feel comfortable holding and staying put. They must have the cash to tide them over during this time and wait for the market to improve.
Phase 2: Expansion
The expansion phase is the time that the market experiences growth and recovery. The nation’s GDP is back to normal levels, housing has a balanced supply and demand, job growth is stable, rental rates are on the upsurge, and construction starts to boom again. There is public confidence that the economy is looking up, and people are spending their money again. During this phase, there is high investor activity.
Signs of Expansion
- Significant increase in leasing and home sales, and rapid rising of rental and housing prices
- Construction is on the upswing, as well as flipping in the single-family market
- Modest increase or stable interest rate
- GDP is back to its healthy level
- Consumer sentiment is that of excitement, confidence, and optimism
Opportunities During Expansion Phase
- Banks loosen their lending criteria as interest rates remain low
- Refinancing is an excellent option because of increasing housing prices
- Investing in other properties using a value-add strategy is another alternative
Dangers of the Expansion Stage
Overextending has a higher chance through leveraging. You can advise your clients not to incur too much debt. They must be confident that their investments will be profitable regardless of the real estate cycles. Prices go up toward the end of the phase, and properties that rely on price appreciation may experience hardships.
Phase 3: Hyper-Supply
The hyper-supply phase is the tipping point to oversupply. More properties are up for sale, but there are fewer buyers. This scenario results in lower prices, and construction slows down because market inventory is high. Rental rates are high, but there is decreased demand. Interest rates, GDP, and job growth remain stable. You can expect the prices to be at their peak, right before the market declines.
Signs of Hyper-Supply
- The supply of housing exceeds the demand that causes the prices to drop
- Rental housing demand also decreases, but rental rates maintain their high prices
- Market sentiment is that of overconfidence because the people believe that high growth, rental rates, and prices will continue
Opportunities During the Hyper-Supply Phase
- Perfect time to sell the assets that have gained equity
- Excellent opportunity to purchase a stabilized real estate property for long-term cash flow
Dangers of the Hyper-Supply Stage
Waiting for the perfect time to buy or sell real estate can be risky. Some investors may sell their properties because they can feel a market decline. They may hold onto their money for months or years before the next recession occurs. On the other hand, waiting too long to sell is another mistake. Your clients may think that the prices have not peaked yet. They fail to realize that it’s challenging to cut losses when the market is on its downward trend.
Not recognizing the warning signs and overconfidence are two of the prevalent problems that investors may face. Some well-informed investors can sell their properties or invest in stable assets to tide them over the next downturn. This phase is the most difficult to purchase real estate because the prices are too high (cap rates too low).
Building new construction when there is decreased demand is problematic because it contributes to the oversupply. Investors who are into property development may find themselves in a difficult situation.
Phase 4: Recession
The recession stage occurs because of over-inflated growth. The market is declining because new construction, rental demand, jobs, and prices are plummeting. Defaults on credit cards, loans, and mortgages are also increasing, as well as unemployment, business closures, and foreclosures. Real estate prices are at their lowest in this cycle.
Signs of Recession
- Rapid decrease in rental rates and housing prices due to reduced demand and increased supply
- People halt their spending as they save their money because of panic
Opportunities During the Recession Phase
If you are liquid and have capital, you may be looking to buy real estate because prices are low. You can invest in value-add, non-performing mortgages, short sales, REOs, and other distressed sales.
Dangers of the Recession Cycle
Your clients may not have enough liquidity or capital reserves and sell their real estate even at rock-bottom prices because they need the money. They don’t have stable assets, capital, or liquidity to tide them over through the recession.
It’s challenging to determine the exact cycle that the market is experiencing. Some economists say that the average real estate cycle spans 18 years, with mid-stage recessions through the cycle. Others believe that it’s impossible to time the market, and investors lose money anticipating or preparing for corrections. Other people use specific indicators to time the market, but if they don’t have a firm understanding of the real estate cycles, they may discover themselves in a bind.
However, you can apply the framework of market cycles to influence your investment strategies, but it’s not a walk in the park. Timing the market is very challenging, and it pays to be informed.
If you want help with analysis and valuation, you may want to try Money Weighted, a web-based investment modeling software. With this software, you won’t have to use Excel to run the numbers to find out if an investment property will be profitable or not.