Understanding The Detail Of Real Estate Market Cycles
We all know that the real estate market fluctuates between highs and lows, between periods of stability and instability, but few people realize that there is a real estate market cycle. This cycle rolls from state to state on an ongoing basis. Understanding where we are now, and where we’re going, and predicting how the market will react is a great way to make a serious profit.
What Are Real Estate Market Cycles?
The real estate market is primarily driven by the people within it and the overarching economic conditions. The overall economy and the real estate market are inextricably linked. One directly influences the other in both ways. Typically when one is buoyant, so is the other. The same can be said when markets are in a depressed state.
As with all economic systems, the real estate market is cyclical, meaning it runs in a cycle that, in this case, has four distinct phases. These phases affect all kinds of real estate; residential, commercial, and even industrial. Those four phases are known as recovery, expansion, hyper-supply, and recession.
This cycle has been part of the economy for almost a century. It has been regularly used by investors and analysts to understand the current state of the market, and what it might be like in the coming period. It becomes a very real part of their real estate investment strategy.
Interpreted correctly, investors can gauge what returns might look like when investing in a new property and whether it is the right time to make the investment. Those who already own property are also able to make use of the cycles to better understand where their current investment lies. Homeowners can leverage the information to their benefit to maximize their sale value.
The Four Real Estate Market Cycle Phases
The real estate cycle was first studied in 1933 by American economist Homer Hoyt, who discovered that the real estate business cycle lasted an average of 18 years. Despite this, recent research indicates that real estate cycles are too unpredictable to establish a precise time frame due to the numerous variables that can affect the cycle.
External economic factors and governmental policies can directly influence the cycle, either shortening or extending phases (or the whole cycle) accordingly. Recent influences have included the 2008 Great Recession, rapid periods of inflation, Brexit, the COVID-19 Pandemic, and the war in Ukraine.
If you were to study the previous cycles over the last century, you’d notice that whenever there was a sustained period of expansion and hyper-supply, a recession has always followed. That, in turn, is followed by recovery, and the cycle replays again.
The real estate cycle’s recovery phase marks the beginning of the cycle following a recession. Identifying the recovery phase, which is characterized by low occupancy rates, weak demand for housing, limited new development projects, and flat rental growth, can be difficult because many people are still feeling the effects of the previous recession and have a negative outlook.
The real estate cycle then transitions from recovery to expansion. The general economy improves during the expansion phase, with strong job growth and increased demand for housing and space. Occupancy rates are rising, rental prices are rising, and the number of new property developments is increasing. As people regain confidence in the economy, this market boost leads to increased investment activity.
Next comes hyper-supply. The hyper-supply phase of the real estate cycle is characterized by an oversupply of properties in the market, which causes price declines because demand cannot keep up. Rental rates may remain high during this phase due to circumstantial economic factors, but vacancy rates rise as market inventory rises. A slowdown in new development projects may last for some time before a recession occurs.
For property investors, the real estate market’s recession phase is an all-too-familiar and challenging time. Real estate prices fall dramatically when there is an excess supply of properties and a drop in demand. Landlords and property owners face high vacancy rates and reduced rental income. In fact, many begin to wonder if it’s possible to invest in real estate without being a landlord. During a recession, unemployment rates rise, and tenants may also request rent reductions. New construction projects begin to decrease, and investment activity slows. It’s at this time that many people begin to seek out alternative investment strategies rather than looking to the traditional property market.
Strategies You Should Implement During Each Phase
Each phase should be approached by investors differently. The following strategies are a great way to start and could act as a way to begin theorizing how you could invest, but you should always seek professional financial advice before investing.
Many experienced real estate investors view this period as a golden opportunity to purchase properties at below-market prices. Timing is critical during this period, and it is important to closely monitor the market and act quickly when the first signs of recovery appear if you’re looking to maximize your profits. Investors can position themselves for success as the economy enters the expansion phase by adding value to these properties during this phase.
This is a good time for investors who bought at a discount during the recovery phase to sell because prices and rents have reached their peak, where demand and supply are balanced. The key to success in this stage is to invest in properties that cater to the tastes of the current market and sell for more than market value.
This stage provides an opportunity for investors to adopt a buy-and-hold strategy. They will also seek to identify properties that they believe will perform well in the next real estate cycle. Many property owners may liquidate their inventory in order to avoid unsold or vacant properties sitting in their position as the market begins to depreciate. This, in turn, creates chances for investors to take an opportunistic approach. If you feel that you’ve missed the boat, the key is to maintain your confidence and hold onto your properties until the next upswing.
Despite the challenges the recession period delivers, it also provides opportunities for investors to buy distressed properties at a discount, including properties that have been foreclosed and repossessed by lenders. Banks and lenders tend to sell at below-market rates to secure their capital as fast as possible. As a result, investors should save a rainy day fund and take advantage of these opportunities by purchasing great properties at great savings and holding onto them until the economy begins to recover.
Mastering your understanding of the four key phases during the real estate market cycle is your best course to investment success. There will be highs and lows as the years go by, that is for sure, but understanding when to play the right cards is where profit will lie.
- Each phase requires investors to adopt a slightly different strategy.
- There are no set timings for each cycle, some stages will last longer than others, and some cycles will last longer than others.