Understanding the Real Estate Cycle
Updated: Mar 2, 2021
Importance of the real estate cycle
How long is the real estate cycle?
Factors that affect the real estate cycle
Phases of the real estate cycle
As a real estate investor, it’s essential that you keep a pulse on the real estate cycle, both on the macroeconomic and microeconomic scales, and knowing where we are in said cycle. The housing market cycle is closely tied to the general economy. Still, you also can’t assume that just because the general economy is doing well, the housing market is doing well, or that the commercial property market has remained strong.
Real estate cycles are highly nuanced. However, the great news is that it’s possible to realize success as an investor no matter what phase of the real estate market cycle we’re in — there are strategies to help you make the most of each. Keep reading to understand how the real estate cycle works, what the different phases are, and how to best strategize in each phase.
Importance Of The Real Estate Cycle
The real estate cycle can provide reliable information about the possible returns of an investment property. As an investor, you should determine if your property is in the recovery, expansion, hyper supply, or recession phase of the real estate cycle. Doing so will allow you to make a more accurate assumption for the length of time the property must be held and the proper exit strategy to take. Additionally, the real estate cycle can predict the income and appreciation performance of an investment property. This will allow you to better decide when to make capital improvements.
How Long is the Average Real Estate Cycle?
Researchers have found that the average real estate cycle spans 18 years. However, the word “average” in this case is loose – real estate cycles are unpredictable, and some can last much longer than others. We are currently in roughly the tenth year of what experts call a bull market, where prices continue to increase. Over the last couple of years, many have predicted once and again that the bull market would slow, but we have yet to witness the slowdown.
The real estate market is also evolving right now in light of the coronavirus pandemic.
Factors Affecting the Real Estate Cycle
Several factors affect the real estate cycle, so much so that it’s nearly impossible to provide a concrete list. However, experts can collectively agree that the following factors are some of the main contributors:
Demographics: The makeup of the population, and major shifts in this population makeup, can drive a market significantly. For example, the baby boomer generation’s retirement is expected to cause major shifts in the housing market, as many choose to downsize or move to vacation areas.
Interest rates: Interest rates greatly influence potential homebuyers’ buying power. When interest rates are high, it could serve as a deterrent for many would-be buyers from buying. Conversely, when interest rates are low, it could encourage a spurt in home buying activity, as the long-term cost of financing a home is cheaper.
General economy: The overall health of the economy is also a heavy-hitter when it comes to predicting the housing market cycle. Generally, when the economy is doing well or is in an upward trend, consumers feel more encouraged to buy residential real estate. They feel that their personal wealth will improve while placing a bet that their property’s value would continue to increase. Generally, if the general economy is doing well, the real estate market is also doing well. If the economy is sluggish, the real estate market also tends to follow suit.
Government policies: The government will occasionally intervene with policies to help boost a market that is particularly sluggish or in a prolonged recession. Policymakers have the ability to implement tax deductions, subsidies, tax credits, and different homebuyer programs to incentivize consumers to purchase real estate. These types of governance mechanisms can greatly influence the housing market cycle.
The Four Phases of the Real Estate Cycle
The real estate cycle is composed of four main phases: recovery, expansion, hyper supply, and recession. This implies that historically, there has never been a sustained expansion or hyper supply period without an eventual recession, followed by recovery. This may induce some anxiety for you as a real estate investor, but fear not! The great news here is that investment strategies make it possible to invest successfully across each of these cycles.
Identifying the recovery phase of the cycle can be tricky, as most of the nation will still be feeling the effects of a recession and have a bleak outlook. Rental growth will remain stagnant, with no signs of new construction. However, this is where real estate investors must keep a close watch and act quickly at any signs of recovery. This is a great time to pounce on below-market value properties that are in various states of financial or physical distress. You can wait out the rest of the recovery period by adding value to these properties so that they are ready to sell or rent outright as the economy shifts into the expansion phase. Timing is the key.
The general economy is improving, job growth is strong, and there is an increased demand for space and housing. The expansion phase is when the general public will start regaining their confidence in the economy. Thus, the real estate market and individual renters and homebuyers will start generating demand once again. While the market is on an upswing, it’s advantageous to invest your efforts into developing or redeveloping properties that cater to the current market’s tastes and sell for more than market value.
3. Hyper Supply
During the expansion phase, investors and developers alike get into a frenzy to ensure that supply meets a growing demand. Inevitably, there will come a tipping point at which supply begins to exceed demand — either from too much inventory on the market or because of a sudden shift in the economy through which demand pulls back. As an investor, this is a time to hold strong. Property owners will often liquidate their inventory out of fear that their properties will go vacant or unsold. This is a great time to take an opportunistic approach; identify properties that you feel confident will perform well in the next real estate cycle. This is a great time to enlist the buy and hold strategy so that you have promising properties already in stock when it becomes an ideal time to sell again.
The recession phase is one we’re unfortunately all too familiar with. The great financial crisis of the early 2000s, followed by a sustained recession, left the entire nation reeling for many years. During the recession phase, supply exceeds demand by a wide margin, and property owners suffer from high vacancy rates. Also, not only is rent growth not present, some landlords are forced to offer reduced rental rates to attract renters who are also suffering from the economic downturn. As an investor, it’s a great idea to save up a rainy day fund for the next recession – this is not the time to sit back and feel sorry about the economy’s state. A recession provides the opportunity to purchase distressed properties at a deep discount. There will be an increase in real-estate owned properties, which are properties that have been foreclosed upon and repossessed by lenders. This is your opportunity to buy great properties with great savings. You can hold these properties (or add value if you see fit) so that they are ready to hit the market just as the economy begins to recover.
The real estate cycle is a concept that any real estate investor must understand if they strive for long-term success. All four phases of the cycle – recovery, expansion, hyper supply, and recession – cause the real estate market to shift significantly, so investors must stay on top of their toes if they hope to find opportunities in each. The great news is that there are strategies to remain vibrant and successful throughout the real estate market cycle, even if the economy feels sluggish.