How to predict the real estate cycle and profit - part 1
Is it possible to know what the real estate market is going to do in the future? Sorry, to get your hopes up, but there is not a way to foretell what the market will do tomorrow.
However, there are methods to predict what may happen based on trends that occurred in the past. Analyzing the trends in the financial and real estate markets over many years gives economists the ability to recognize a cycle.
Want to know how to profit during each phase? Review “your strategy” in each section below to find what you can do as a savvy investor.
By the way, when we say “market,” we are referring to the overall economic state or condition of money or real estate. A market is a broad term as it relates to real estate and could be a local area, a specific type of real estate or even renting versus buying.
The financial market tends to be on an 18-year cycle discovered by Economist Homer Hoyt in 1930. The financial cycle feeds the real estate cycle. In 1876 Economist Henry George analyzed the trends and found real estate to follow a four-phase cycle, which follows the 18-year financial cycle.
Phase 1 - Recovery
After an oversupply of inventory caused by new construction or negative demand and growth, we enter recovery. New construction stops and demand slowly absorbs oversupply, but the economy is starting to look upward.
Vacancy rates slowly decrease causing rents to stabilize. The Federal Reserve may intercede by lowering interest rates to stimulate the economy making the investment in real estate more profitable.
As vacancy rates stabilize, unemployment rates start to decrease as we enter into the next phase.
Your strategy - look for opportunities to purchase distressed properties at bargain prices and plan on holding until the expansion phase. Be careful with trying to add value as it may not come back to you with increased rents or occupancy. Buy leased-up “trophy” properties at below market prices and hold until the expansion phase where a profit can be made.
Phase 2 - Expansion
Expansion can be seen as an increase in confidence in real estate ownership, new investing is growing, and workers are finding employment. Rents are on the rise, and vacancy rates are decreasing. With an increase in demand and rents property values increase.
Soon the current supply is met with demand while new construction looks more and more lucrative with new projects starting. Rent growth is accelerating so quickly that investors tend to forecast income based on future rents rather than current market conditions.
Soon we are overpaying for developable land and operating investments. This is what we call a real estate bubble.
Supply and demand equalize, occupancy rates are high as well as rents. Most do not recognize the level of equilibrium occurring until we enter the next phase.
Your strategy - this would be an excellent time to consider a development project or an upgrade to an existing property. With the increase in demand, a property should be leased quickly at higher rents. A property in need of improvements where you can add value thereby increasing rents is opportune in this phase. With rents usually low any improvement can be immediately capitalized upon and later sold or refinanced once stabilized.
In part 2 we will discuss phase three and four, hyper supply and recession.
Burt M. Polson, CCIM, is an active commercial real estate broker. Reach him at 707-254-8000, or firstname.lastname@example.org. Sign up for his email newsletter at BurtPolson.com.