How to predict the real estate cycle and profit - part 2
I have not lost my mind. I am not offering a “get rich scheme” or a secret way of “timing the market.” The truth is these teachings usually found at high-energy seminars are full of hot air.
Profiting in investment real estate takes time. There may be a few outliers who tell you how they doubled their money in three months flipping a property, but these are not all that common.
Knowing the real estate cycle can give you a strategy of when to buy, hold and sell as well as what to look for in a potential investment property.
In part one, I provided you an overview of the first two phases of the real estate cycle, recovery, and expansion. Phase 1, recovery, is when the market starts looking better after a recession. You may find vacancy rates decreasing, the Federal Reserve potentially lowering interest rates, and people begin to find jobs.
Phase 2, expansion, is when confidence in the markets grows. Rents and property values are on the rise and vacancy rates continue to decrease. More construction projects come online, and the potential for a “real estate bubble” starts to become apparent.
Be sure to review part one to learn the strategies to follow in purchasing investment real estate for phases one and two. Next in the cycle is phase two and three.
Phase 3 - Hyper supply
The new construction that was in the works years ago comes online, and vacancy rates start to rise because of the increase in supply. Rental growth slows down, and competition for tenants becomes fierce.
The first indication of trouble is an increase in unsold inventory and higher vacancy rates.
Developers see the slow down in the market and put their new construction projects on hold. New construction projects in the pipeline continue to come online while demand continues to fall. Occupancy averages start to decrease as we enter phase four.
Your strategy - some investors in core properties may decide to sell before the market goes into recession. Most likely you could ride out the coming downturn if you have credit tenants with leases exceeding five-years. For the investor looking for opportunities, it is all about pricing. Many property owners may be in a weak position financially and will need to liquidate.
Phase 4 - Recession
Supply starts to increase with demand decreasing producing higher vacancy rates. Followed by an increase in interest rates from the Federal Reserve to fight inflation caused by the now higher prices.
The second indication of trouble are occupancy rates that start falling below the average--vacancy rates increase, followed by the fourth indication--a rise in interest rates.
The combination of below average occupancy, lower rents, increased interest expense and decreasing values causes investors to sell and developers to stop building. If investors are unable to sell, this may force them to lose the property.
Your strategy - this would be an opportune time for a well-capitalized investor to purchase distressed properties. It is essential to pay attention to the local market and property classes as a recession hits areas and classes differently.
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.