Understanding Real Estate Cycles & Factors That Affect Them
June 20, 2022
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The real estate cycle coincides with the economic cycle but has four distinct phases all investors should understand. Knowing how the real estate cycles work can help investors make intelligent investing decisions and create long-term strategies.
What Is the Real Estate Cycle?
The real estate market cycle is four phases both real estate housing market and commercial real estate go through in around 18 years. The phases include the recovery, expansion, hyper-supply, and recession phases. Knowing the housing market cycle, when each might occur, and what happens in each cycle can help you make good real estate investing decisions and create solid commercial and house market strategies.
The Four Phases of the Real Estate Cycle
Like any business cycle, the four phases of the real estate cycle aren't time-bound or predictable. One phase may last longer or shorter than another during some cycles, but overall here's what the real estate industry goes through every 18 years.
The recovery phase always follows the recession phase. The real estate market goes through a continuous circle, with one phase immediately following the other.
When in the recovery phase, the real estate market is trying to bounce back from a recession. There's generally higher vacancy rates, and rental rates are low. New construction may be present, but it's minimal at best.
The recovery phase is a great time for real estate investors to jump into properties because real estate prices and values are low, giving investors a lower barrier to entry. Unfortunately, homeowners typically struggle during this time, just like the recession phase, because of the lower real estate values and the inability to get financing to buy or refinance a home. As a result, the house market for primary residence buyers is typically low.
During the expansion phase, the real estate housing market improved and feels back on track to real estate investors. Vacancies are usually much lower during the expansion phase, and rental rates increase at high speeds.
Property values increase, as do commercial and residential real estate prices, and new construction takes off much faster than in the recovery phase.
The demand for rental properties during this time is usually very high, so it's a great phase for real estate investors. Those who haven't bought properties yet will do so during this time, and those who have may renovate what they have and take advantage of the chance to charge higher rents.
As is the case with the standard economy, eventually, supply exceeds demand. With the market oversaturated with properties and investors, the market starts to dwindle. As a result, demand for rental properties decreases, as does rental growth.
Investors usually implement a buy-and-hold strategy during this phase. They'll either buy properties at less than their market value from companies worried about the recession phase or buy buildings with long-term leases in place, so they don't have to worry about finding tenants and changing rents.
The hyper-supply phase, however, leads to recession.
When the supply in the housing market is much more than the demand and the industry cannot keep up, a recession occurs. Vacancies are at their highest in this phase, and rental growth is non-existent. Savvy investors often take advantage of this time, growing their real estate business by acquiring properties well below their market value and holding onto them for the next phase.
The real estate cycle focuses on the real estate industry alone or how residential and commercial properties are affected, but it's important to look at the economic growth or lack of growth too.
During the recovery stage, many investors are still struggling. This is a time when investors who aren't struggling can buy real estate assets at lower prices. The key is to buy and hold these assets, waiting for future phases with economic growth and more successful real estate transactions to turn a profit.
The key is to have the ability to hang onto the properties until the expansion stage to take advantage of the profits.
Most people are in a 'good position during the expansion stage.' Real estate investors can sell the properties they snagged at undervalued real estate prices and make a profit. They can also keep the properties, finding a large pool of renters willing to pay higher rent prices.
During the expansion stage, interest rates are typically low, making it easy for investors to leverage investments and grow their real estate portfolios. This is also a time for strong marketing to secure long-term leases on commercial buildings to ride the wave of the impending recession.
The hyper-supply stage is a time to consider liquidation if you don't have a large emergency fund or don't think you'd get through a recession. The real estate values will most likely decline in the next phase, leaving many investors upside down, especially with higher vacancy rates a likely possibility.
Any investors who aren't in a difficult financial situation and who have solid leases in place should hold onto those assets and enjoy the steady rental income as the recession stage approaches.
During the recession phase, unemployment rates are high, and tenants may have trouble keeping up with their rents. As a result, property owners typically have to get creative with their leases and rental prices if they want to keep tenants, as so many struggles during this phase.
For the investors without financial worries right now, the recession stage can also be a great time to scoop up more investments. They won't turn a profit immediately, but if they can hold onto them through the impending recovery stage, it can benefit their portfolios.
Factors That Affect the Real Estate Market Cycles
The real estate market cycles are highly influenced by many other factors outside of the real estate housing market itself. Understanding these factors and being on the outlook for telltale signs can warn a real estate investor when the housing market cycle may change.
General Economic State
The real estate market performs well when the general public is doing well, earning high wages, and flourishing financially. The demand for rental properties is high, and the ability of most investors to purchase real estate and rent it out is also high.
When the economy falls, unemployment rates soar, income falls, and people stop spending. This greatly affects the housing market since real estate is so expensive, most people stop buying during a recession.
When interest rates increase, the ability of investors and even home buyers to purchase properties decreases. Affordability is key in determining if and when investors can afford real estate.
When interest rates are low, though, the real estate industry flourishes, usually causing real estate values to increase because of the higher demand.
When the demographics of an area change, it can significantly affect real estate and the real estate cycle. Say for example, an area was primarily made up of Baby Boomers. During their prime years, they bought houses, and the industry was booming. Now that Boomers are closer to retirement (or already retired), they aren't buying homes, which can cause a decline in those areas with mostly Baby Boomers.
Government policy also directly affects real estate cycles. When the government steps in and changes the interest rates, it can either increase or decrease real estate demand. The same is true of government 'red tape' or tax policies. Friendly policies may spur more demand, but tightened policies can hurt the real estate industry.
Consumers have their own thoughts about what the economy and real estate cycles will do. If they suspect a downturn, they'll buckle up and stop buying. This can dwindle demand and spur a recession. But, when consumers are confident, and consumer spending is up, the real estate market benefits.
Investing Based on the Real Estate Cycle
Real estate investors follow the real estate cycle carefully to determine their next moves.
During the recovery phase, many investors take advantage of lower real estate prices and interest rates. They buy properties to either fix up and sell during the expansion phase, or they buy and hold in anticipation of the higher demand for rental properties.
The expansion phase is great for investors who have already bought properties. They can enjoy the job growth in the area and the high demand for rental properties. Rent prices increase during this time, making it a great time for rental growth, but many investors don't buy during this time with rising prices.
During the hyper-supply stage, investors create their plan for surviving the impending recession. Some may sell off properties that underperform, or they may take advantage of buying properties with long-term leases so they can ride out the recession stage with the potential of steady income.
Real Estate Cycle FAQ
How Long Is the Average Real Estate Cycle?
Overall, the real estate cycle lasts 18 years. There are four phases in each cycle, each of which lasts a different amount of time, but on average, the real estate market cycle 'recycles' itself every 18 years.
How Does the Economy Affect the Real Estate Cycle?
The economic cycle plays a major role in the real estate cycle. When the economy suffers, typically, the real estate industry does too. The real estate industry does well when money flows freely, and job growth is high. The economy and real estate cycles typically follow one another at a steady pace.
What Stage of the Real Estate Cycle Are We in 2022?
The start of 2022 brought us into the expansion phase. Interest rates were still low, affordability was high, and buyer demand was high too. As we get later into the year, though, mortgage rates aren't as affordable, decreasing demand and leading us into hyper supply and, eventually, recession.
The Bottom Line
Understanding the real estate cycle and how they work is important. You can't change or avoid the cycles, but you can prepare for them by creating the right real estate investment strategies based on the current real estate markets and what's to come. Learn more by signing up and visiting our blog.
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