Tom Miller, CCIM
The Real Estate Cycle – What it is and Where we Are
The Phase: Recession
A recession – the recent experience of which will still be fresh in people’s minds – can be summed up as a period of general pessimism, doom and gloom.
Properties are readily available with high vacancies and cheap prices. Value is everywhere.
There is minimal demand.
Everything is negative in the media.
There is fallout with builders, developers, real estate agents, even lenders failing and going out of business.
While many investors see great opportunity in undervalued assets, most resist the urge to buy, which further drives already low prices down to rock bottom.
Construction is zero.
The Phase: Recovery
During a recovery phase, things are picking up – slowly and with great caution. Pay attention,
Demand starts to show signs of life, to the degree that landlords do not feel the need to offer properties at the lowest pricing they were in the recessionary times.
New construction still being nil, the increased demand erodes inventory at a rate far exceeding the recent market periods.
Supply/demand begins to look like a more balanced economic model as prices continue to rise and supply starts to dwindle.
The media picks up the stories and interest increases in real estate.
Momentum builds on itself and rising prices are now the norm.
Prices and values rise by double-digit amounts, prompting a start of new speculative construction, which will be available for use in about seven to eight months.
Some build to suit projects start on selected projects.
Investors who jumped in early in this phase are seeing huge profits. Timid investors who waited until it’s widely known that real estate is “hot” again, are now buying into a somewhat riskier market. These later investors have missed the boat and their long-term asset value accumulation will be challenged.
Savvy investors start to execute their exit strategies now, just as those Johnny-come-lately investors are opening their checkbooks. Those staying heavily invested as this phase completes are driven by the greedy emotion that has been the downfall of many.
As the recovery progresses, new speculative construction is beginning to become the norm again. Developers with nothing coming out of the ground are feeling left out and motivated to get moving.
The expansion phase is a busy time. Buyers are buying, sellers are selling, builders are building, developers are developing. Boat, RV and vacation time share condo sales are booming again. Everyone has a new truck to get to the jobsite all week and to pull their jet skis to the lake on the weekends. Life is good; easy credit is plentiful, we’re all rich and spending like crazy. It’s time to do that kitchen remodel and expand the deck.
Prices are still rising but flattening to their apex.
Real estate is now overpriced.
Construction is churning out new product at a high rate. By now, the real estate investing community is all in and the amount of capital chasing deals has started to taper severely.
Sellers are now seeing that the buying frenzy is clearly over and inventory is showing increased time on the market.
Some sellers start to think about a cut in prices.
The few remaining buyers grab these reduced price deals thinking they are getting a good value. However, cap rates are still extremely aggressive.
Even though demand is falling off, some still think the rosy real estate market remains a solid place to be invested – despite tenants beginning to achieve lower rents than were available a while ago, an indication of overall market weakening.
Few see the signs of trouble ahead.
The oversupply phase is when real trouble starts brewing and emotions take over. The overall economy is down, demand is slow, widespread employment rates are growing and it’s basically every man for himself as the market bottoms out. Workers at the plant start to show up earlier and ask for less vacation time. The expensive toys are showing up on Craigslist. Some people start to whisper the dreaded words, “real estate bubble,” again.
Demand continues to shrink and prices continue to erode accordingly.
Sellers cling to the hope this is just a slight bump in the road and continue to hold out for high prices in the face of falling revenues and declining asset values. This is where the wheels start to wobble.
As time wears on, with weakening demand, sellers and landlords finally “get it” and the price cutting wars begin.
Lenders are soon faced with failing loan collaterals and the lending industry starts to pull in its horns considerably. Lenders quickly become unfriendly, in general.
No one is happy except those lucky tenants and buyers who are shopping in a market where demand is rare and cash is king. They swoop in and find bargains everywhere.
The greedy investors who held well past the recovery phase are now in panic mode.
Increasing negative press again is starting to show up, interspersed with a few hopefuls who predict a quick economic turnaround.
Sometime in this phase, the market bottoms out. But there are no flags or buzzers that will sound on that date – the economy has to start up again to know where the bottom was. This is when some hearty investors jump, or maybe already have and are rewarded well for their investing acumen, fortitude and lack of greed. Most investors will pass at this phase and wait for a safer time. As economic safety resumes, investing profits fall.
While the real estate cycle and its phases are generally traditional, there’s no handy calendar that indicates when to buy, hold and sell because no one can be absolutely sure of the precise timing of it all. Like many things, it’s a matter of reading the signs, watching the indicators and most importantly shelving your emotions and listening to your spreadsheets and your intuitions. Of course, teaming with a qualified commercial real estate professional along the way for expert assistance might add some significant value as well.