Just like our year has four seasons during which temperatures rise and fall, the real estate market has four general cycles during which prices rise and fall; but while spring, summer, fall, and winter last only a few months, cycles in the real estate market last longer—seven to ten years. Keep in mind that these cycles are normal functions of dynamic markets and are affected by factors within those markets.
Of the four market cycles, two represent appreciating markets and two represent declining markets. The two appreciating market cycles are called Recovery and Expansion. The two declining market cycles are called Hyper-supply and Recession. The main characteristics driving market cycles are vacancy rates, new construction, employment growth and rental rate growth. Now, let’s take a closer look at the four general market cycles and what goes on in each of them.
Expansion is an exciting market cycle because it’s where the economy starts to get rolling again. You’ll start to see vacancy rates decreasing and a little new construction at first with a great deal more toward the end of the cycle. Absorption rates pick up as more people go back to work or upgrade jobs, and the pickup in income brings moderate to high growth rates in rents. Property values start increasing until the end of the cycle where they’ll peak. Investors want to buy at the beginning or middle of this cycle and sell toward the end (when property values peak) before the market starts declining again. The country experienced a lot of this in 2006-07 when property values hit their peak. Those who sold during those years made a killing while those who bought at the peak and overpaid will take years for their properties to get back to the value at which they purchased.
The market cycle following Expansion is called Hypersupply, and it happens when the market gets oversupplied during expansion while job growth slows down. Due to the amount of new construction, supply outweighs demand, and vacancy rates begin to increase again. There is still new construction happening, but absorption of apartments starts to really slow down. Employment also starts to slow as companies have already done their major expansions. Rental rates may still be growing, but at a pace between a crawl and a stop. Investors don’t want to buy during Hypersupply unless it’s for major cash flow that can withstand prices going down and weathering the storm to follow; and should be very careful to sell marginal properties before the market starts to decline more rapidly.
Recession is the last stage of the market cycle; and it’s the cycle that most of the country; and at the time this book is being written, it’s the cycle that most of the US and the world have experienced over the last 4-5 years. During a recession, vacancy rates increase as jobs and income decline. New construction slows to a halt and fewer apartments or houses are absorbed. You’ll see low to negative growth in employment as salaries level off or companies even implement layoffs. With the general economy in a slump, see many more concessions offered and rental rates go down with fewer people willing to pay as much for apartments. In this phase, investors want to focus on buying quality properties that provide strong cash flow. While your value will probably not increase anytime soon, you can still find properties that will provide a strong cash flow again.
The Recovery market cycle starts at the point that most people call the “bottoming of the market”—the moment when the market stops declining and slowly starts to level off or grow again. During a recovery, you’ll see vacancy rates stabilize and actually start to slowly decrease, due largely to very low or virtually no new construction. With little new supply coming on the market, property occupancy rates start to stabilize. There is usually low employment growth, but the decrease in jobs has ended. You’ll see very low rental rate growth and it may even go down a little. The good thing about this market is that it signals the end of a decline. This is a great time for investors to buy properties for cash flow; and when the market really improves you’ll see major jumps in rental rates, occupancy, and value. And with that recovery comes the opportunity to raise rents.
By Tami L. Siewruk
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