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Real estate is an asset that nearly every business needs. Even if every consumer shopped online, manufacturers and sellers require space to make and warehouse their goods, server sites for their data, and call centers for customer support.
In the residential space, single-family rental demand has been strong since the beginning of 2022 likely due to the lack of affordability for homebuyers. Rising interest rates, climbing listing prices, and fierce competition from migrating buyers with bigger budgets are hurdles to homeownership for many. The results are continued demand for rental properties of all types including single-family homes, townhouses, condos, and apartments.
Although there are risks with every investment asset, the ongoing need for real estate makes it an attractive one.
Seasoned real estate investors use historical knowledge to understand how the market is moving and make changes to their investment strategies. While no one has a crystal ball, understanding the phases of the real estate cycle is one way to potentially predict what might be on the horizon.
Generally, the real estate cycle represents the overall macroeconomic and microeconomic status of the real estate market, but the real estate market is affected by many factors.
Location is usually the first consideration. One region may not reflect what the national averages show. For instance, in April 2022, home sales fell in the Northeast by 23%. In the Midwest, it was a decrease of 22%. However, in the South and West, sales increased by 10% and 3%, respectively.
Niches like single-family homes, apartment complexes, multi-family duplexes, triplexes, quadplexes, office buildings, storefronts, and other commercial properties may also experience vastly different rates of growth or decline in demand within the same time period.
Certain investment strategies like wholesaling, fix-and-flip, and buy-and-hold also make more sense under particular market conditions than others.
A few of the characteristics to gauge include:
These characteristics, plus other factors like interest rates, migration patterns, employment, wages, demographic shifts, and government intervention, can help you determine whether it’s a buy, hold, or sell environment.
Economists and analysts like Philip J. Anderson, have been tracing the history of real estate bubbles since 1800. In a human circadian rhythm, there is a natural cycle of rest and activity in a 24-hour period. Similarly, the real estate market experiences multi-year cycles of growth and decline. When left uninterrupted by government regulation, each cycle from 1800 to 1925 lasted a predictable or “natural” length of 18.6 years, averaging 14 years up and 4 years down.
Between 1925 to 1979, there were only two cycles, based on historical data, when there should have been three. During this time, the government responded to the Great Depression with regulations in hopes of mitigating the economic damage.
Within this timeframe, there was an extended 48-year cycle including the post-World War II economic prosperity ushering in the emergence of the American middle class. Homeownership rates boomed after World War II thanks to GI BIll’s effort to reintegrate soldiers back into civilian life with education and training, job placement, and home loans that required no money down.
A compressed cycle followed in the 1970s when the Federal Reserve doubled interest rates in 1979.
Regardless of length, the real estate cycle consists of four phases:
Still reeling from recession, this phase of the cycle is usually characterized by low consumer confidence, high unemployment, and a gloomy outlook on the economy. There may be a rash of foreclosures on the market, and builders are slow to start construction due to low vacancy rates.
This is usually a great time for investors to find a below-market value property in financial or physical distress to acquire. Anticipating the eventual expansion and demand for more housing, there’s a possibility to fix and flip or hold and rent as the property’s value grows.
Unfortunately, financing may be difficult to obtain as lenders and other investors may be skeptical about whether recovery has begun and if the net operating income will cover the debt. Investors may turn to private lenders or hard money loans as a result.
This phase corresponds with strong job growth, increased demand from both homebuyers and renters, and an overall stable economy. The slowdown in construction creates more of an uneven distribution of supply and demand, and as occupancy rates increase, rent goes up too.
Many experts see this as an opportune time to invest in developing or redeveloping properties to meet buyers’ expectations and increase the desirability and price tag.
In addition to buying to renovate and sell, investors are likely to buy and hold single-family properties or purchase multifamily properties to cater to the demands of renters.
Also known as the oversupply phase, this stage begins when inventory exceeds demand. Demand decreases either because supply has finally caught up or a sudden shift in the economy leads to unemployment and borrowers can’t maintain mortgage payments. Sensing the next phase of a recession, nervous investors may feel inclined to sell off properties as vacancies rise and rent growth slows. For other investors, it’s an opportunity to implement a buy and hold strategy, adding to their portfolio to sell when the cycle returns to the expansion phase.
At this point, the supply oversaturates the market as demand continues to fall. The result is high vacancy rates and negative rent growth. Landlords may be forced to reduce their rental rates, decreasing their net operating income and potentially increasing their debt. As Jeremy Grantham stated on CNBC, “The first thing to go in a recession is the profit margin.”
Investors who plan and save for this phase will have the opportunity to buy properties at foreclosure for cheap and hold them until the market swings back. For those with the capital already available, they’ll likely find good deals on distressed properties.
Depending on your risk tolerance, financing options, and overall investing goals, certain phases of the real estate cycle may be more appealing to you than others. Before you make a decision on which phase is best suited for you, consider these additional details to help guide you:
Blueprint works with real estate investors, lenders, and other professionals. Within our title and closing platform, users can submit, track, and close transactions without sifting through email chains or calling to check in. Blueprint’s API allows for new transaction submissions, pulls information about in-progress deals, and pushes real-time updates when there’s a change in status, giving you the power to manage all your transaction data in one place. When it’s time to close, you can schedule convenient remote online notarization or mobile loan signing appointments, where available.
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