Real Estate Cycle

If you investigate the history of real estate over the past century, no matter where you live, a foreseeable pattern often comes to light known as the real estate cycle. When left to its own devices, barring political upheaval, the pattern remains much the same as do the influences and indicators dictating the pattern. As an agent, being able to recognize the evidence of a changing cycle can give your clients an untold advantage in the marketplace.

Historically cycles last anywhere from 7 to 18 years and are essentially driven by the basic principal of supply and demand. The core fundamental in any change to a cycle is usually driven by the abundance or lack of employment opportunities. People will migrate to where the jobs are and move from areas where they are not. To a slightly lesser degree, interest rates, lending criteria and affordability are key influencers; however employment and wages play a huge part in this as well.

It is important to understand that every metro area or town will reflect a particular cycle and suburbs or “pockets” within that metro area or town may reflect their own cycles. It is therefore important to pay attention to both the macro cycles (those in your metro area) and the micro cycles (found in “pockets” of your metro area) by becoming a local expert.

In order to become more aware of the indicators and gain expertise in your area, you must investigate and become familiar with the following: (these are in no particular order of importance as they are all important)

  • Changes in price (month to month)
  • Number of Days on market (DOM)
  • Number of existing listings
  • Number of expired listings
  • Vacancy rates
  • Rental statistics
  • Construction trends and new building permits
  • Industry/economic growth
  • Employment factors
  • Absorption rates
  • Population increases/decreases
  • Mortgage qualification and guidelines
  • Foreclosure/Power of Sales
  • Affordability
  • Public perception

In this and the following article, we will discuss the stages of a real estate cycle using the indicators outlined above to determine the best course of action for your investor. At the time of this writing, the market is in a decline, so let’s begin there.

A “Down” market

A downward trending market happens after the “top” of the boom cycle. This move can be subtle at first. Many inexperienced investors and homeowners alike can “get caught” during this shift. This can result from maintaining a selling price higher and longer than the market will bear, rather than anticipating the downward trend and unloading inventory with good pricing or speculating in preconstruction.

A down trending market occurs when prices are rising at unsustainable rates and new construction exceeds demand and/or prices hit maximum affordability. Unemployment rates may be trending upward as the job market peaks. This results in a glut of overpriced listings.

Once this happens, prices begin leveling off, demand slows down, and public optimism becomes uncertain.
When a market has too much inventory, demand goes down causing a decrease in sales, ultimately triggering the amount of MLS listings to increase. This causes the average “days on the market” (DOM) of each property to increase, naturally triggering a downward pressure on prices. This gives rise to less competition for property resulting in the dreaded “low ball” offers.

Anyone who purchased a property to flip when property values were increasing, may have to go to plan B and rent the property until the recovery, or sell at a loss, or worst case, may be forced into foreclosure/power of sale. The market ultimately dictates when the decline will stop and when prices become reasonable for what the market (masses) will bear.

During the down-market time, construction often continues as the contracts and obligations the builders have in place must be fulfilled. Construction will ultimately begin to decrease during this cycle. Some pre – construction buyers may be seen to back out of their obligations to the builders as prices move downward.

Mortgage qualification often is difficult as overall lending criteria becomes more “stringent” and bank appraisers become conservative.
Depending on rental unit supply, vacancy rates may begin increasing as tenants have more choice of units and landlords begin offering discounted rents or move in specials.

What does this mean for you and your client’s portfolios?

  1. If you missed selling at the top of the market, your clients may need to sell fast and would be encouraged to not hold out for top dollar (if a sale is absolutely required)
  2. Your clients may need to decrease rents or offer incentives to attract or keep tenants
  3. Many landlords will have higher vacancies and may be highly negotiable on price (wait until later in the cycle)
  4. If your clients don’t sell now (if selling at the market top was the initial idea), you may suggest they hold their existing properties until the market corrects
  5. As the cycle moves, this becomes the beginning of a Buyer’s Market. This can be a great time to work with your investors as they benefit from the fear and panic experienced in sellers and can become quite open to negotiation.
  6. Builders may become negotiable as their unsold inventory increases. Purchasing (or controlling) multiple units from a builder makes good sense for your investors sitting with cash during this cycle.
  7. Buy- fix- sell strategies can work well at the beginning of this phase provided the property is acquired under fair market value.

The “Bottom”

At the bottom of a market, generally public perception and the economic outlook is negative. The banks’ lending criteria becomes even more stringent. Prices tend to decline, and it is not until prices ultimately begin to increase and vacancies begin to decrease will you know where the bottom is (or was). Foreclosures or power of sales become more frequent and economic pessimism prevails as demand continues to slow.
The amount of MLS listings will be very high as will the number of expired listings as sellers just give up and decide to wait it out until the next phase. Very few sales happen during this time as people are very conservative; however, it is ultimately a buyer’s market and a great time for your investor’s to be buying deals.
New construction during this time generally drops, however new builds already underway still may come online. Many contractors either become renovators or get out of the business altogether. Many Realtors and mortgage brokers tend to leave the business during this cycle, so if you are a realtor, you should be building your investor database as investors will be the ones transacting.

What does this mean for you and your client’s portfolio?

  1. Take buying slowly but start buying distressed properties later in the cycle
  2. Holding and waiting for the “recovery “market indicators if your clients are looking to ultimately sell
  3. Suggest to your investors to provide furnished rentals to keep their unit rents up
  4. Approach builders who have unsold inventory and have your investors purchase one, several or all of their unsold inventory at a discount or with a purchase option.

The public is usually driven by the media who are usually trailing the middle or even the end of a wave. This gives those who are studying the key market indicators a distinct advantage. However, acting when no one else has acted takes knowledge, courage and sometimes trusting your gut. Your investors will be relying on you as to the right strategy to implement and the right time to pull the trigger.

Just remember, real estate is a localized market which often displays unique indicators not evident in an adjacent city or town. Be sure to investigate your market carefully so you can be ahead of the curve to maximize your investor’s profits.

Are you eager to take the next step in your business journey? Learn more about how you can increase your deal flow, shorten your sales cycle and work with a sophisticated, loyal clientele. Click here to schedule your custom strategy session with a knowledgeable and friendly member of our InAgent Team.

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