Real Estate Market Cycles and Investing

I got thinking about this subject based on a blog post about a current bubble from Ben Leybovich:

http://www.biggerpockets.com/renewsblog/?p=72742

Brandon Hall linked to this interesting article in the comments:

http://www.dce.harvard.edu/professional/blog/how-u...

Ben stated in his blog post that he has been priced out of deals for the last couple of years.  The article Brandon Hall linked to mentions real estate cycles going through 4 phases recovery, expansion, hyper supply and recession.

My first conclusion was that the market that Ben is dealing with has exited the recovery stage, so it isn't terribly surprising that he is having finding trouble finding deals.  In addition to the market, having real estate investing success is making him more picky on deals so there is the personal and the market trends both moving against new investment.

While the Real Estate bubble tended to be national and across classes of Real Estate, I think what is occurring currently is the market is fragmenting and there is less correlation within the broad scope of "Real Estate".  Metropolitan areas is the most obvious division, but I think price point, property use(investment vs. owner occupied) and even micro-markets are other divisions. 

With the price point differentiation - I think the higher priced properties tend to further along the cycle than the average property.  In a lot of areas they seem to have already seen a fair amount of recent appreciation.  Although there may also be better fundamentals driving it - the higher incomes are increasing more than average or lower incomes.  There also is likely more danger of oversupply, since that seems to be where new housing is concentrated in a lot of areas.

I think investment properties may also be further along in the cycle than the average owner occupied home.  Cap rates seem to be pretty low in a lot of areas.  There have been increases in rents, but the appreciation seems to exceed that.  I think one of the drivers of the investing cycle seems to be the funding source.  Early in the recovery(end of recession) phase, it was primarily "smart cash" that was being invested.  One example is the hedge funds buying up large numbers of bank properties.  I think in the next stage it tends to be "smart leverage" that is the primary driver.  There are fewer "home run" deals where you are getting 15%+ on a cash investment, but 10% returns and 5% cost of funds get you there easily.  I think what were are seeing a lot of in the current investment purchases is "dumb cash" - not even that the investors are dumb - but that they are mainly looking for a place to park cash and real estate looks more appealing than a lot of other income investments - the 5% return beats a 1% or less savings account/CD.  Where things get really bad is the recovery from "dumb leverage" - we saw that first hand with the housing bubble.  If something goes wrong on the 7% returns leveraged with funds costing 5% there isn't much margin for error.  I think due to the stricter lending requirements we won't see as sharp a drop as last time.  It hurts personally to lose a down payment, but it won't make the bank insolvent.  The recovery from a "dumb cash" could be prolonged as sellers aren't terribly motivated and are willing to let inventory sit at inflated prices.

In terms of micro markets the big factors I see are school systems and lingering impacts of the real estate bubble.  In PG county in the DC area, there still seems to be a fair amount of the county still in the end of recession/early recovery period.  However the majority of the DC area seems to be further along in the real estate cycle.