The 4 Phases of a Real Estate Cycle (& When to Buy a Multifamily for Maximum Profitability)

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The quickest way to wealth in real estate is to purchase a property in an emerging market during one of the early phases of the market cycle. In this article, it is my objective to describe the four phases of the real estate market and how you can make money while purchasing in these four phases. I will also dive into our criteria for buying a multifamily property and how you can limit your downside risk.

Let’s jump into the four phases.

Phase 1: Recovery

The characteristics in this market phase include declining vacancy and no new construction. In my opinion, this is where the savvy investor looks to buy. Unfortunately, securing financing during this phase can be difficult, and overall sentiment is still weak. This marks the contrarian phase in my estimation, where value investors jump in by buying at low prices.

Most investors have been snake bitten from the recession and are unwilling or unable to buy in this phase. The majority of the real estate markets have emerged from this phase and find themselves in the expansion phase.

Phase 2: Expansion

Many markets find themselves entrenched in the expansion phase, a time of declining vacancy and new construction. It takes a few years for new inventory to come online, and during this period, rents and occupancy both expand. In 2015, rent growth was a robust 5.6%, and occupancy stood at 96.1% — both highs. You may be thinking, “Here we go again!”

Let me tell you why you should still consider investing in multifamily assets if they can be purchased at reasonable values. We have been transitioning to a renter nation, with the aid of a shift in demographics and the Great Recession. Homebuyers are still feeling the ill effects of purchasing a home and getting hammered. There is no guarantee that buying a home and holding on for the long-term will produce any gains. The economy plays a huge role in the expansion phase, and the economy is currently adding jobs to the markets we are invested in.

Two demographics that tend to rent are Millennials and Baby Boomers. Every seven seconds, a person turns sixty in the United States, which creates more demand for our apartments. Millennials are entering the labor force saddled with student debt and are forced to rent, which creates another pool of prospective tenants. This demand has been fueling rent growth and is one of the main reasons why property values will continue to increase.


Related: The Real Estate Market: How to Analyze and Predict Cycles

Phase 3: Hyper-Supply

Trouble is brewing on the horizon in this phase. Vacancy begins to increase, and new construction is still ramping up. This is a period when builders need to recognize what is occurring and should put the brakes on new construction. The party is starting to come to an end, but I would still buy in this cycle if I find a deal that fits my parameters: 10% cash on cash return, 8 cap, and a 1.3 debt coverage ratio.

Deals are harder to come by in this phase, but we are still actively pursuing them. It’s all about the numbers, and we buy on ACTUAL numbers, analyzing the last twelve months of a property’s profit and loss statement. 

Phase 4: Recession

Anyone remember 2008? The vacancy rate was increasing, and new completions were being delivered to the market. The new construction came to a halt, but it was too late. There was a double whammy — less renters with the addition of new inventory. Rental rates, as well as occupancy, continued to plummet, and this accelerated the downturn in real estate values.

Let’s turn our attention to underwriting these deals and how you can “buy right.” The first step to buying right is to analyze a deal based on actual numbers. Ask the broker for the last 12 months of trailing profit and loss figures. If the broker can’t provide you with a profit and loss, either move onto the next deal OR try to obtain the last three months of gross income.

Next, I will create an estimate of what the expenses should be and perform a rudimentary analysis based on these estimates. I know in my market, it costs me around $3,600 per unit to run a property, and investors need to learn how much it costs to run a property in their market. I have also used the rule of thumb for operating expenses as 50% of gross income to perform a quick calculation. For example, if a property is grossing $10,000 per month, I will estimate expenses to be around $5,000.

Once I have calculated income and expenses, I arrive at the net operating income (NOI) by subtracting income by expenses. Visit our previous article on BiggerPockets that discussed how to calculate value using the net operating income.

I focus on three criteria when investing in multifamily assets.

Cash on Cash Return

I expect to earn at least a 10% cash on cash (COC) return from day one. As we progress further into the expansion phase, it has become increasingly difficult to find deals that produce this return, but I maintain my discipline and will not purchase an asset that is not producing an actual 10% COC. Be prepared to analyze a lot more deals.

My biggest mistakes in real estate were all centered on the buying phase. I either overestimated the appreciation of the property or I fell in love with the property. I quickly learned that all savvy investors make their money on the purchase of the asset. Buying with an actual 10% COC limits my downside risk, and any forced appreciation that occurs on the property will become my profit.

Debt Coverage Ratio

I aim for a 1.3 Debt Coverage Ratio (DCR). To calculate DCR, take the NOI and divide it by the annual debt. Banks typically require at least a 1.2 DCR to lend on a property. A property that achieves a 1.2 DCR is simply generating 20% more income than the payment of the debt.


Related: 3 Simple Steps to Increase the Value of Your Multifamily Property

Cap Rates

As the market continues to appreciate throughout the United States, we have been witnessing a compression of cap rates.   Simply put, values increase, and cap rates drop. In our market, we aim to purchase a C-asset with an 8 cap. I know most readers will find it incredulous that there are still properties out there trading at an 8 cap. If I can’t buy at an 8 cap, then I will pass on the deal unless there are incredible value adds with the property that will allow me to explode the NOI of the asset.

Consistency in the buying process will allow you to analyze deals quicker and become more accurate in your underwriting. Emotion will be removed from the buying process, and the numbers become the focal point. Don’t commit my mistake of falling in love with a deal. Fall in love with the numbers first.

Your Task

Decide what market to invest in, and begin to research the market. Focus on job growth, which should average at least 2% growth for two consecutive years. To access data for jobs in a market, Google the name of the city and “job growth” or utilize the website to gather employment data for a specific city. Look for companies announcing a move to a market, and become familiar with employers in your market.

Target markets that are experiencing household and population growth. Household growth is a more powerful barometer because households are the ones that become our clients.

Study the demographics of the market and look for a higher percentage of Millennials and Baby Boomers. The middle aged demographic tends to have families and are more apt to become homeowners.

Finally, take action and educate yourself on the power of multifamily investing. A wise man once told me, “It’s not what you buy, but what you pay.”

We’re republishing this article to help out our newer readers.

I want to know what’s going on in your market. Please leave me a comment and tell me where cap rates are in your market and where you are finding deals! I know they’re out there, it’s just much harder to find them.

Be sure to leave a comment!

About Author

Gino Barbaro

Gino Barbaro is a father of six and the co-founder of Jake & Gino LLC, a real estate education company focused on multifamily investing. He has grown his portfolio to 674 units in three years and is the best-selling author of "Wheelbarrow Profits".


    • Gino Barbaro

      When I started buying, that’s what the cap rate was. They have obviously dropped. I just want to try and earn a good rate of return. The risk premium is the spread between the 10 yr t bond and the cap rate. Back in 08 risk premium was around 2-3 which signified huge risk and we know what happened next.
      Cap rates are market specific so you may not be able to obtain an 8 cap. Remember it is only one metric.
      Take care Chudi!

  1. I agree that “We have been transitioning to a renter nation,” driven in part by “Every seven seconds, a (baby boomer) turns sixty in the United States, which creates more demand for our apartments.” We must remember that boomers are likely to be savvy tenants with higher expectations for the quality of the unit than the usual “tenant class.” These higher expectations are not actually a greater willingness to pay higher rent, because when they were younger they may have been willing to tolerate the cheapiness of their rental house, but no more. They expect a “home” the landlord himself would be willing to live in along with responsive maintenance. They also expect to be treated with more respect than many landlords have traditionally exhibited toward tenants. They also expect landlords to be cognizant of the fact they are living on fixed incomes. The days when landlords could expect them to “better themselves” through education and job promotions are long gone. Landlords also have a greater possibility of running in the same social circles as their tenants or someone else’s tenants. No baby boomer tenant will like hearing the landlord sitting next to them during their Wednesday morning watercolor class spouting off about the “irresponsible tenant class.” Baby boomers becoming tenants again may be just the thing to wake landlords up, and help them do something about what Josh and Brandon have repeatedly referred to as the bad rap landlords generally have.

  2. leo Khmelniker

    Hey Gino, great article!

    In Nashville I would describe us as being in the Hyper-Supply phase. Cap rates are in the 3-6% range and it feels as though EVERYONE is in the market to buy a home. I’m curious what you’re seeing in Knoxville and if you’re expanding into any other markets?

    Best, Leo

  3. Gino Barbaro

    Dear Leo
    I agree. Nashville has thousands of units coming online. Supply is outstripping demand and you are ahead of most investors to realize this. The only caveat is that jobs are still entering the market but landlords In the short term are giving concessions. The Knoxville market is still on expansion but is harder to find a great deal. It’s a slower growing market than Nashville

  4. Tyler Herman

    Thanks for writing this good article Gino.

    I’m curious are you expecting/counting on appreciation when you came up with your minimum numbers for pulling the trigger on a deal?

    I’m just curious because here is Mississippi you can find plenty of properties on the MLS that meet your criteria without a lot of effort but the difference being the properties will never appreciate, whereas your markets will probably grow steadily in value over time. In a market like mine should I be adjusting my numbers to compensate for a flat appreciation rate?

  5. Hi Gino,
    Nice article with great advice. I am SFh investor and second the advice “don’t fall in love with the property” and “it is not what you buy but the price you pay”. Thanks for keeping it simple and straight.

  6. Gino Barbaro

    Hi Tyler,
    If you have properties that fit my criteria, then buy. In multifamily real estate, it’s all about the NOI. Increase income or reduce expenses, your NOI goes up and you will be forcing the appreciation. The key for you is to find properties where you can add value. Many markets have slow appreciation. There are so many other benefits to real estate.

    • Fuad Ayeshalmoutey

      Once I study the market enough to be confident. 5 units and more is a commercial loan in WA state, but comes with more expenses and liability. I’m leaning more towards development. I guess out if my comfort zone would be looking into other states. What do you think?

  7. Gino Barbaro

    A commercial loan is sometimes easier to qualify. Banks look at the numbers more, comps are less important. There are somer different features, such as commercial loans have terms. I would look at other markets, but still research your backyard

  8. Mike Dymski

    Nice article. I like that you reinforce buying during all cycles as (1) many investors entry to the market can not be timed to coincide with the best cycle (2) many investors plans do not permit sitting on the sidelines for extended periods and (3) it’s hard for part time investors to time the market.

    Thanks also for sharing your thresholds. Even if they vary by market, they help others benchmark deals and expectations. Many of us do this on our own and hearing data from some experts can be the catalyst that gets us from analysis to action.

  9. Gino Barbaro

    Hey Mike,
    I am trying to teach people to identify what type of phase their market is in. I would still buy in a hyper supply phase, but the deal better be smokin, and i better think about limiting my downside risk. The problem is in a hyper supply, these deals are more difficult to come by. I also think every investor should shoot for at least a 10% Cash on Cash, and a relatively high cap. Real estate is a lot of work, and you need to get paid for that work.

  10. Mike Dymski

    I agree, REI is too much work to not earn high rates of return (including appreciation, if applicable); otherwise, you can just invest with sponsors or in other assets classes, cut checks and spend more time relaxing.

  11. Sameer Dalal

    Hi Gino or anyone else,
    Do these metrics really work for states such as California (large cities e.g. Los Angeles)? It’s all about appreciation there. I think it’s next to impossible to find a property with the metrics you mention as a rental in that market.

    • It IS next to impossible to find rental properties in California with numbers that work. Therefore, instead of not buying, too many California investors pay too much and then rationalize that it is all about appreciation. If they stuck to their guns and made offers based on fundamental valuation metrics instead of jumping on the comparable sales bandwagon, maybe Cali prices would not be so disconnected from value. Buyer’s agents want buyers to rely on appreciation, but the last go-around should have taught us how foolish that is.

  12. Gino Barbaro

    Hi Sameer,
    The coasts present a different problem. They are beautiful places to live and attract a lot of competition. With so many people chasing so few deals, prices inevitably rise. Do not buy only for appreciation. You need to buy for cash flow and have the ability to force the appreciation.

    • Sameer Dalal

      Katie, Jerome and Gino thanks for your insight. I totally agree that it doesn’t make sense to invest if there is no cash flow. Costal properties and big metro properties do cash flow but nowhere near the benchmark numbers mentioned in Gino’s post or what BP community considers an industry standard. As Tyler Herman mentioned and I tend to agree the type of properties that meet the benchmark numbers are almost always flat appreciation or appreciate marginally. Katie and Jerome in my opinion you can’t just disregard appreciation even with the stock market if you hold stocks for 20 years you will eventually come out on the top. We are talking about buy and hold or long term investments that generally weather the markets cycles. Market downs would be a concern for investors that are flipping houses not so much for a buy and hold type investor.

      The question is do low cash flowing but high appreciating properties (costal or metro areas) eventually catch up or beat high cash flowing but marginally appreciating properties in the long run?

      • We are not talking about disregarding appreciation. If you hold stocks for 20 years, you may eventually come out on top. However, keep in mind that it has been ten years since people bought at the false comparable-sales inflated prices (not values) of 2006. Many of those people are still underwater. Prices may have finally come back to those 2006 levels in some places, but value has still not caught up.

        Your final question is possibly not phrased correctly. There are more than two choices. Almost any other choice/situation is healthier than the two choices you posit. Generally speaking, real estate historically appreciates at 2-3% annually depending on locale. If your market is currently appreciating faster than that, most sellers try to bundle that (possible) future appreciation in the sell price, leaving the buyer in a precarious situation. In other words, if you buy for appreciation, you are buying high and hoping, praying for higher. That is just the exact opposite of buy low and sell higher.

        My problem with bidding on coastal properties is that too may buyer’s agents have “greater fools” for clients who believe the agent’s advice to buy “before you are really priced out” and don’t worry, because the “guaranteed appreciation will make you rich.” If I wait awhile, a number of these properties will end up at auction. Until hedge funds swooped in, auctions were a great opportunity.

        Hedge funds tend to overbid at auction, but they do not actually care about cash flow or appreciation. In fact, most hedge fund performance is terrible. They make their money in fees. Keep in mind, they retain (risk-free) 2% annually of assets under management (AUM) regardless of actual performance.

        We are not disregarding appreciation. We are saying that appreciation needs to be analyzed correctly. Cash flow is REAL money that comes to you monthly, like dividends. Appreciation is PAPER money that needs to REALized by selling the asset.

  13. Jerome Kaidor

    Before I mess around with cap rate or cash-on-cash, I look at one simple number, and I can reject most deals in about 50 seconds. It’s called Gross Rent Multiple ( GRM ). Just take the gross yearly actual (without vacancy factor) rents and divide it into the asking price. If it’s 10, you will make money. 12 is marginal. Above 12 might be acceptable if it’s an SFR where the tenant pays ALL the utilities. If it’s 15 or above, you will NOT make money; the seller has sucked all the juice out of the deal.

    This all assumes an ok neighborhood and a reasonable rental market.

    Here in the hyper-inflated SF Bay Area, I often see properties offered at multiples north of 18.

    GRM is a very simple number, and less vulnerable to finagling than cap rate. But there ARE gotchas.
    * Sellers can lie about the rents, quoting “pro forma” numbers. This is almost comical when they do so
    in a rent controlled jurisdiction.
    * Properties can be in bad areas where a much lower GRM is required to make money. I have a complex in the California central valley that always has vacancies, and has always required a good deal of TLC and work
    to try to keep it rented up. But it works, because I got it at a GRM of less than 6!
    * SFR’s with all utilities tenant-paid can tolerate a higher GRM than multifamilies.

    So GRM is just a quick and dirty number that tells me whether I want to bother with further analysis.

  14. Joseph Copeland

    Great article and one I could learn much more from. Hoping to get a little better at reading market trends and at what stage each market is in as I try to get more into the larger multi units rather than the smaller ones I currently own.

    Thanks for the article and look forward to reading some of your future articles!

  15. Michael Swan

    Hi Gino and all,

    This is an excellent topic and I have 1031 exchanged my pricey San Diego rental properties due to incredible appreciation since first investing in 10 single family in 2011-2012. At that time I invested for cash flow and decided that as soon as these properties doubled in price, I would sell them. When I found out about the power of the 1031 Exchange, I was off to the races.

    Right now fast forward to today. I have 5 offers approximately $15,000-$20,000 over asking price on my remaining rental property here in San Diego. I am going to trade in $5000.00 cash flow for approximately $20,000-$27,000 cash flow on a 24 unit in Ohio.

    Currently, I have 86 front doors, soon to be 109 front doors. By 1031 exchanging my pricey San Diego rental properties, my cash flow has risen from $50,000 to $120,000 a year and rising rapidly. I expect to be at $200,000 cash flow in one year from today on my way to 1000 front doors and $750,000-$1,000,000 in cash flow each year.


  16. Michael V Akbar


    Thank you, this article was incredibly educational for me.

    Being a newbie I have two dumb questions; while each region or MSA may be at a different points in a cycle, is it possible to characterize our current overall market in terms of one of these cycles? Where are we now (4/18)? Also in markets that are in Hyper supply or getting there how reliably can you use the past three years NOI for analysis if we are in a situation where vacancy rates are or about to increase significantly?

    Thank you again.

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