4 Phases of a Real Estate Cycle
Successful real estate investors keep their eye on the real estate cycle to identify investment opportunities. Like the broader economy, there are four phases to the real estate cycle – recovery, expansion, hyper supply and recession. The cycle repeats in waves so that the recession of the last cycle leads to the recovery period of the next cycle. As an investor, you can use the real estate cycle to match your investment strategy to the cycle phase. However, it is impossible to tell how long each cycle will last.
What the Real Estate Cycle Tells Investors
A close examination of the current real estate phase can tell you a great deal about the desirability of an investment opportunity. Determining if you are in the recovery, expansion, hyper supply or recession phase allows you to make some assumptions about how much of a return you can expect on your investment. You can also make an educated guess about how long you will have to hold the property and what your exit strategy is likely to be. The real estate cycle can indicate the income and appreciation performance of a property, and it can suggest the right time to make capital improvements.
The Recovery Phase
During the recovery phase, the real estate market is at its lowest point. There is typically a high rate of unemployment and a large number of foreclosures. Prices for real estate start to stabilize, new construction begins and the vacancy rate declines. The recovery phase is the time to buy if you can buy low and hold the property to sell high in the future. This is a good time to find a deal on a core property. Investing in a value-add property requiring improvements takes a great deal of thought during the recovery phase, since leases may be down at this time. If you are willing to take a risk, a distressed opportunistic property obtained at a bargain basement price can produce a high return when you sell after several years.
The Expansion Phase
After the recovery phase, the real estate market is in the expansion. Prices rise and new construction increases as the unemployment rate goes down. The Gross Domestic Product rate is at normal levels and job growth strengthens. Rent prices rise as occupancy rates improve. At the high point of the expansion phase, supply and demand for real estate are in perfect balance. The expansion phase is a good time for value-add investors who acquire properties at a discounted price and invest in improvements so the property will command a higher value. Core plus investors who want lower risk will benefit from a high tenant retention rate and continuing increases in rental prices. However, opportunistic investment opportunities are generally few and far between in the expansion phase.
The Hyper Supply Phase
Development and redevelopment during the expansion phase can contribute to the hyper supply phase when there is an excess of space available. There may be a weakening of demand due to economic factors, and vacancies begin to rise as rent declines. During the hyper supply phase, some core investors sell ahead of a challenging leasing market and a possible decline in property values. However, core properties that have a high occupancy rate and strong tenants with longer leases may choose to ride out the coming downturn. The hyper supply real estate phase can last for a long time.
The Recession Phase
In the recession phase, real estate supply overshadows demand, producing a high vacancy rate. New construction typically stops and home prices fall as selling begins, making homes more affordable. Rent reductions are common, and owners may offer concessions. The recession phase is a good time for opportunistic investors. They can find a distressed property or a foreclosure at rock bottom pricing, improve and reposition the asset and dispose of it early in the expansion real estate phase.
Tips for Matching your Strategy to the Cycle
Keep in mind that the four real estate phases do not occur in equal time periods. Recovery can be brief and transition quickly to expansion, or it may last for years. The real estate cycle also varies according to geographic and asset class factors. Savvy investors balance performance highs and lows with a diverse portfolio of investments targeting different strategies.