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 the same as do the influences and indicators dictating the pattern. Being able to recognize the evidence of a changing cycle can give you an untold advantage in the marketplace allowing you implement strategies prior to the eventual market shift.
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 therefore it is 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
· Public perception
We will now discuss the 4 stages of a real estate cycle using the indicators outlined above to determine our investor strategies. We will begin at the bottom of the cycle at the point where recovery is beginning and work our way around.
A Recovery Market
The recovery stage of a cycle begins at the point when a market has “bottomed out”. There will be much pessimism in the public as they have been experiencing low or stagnant job growth, poor housing sales and general economic negativity.
This stage is subtle in its shift, so identifying the change in the market is challenging. The existing environment at this point will reflect disheartened home owners whose properties have gone down in price. There will be an overabundance of MLS listings and for sale by owner (FSBOs) ads available on the market. As prices continue to fall, expired listings will increase as despondent owners decide to wait for a recovery in the market. The overall absorption rate for home purchases and any remaining new construction will be low.
The vacancy rate for rentals during this time is low as many potential buyers are delaying their decision to buy as public perception of sustainable real estate growth is low. This is good for landlords as rental rates go up and cash flow increases.
New inventory is down as new construction is almost at a standstill however, as the cycle continues and demand becomes more evident, new construction slowly begins as does a small amount of pre- construction speculation. You can check at your local City Hall to monitor how many new building permits are being issued.
Of course the stimulus for any market movement, as mentioned previously, stems from employment. Typically when employment growth begins, new migration comes to the area. The great aspect for investors is the fact that real estate price increases typically lag behind actual demand. It is not until the public perceives the impending demand and the next phase of the cycle kicks in do prices increase dramatically.
Within this stage, many people may experience foreclosure/power of sale as a result of the previous lack of employment. Low or stagnant property value and a lack of income create difficulty in renegotiating or refinancing mortgages.
This initial phase can be an amazing window of opportunity for the investor to get a “jump” on the market to cautiously begin buying.
What does this mean for your portfolio?
Buy and Hold during this phase to capture maximum equity growth. Buy and flip later in this stage. In order to increase your portfolio and leverage your purchasing power you may want to:
1. Establish purchases using joint venture partners
2. Utilize “purchase options” with despondent sellers or builders
3. Create win/win deals with pre-foreclosure/power of sale owners
4. Increase your marketing to attract anxious sellers
As public perception becomes more positive due to favorable and sustainable economic growth, demand increases. This stage now moves into a higher growth “boom” phase.
A Boom Market
When employment opportunities increase, people move closer to that area and demand for housing naturally increases. This will trigger the following:
– The number of listings will increase as those owners needing to sell put their properties back on the market, however the absorption rate for those properties will become sustainable
– The number of days on market for a listing (DOM) diminish substantially and eventually multiple offer situations become commonplace
– There will be a rise in construction of residential properties and pre-sales will increase as will the number of speculators
– Mortgage qualification may become less “stringent” allowing more borrowers to get into the market and with increasing property value, more people may decide to refinance
– The foreclosure / power of sale rate goes down as property values increase
– Rental vacancy rates decrease with more renters migrating for employment opportunities
– Public perception becomes more positive
In this stage it is still an excellent time to buy as prices will lag behind the demand.
What does this mean for your portfolio?
1. Buy from other investors for bargain prices who still haven’t realized a new cycle has begun
2. Buy and hold for increased equity growth
3. If you can raise your rents, now is definitely the time. Renew leases. With low vacancy and high migration to the area, there is high demand for rental units, however if interest rates are low, renters may be jumping into new homes. It could be a time to talk to your tenants about becoming tenant/buyers and put them in a rent to own program.
4. Rent to own. This strategy works well for tenant/buyers who want to get into the market but can’t due to inability to mortgage qualify.
5. Buy, fix and sell. There are times during a boom where minimal renovation is required in order to make a profit. Be careful to not overprice your property even in a frenzied market.
6. Refinance existing properties to buy more
7. Sell your “less desirable” properties if you can move the equity into a more valuable property
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 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 “low ball” offers. Anyone who purchased a property to flip but can’t sell 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 this 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.
Vacancy rates 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 portfolio?
1. If you missed selling at the top of the market, sell fast and don’t hold out for top dollar
2. You 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 you don’t sell now, hold your 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 capture the fear and panic experienced in sellers as they 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 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.
Tip – Be careful to not label a “self-correcting” market a down market as the factors varies slightly from a down market.
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 amount 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.
New construction during this time is drops however new builds already underway still come on line. Many contractors either become renovators or get out of the business altogether. Realtors and mortgage brokers tend to leave the business during this cycle.
What does this mean for you and your portfolio?
1. Take buying slowly but start buying distressed properties later in the cycle
2. Holding and waiting for the “recovery ” market indicators if you are looking to ultimately sell
3. Provide furnished rentals to keep your unit rents up
4. Approach builders who have unsold inventory and 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.
Many Canadian metropolitan cities today (as of this writing) have been touted as being at the top of their market whereas many US cities are on their way back up. Some markets are booming, yet others remain stagnant and still others are “correcting.” You can make these observances at almost any time as each area seems to reflect the characteristics of one of the four quadrants.
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 in order to maximize your profits.