Understanding The Four Phases of The Real Estate Cycle

Predicting a city’s position in the real estate cycle can result in opportunities for profit. On the other hand, failure to know where the market is in the cycle can be disastrous.

To help identify the opportunities in our current real estate market lets first get a better understanding of the four phases of a real estate market cycle.

Recession. In this phase, sales activity is very slow, while prices and rents continue to decline. The rate of decline begins to decrease and eventually bottoms out. Almost no new construction occurs.

Recovery. After a recession, the market stabilizes, prices begin to recover, and excess space begins to be absorbed. This process continues, and the vacancy rate begins to approach equilibrium, where supply equals demand. Recovery is usually caused by one of two factors: External shock from a development outside of real estate, such a revision of tax laws, may cause the recovery, or, passage of time from the real estate cycle running its normal course. After a recession or depression, very little or no new construction may occur for several months or years. Eventually, general economic activity begins to increase the demand for space, excess space is absorbed, and financing become available on favorable terms.

Expansion. During the expansion phase, space becomes difficult to find, rents rise rapidly toward new construction levels, and prices continue to increase. Construction activity increases dramatically, but vacancy rates remain at the normal level or lower. This phase may last for a few months or for years, depending on the activity of system components, national economic trends, shifts in basic employment, or changes in social relationships (such as family size or space needed per worker).

Hypersupply or Oversupply. At some point in the expansion phase, the market may become over built. Builders and lenders may not perceive that the market is saturated. They continue to pump capital and new buildings into the market or an external shock occurs such as an unfavorable tax law or a general economic recession. In this phase, prices begin to drop, sales activity begins to slow, and vacancies begin to increase. As these changes occur, the tend to gather momentum, and prices and sales activity continue to slow even more. New construction continues for a while in this phase for two major reasons; Builders, developers, or lenders do not detect the changes occurring in the market, or some projects cannot be stopped. When these projects are completed, however, new developments and construction quickly come to a halt.

Identifying what phase the market is in is extremely helpful when developing an investment strategy.

Which is why I offer my clients a quarterly market report as a value added service to help them better understand the current market and make informed investment decisions. By working together with my clients to understand their goals and objectives I am able to develop an investment strategy to add value to their property. Contact me today to see how I can help you!

Sources: CCIM Institute & IRR Viewpoint 2007