Profiting From Understanding the Real Estate Cycle

Profiting From Understanding the Real Estate Cycle

If you probe 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 pushed by the basic principal of supply and need. The chief basic in any change to a cycle is usually pushed by the abundance or without 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 meaningful influencers; however employment and wages play a huge part in this in addition.

It is important to understand that every metro area or town will mirror a particular cycle and suburbs or “pockets” within that metro area or town may mirror their own cycles consequently 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 skill in your area, you must probe 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/strength of Sales

· Affordability

· 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 ecosystem at this point will mirror disheartened home owners whose similarities have gone down in price. There will be an overabundance of MLS listings and for sale by owner (FSBOs) ads obtainable 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 possible 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 need becomes more apparent, 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 before, 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 need. It is not until the public perceives the impending need and the next phase of the cycle kicks in do prices increase dramatically.

Within this stage, many people may experience foreclosure/strength of sale as a consequence of the past without of employment. Low or stagnant character value and a without 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 average for your portfolio?

Buy and keep up 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 strength you may want to:

1. Establish purchases using joint venture partners

2. Utilize “buy options” with despondent sellers or builders

3. Create win/win deals with pre-foreclosure/strength of sale owners

4. Increase your marketing to attract eager sellers

As public perception becomes more positive due to popular and sustainable economic growth, need increases. This stage now moves into a higher growth “expansion” phase.

A expansion Market

When employment opportunities increase, people move closer to that area and need for housing naturally increases. This will cause the following:

– The number of listings will increase as those owners needing to sell put their similarities back on the market, however the absorption rate for those similarities will become sustainable

– The number of days on market for a listing (DOM) diminish significantly and ultimately multiple offer situations become standard

– There will be a rise in construction of residential similarities 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 character value, more people may decide to refinance

– The foreclosure / strength of sale rate goes down as character values increase

– Rental vacancy rates decline with more renters migrating for employment opportunities

– Public perception becomes more positive

In this stage it is nevertheless an excellent time to buy as prices will lag behind the need.

What does this average for your portfolio?

1. Buy from other investors for bargain prices who nevertheless haven’t realized a new cycle has begun

2. Buy and keep up for increased equity growth

3. If you can raise your rents, now is definitely the time. revive leases. With low vacancy and high migration to the area, there is high need 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 expansion where minimal renovation is required in order to make a profit. Be careful to not overprice your character already in a frenzied market.

6. Refinance existing similarities to buy more

7. Sell your “less desirable” similarities if you can move the equity into a more valuable character

A “Down” market

A downward trending market happens after the “top” of the expansion cycle. This move can be subtle at first. Many inexperienced investors can “get caught” during this shift. This can consequence from maintaining a selling price higher and longer than the market will bear, instead of 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 need 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, need slows down, and public optimism becomes uncertain.

When a market has too much inventory, need goes down causing a decline in sales, ultimately triggering the amount of MLS listings to increase. This causes the average “days on the market” (DOM) of each character to increase, naturally triggering a downward pressure on prices. This gives rise to less competition for character resulting in “low ball” offers. Anyone who purchased a character to flip but can’t sell may be forced into foreclosure/strength 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 decline 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 average for you and your portfolio?

1. If you missed selling at the top of the market, sell fast and don’t keep up out for top dollar

2. You may need to decline 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, keep up your existing similarities 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 character 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.

The “Bottom”

At the bottom of a market, generally public perception and the economic outlook is negative. The edges’ lending criteria becomes already more stringent. Prices tend to decline and it is not until prices ultimately begin to increase and vacancies begin to decline will you know where the bottom is (or was). Foreclosures or strength of sales become more frequent and economic pessimism prevails as need 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 nevertheless 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 average for you and your portfolio?

1. Take buying slowly but start buying distressed similarities 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 buy one, several or all of their unsold inventory at a discount or with a buy option

The public is usually pushed by the media who are usually trailing the middle or already the end of a wave. This gives those who are studying the meaningful market indicators a definite 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 while many US cities are on their way back up. Some markets are booming, however others keep stagnant and nevertheless others are “correcting.” You can make these observances at almost any time as each area seems to mirror the characteristics of one of the four quadrants.

Just remember, real estate is a localized market which often displays rare indicators not apparent in an nearby city or town. Be sure to probe your market carefully so you can be ahead of the curve in order to maximize your profits.

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