One helpful way to determine the optimal time to buy, sell or hold your property investments is to track the real estate cycle for your local area. (See the video)
Of course, the real estate cycle can be tracked on the national level. However, savvy investors know that local factors matter most when it comes to selecting an investment within a specific market.
Understanding the trends and what to look for will help you read when a market is hot and respond wisely, no matter what phase of the cycle you find yourself in.
What are the phases of the real estate cycle?
The real estate cycle has four phases: recovery, expansion, hypersupply and recession. Each quadrant will tell you something different about the supply of housing, vacancy rates and the relative value of properties.
It is also important to note that this concept can be applied to both the residential homes and commercial properties. We will be focusing on what this cycle means for investment properties.
The first phase of the cycle, the recovery phase, follows after a recession in the real estate market. Most recessions are not as dramatic as the Great Recession of the late 2000s, but that highly visible event can help us think through what usually happens on a smaller scale.
After an economic slump, construction of new housing slows or sometimes stops entirely as consumers lose interest or capacity to make large-scale purchases. Gradually, as the economy recovers, individuals gain more of an appetite to spend. Without an influx of new housing produced by ongoing construction, the existing supply of housing becomes more scarce and more valuable.
This is where you will see an increase in rental property occupancies. Costs also will increase, both for rent and property purchases.
It can be tricky to identify the beginning of a recovery, because the recovery will not affect everyone at the same time or in the same way. Most families will still be feeling the effects of the recession, even while the housing supply is tightening.
Ironically, the moment it is obvious to most people that the economy is recovering usually means we have entered a new phase in the cycle: expansion. During expansion, new construction has begun but has not caught up to the demand for housing that now exists. Prices climb even higher for a dwindling inventory of housing options.
Eventually, the market will reach an equilibrium point. This is where new construction and the existing supply equals the current demand for housing. However, what quickly follows equilibrium is a slide into the third phase of the real estate cycle: hypersupply.
The hypersupply phase means that rental and purchase prices for housing will begin to fall again. With an influx of new housing and lower prices on existing housing options, consumers have more options. The market will become more competitive to those selling or looking to profit from their investments.
Construction tends to lag behind the demand. This means that new housing will continue to be completed even as the market falls into the fourth and phase of the cycle: recession.
Again, not every recession will be a Great Recession. However, a recession does mean that investors who are unprepared may find themselves overspent and unable to sell properties that have a slowly decreasing value.
Importantly, a local real estate market might experience dips and upswings that are not reflected in the wider economy. It is important to look for signs that indicate where the local economy is in the cycle before choosing an investment strategy.
How should I invest at each phase of the cycle?
An investor’s goal is to stay just one step ahead of the real estate cycle. You certainly do not want to get caught behind the curve, holding on to a property no one is interested in renting or buying from you. So, if you are able to read the market, what is the right move for each phase?
Ideally, a recession is a great time to purchase properties that are being sold for rock-bottom prices. During this time, homes in foreclosure or bank-owned make great options. While the local economy is lagging behind, investors may find more families interested in renting their properties rather than purchasing their own.
When the market starts to recover, look for investments that can be refurbished into higher income properties when the economy swings into expansion. Such investments may require some vision for the rebound of the economy that is coming.
Expansion, of course, is a great time to sell your investment properties at top-dollar prices. You will want to make sure you identify and hold on to key properties that will remain profitable even during bleaker conditions of a recession.
Every phase offers different opportunities for real estate growth, as long as you invest wisely and maintain some capital on hand for leaner seasons.
What phase are we in now?
The whole reason I am tackling this topic now is because I believe we are at a critical juncture in the real estate cycle. The real estate market, especially in my local community of South Florida, has been expanding exponentially. However, I believe we are close to an unfortunate point in the cycle where it will become too late to sell.
At the moment, the temptation is to continue to invest while prices continue to rise and rise. Though I do not think we are in for a full housing market crash, I do think we are getting close to the peak of home prices.
Now is the time to select those key properties that will remain part of your long-term investment strategy. My advice is to consider new purchases carefully. Calculate your profit margin with two outcomes in mind: one if the market continues to grow, and another where real estate suddenly cools. Would a price you are willing to pay today be too high if an influx of housing inventory were to flood the market?
Seek the local investment experts
Of course, every situation is different. As I said before, the local conditions that surround your potential investment play a big part in determining whether the purchase is worthwhile or risky.
Royal Empire Realty is your answer for personalized advice on your current or future South Florida investment properties. We regularly provide our clients with an up-to-date forecast of the market conditions.
Call us today for advice on how to expand and maintain your Empire.