Understanding Real Estate Cycles
Be it an investor or a real estate developer; it is essential to have knowledge on the real estate cycle, both on a macroeconomic and microeconomic scale (Bouchouicha, 2012). The real estate sector is closely linked with the general economy, and it cannot be assumed that the market is performing well because the general economy is performing well. Real estate cycles can be incredibly nuanced; however, it’s possible to realise each phase, no matter what cycle the market is currently experiencing. The cycle is a four-phase wave pattern through which commercial and residential markets move. These phases are recovery, expansion, hyper supply, and recession (Esajian, 2021). Understanding each phase helps in predicting upcoming trends and making informed decisions about investments, developments, and regulations. Continue reading to understand the four phases of a real estate cycle.
What Are the Phases of the Real Estate Cycle?
As the four phases of a real estate market are intertwined in a cycle and loop, there is no definite way to describe the first step of the market cycle. Each phase follows the one preceding it and is linked to the next. The most significant event of this century in terms of real estate cycles was the US market crash in 2008. Although some believe that it was not predictable, there were actually many indicators that made it inevitable sooner or later. It is, therefore, only reasonable to start with understanding the recovery phase. It can be understood from the name that the recovery phase starts when a market is at its lowest point and in a recession (Formigle, 2016). But what does it mean for a market to be in a recession? It is the point where occupancy rates for properties are at the lowest, and new construction projects are very limited or non-existent. Rental growth is also experienced at a rate below that of inflation. For individual homeowners and renters, it might be challenging to differentiate between the recovery and the recession phase because the market will look the same. Experts in the field look at trends such as gradual occupancy rate increases or growing demand to identify when the recovery stage has begun. The recession phase is a good time for real estate investment and speculation as prices of properties are low and the potential for profit generation is very high (Kuhail, 2020).
The next phase of a real estate cycle is called expansion. The phase starts when the market has completely recovered from the recession phase and is strong. The market is considered to be in the expansion phase when the vacancy is low, rent rates are high and rising, property values are high, and new construction and development is ongoing. This presents an opportunity for investors to invest in rental properties and renovations of old buildings since the demand is high and tenants are usually easy to find. However, due to large profits being made in the sector, multiple investors and developers can collectively contribute to an increased supply of units in the market. This is known as the next phase of a real estate cycle called the hyper supply phase. In this phase, the supply catches up and exceeds the high demand as previously constructed projects continued to add inventory in the market. This can lead to a rise in vacancies and slow rental growth. However, some investors can also buy commercial and rental properties from companies that are nervous about an impending recession to sell at a more attractive price. The last phase of the real estate cycle is called the recession phase. In this phase, the supply has over exceeded the demand, and we can see rates and rental growth plummets. Investors can look for acceptable investment opportunities during this phase since properties usually hit rock bottom prices. As the market begins to recover, these properties can be sold to eventually gain high profits.
Factors Affecting Real Estate Market Cycles
Several factors can contribute to different phases of the real estate cycle. It is impossible to provide a concrete list for these factors; however, experts believe that some of the following factors are the main contributors. Firstly, demographics have a huge impact on the real estate cycle. The makeup of a population and major shifts in thereon can drive a market upwards or downwards, respectively. An ageing population will have distinct and unique needs compared to a population having young individuals. This can result in shifts in housing demands, medical facilities, recreation facilities, and transport infrastructure. Secondly, interest rates also influence a potential buyer or seller’s perspective on buying property. When interest rates are high, many investors can be deterred from investing. Conversely, lower interest rates encourage investment and spur home buying activity, as the long-term cost of financing is lower. Thirdly, the role of the general economy can also play a role in determining the future of a market. When the economy is growing, consumers feel encouraged to buy residential real estate. An increase in personal wealth improves living standards, and more people are comfortable investing in a home. Vice versa, a sluggish economy can slow down the market significantly as other areas of surviving become more important. Lastly, government policies also play a massive role in the growth of markets, especially after a prolonged recession. Policymakers can implement tax deductions, subsidies, tax credits and provide incentives to consumers in purchasing real estate. These types of governance mechanisms can greatly influence the housing market cycle (Rhode, 2021).
Understanding the phase of a real estate market can help investors, developers, regulators, and the general public to make informed decisions. The four phases of real estate market cycles are recession, expansion, hyper supply, and recovery. Each phase has specific characteristics which allow stakeholders to manoeuvre themselves accordingly. There are also several factors that impact each real estate cycle, such as demographics, interest rates, the role of the general economy, and government regulation.