Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from Ms. Nadia (unknown location): Good Day, My aim is to invest in real estate such as the acquisition of land, villas, or other properties, to set up a hotel around a beachside area. Do you think that can be profitable at this time of the pandemic or do you have an idea of any lucrative business to invest the huge amount left for me by my late father? Looking forward to hearing from you.
Answer: Hello Ms. Nadia. Setting up a hotel is very much a commercial investment rather than a residential investment. It will require advanced and long-term investing advice and project management. Although a beach hotel sounds appealing, it’s my humble opinion (supported by data) that hotels are one of the riskiest commercial investments. The thought that first comes to mind is that very few people are traveling during the pandemic and even fewer are traveling for pleasure. But we may soon reach a post-pandemic normal.
Developing raw land or converting another property will take significant time to accomplish. The pandemic could very well be in the rearview mirror by the time a hotel comes online. The bigger question to answer is probably how long a post-pandemic economy will take to fully recover. Also, you didn’t mention what part of the world you are considering for your investment. The world economy doesn’t usually recover all at the same time. With that said, let’s look at the different phases of the real estate market cycle.
Ms. Nadia, with the COVID-19 vaccine now rolling out, we are hopefully near the end of phase 4 and will soon enter phase 1. This can be the best time to make new investments if you don’t need immediate income from the property (that is the case when beginning new construction).
Real estate follows the most basic economic law of supply and demand. However, a few twists make it very different from basic consumer products. Namely, that constructing a new property takes considerably longer than bringing most consumer products to market. Also, real estate never goes out of vogue the way consumer products do.
There are four major phases to the real estate business cycle. These are:
Phase 1. Recovery from the previous recession. This is primarily notable for a marked decrease in vacancy rates. However, very little new construction is occurring. For investors, this is a good time to position yourself to be among the first to market.
Phase 2. Beginning expansion of new construction. Vacancy rates remain low and typically continue declining as new construction planning begins. Investor profits from rents and sales near the peak during this phase and hopefully will remain robust for some time to come.
Phase 3. New construction comes to market and vacancy rates begin increasing. Rent and sale profits slow before declining into recession.
Phase 4. Recession. An excess of new construction is on the market. Vacancy rates increase. Rents stagnate and force price concessions to encourage occupancy. Strong competition exists as rents/sales decline.
The pandemic put us in phase 4 beginning last March. This was marked by high unemployment, decreased consumer purchasing, almost nonexistent business expansion, and government intervention with low-interest rates and stimulation. For real estate investors, this is also the lowest price point and offers the best opportunity to get in before the recovery phase.
Soon, the distribution of the vaccine should move us into phase 1. Although this is an opportunistic time for investors, it is also risky. The risk comes from not knowing how long the recovery will take nor how robust it will be. Adding to the risk for real estate investors is the amount of capital required for new construction and the length of time to bring a new property online. Real estate development is a long process beginning with market studies and sales negotiations for vacant or underused properties. Zoning and permitting must also be accomplished. Finally, financing is put in place before sales are completed and new construction begins. Astute investors can still get in on great deals at this point. Phase 1 is when early movers invest in the most promising deals that will come to market sooner rather than later.
Ms. Nadia, the critical question is how long each of these phases lasts. Every new cycle lasts for a different length of time. The Great Recession went on for years and years. So far, the COVID recession has been about 9 months and might fully recover by this summer. Certainly, this is the time for early investors as a new cycle begins. However, that window will close and it’s possible the next cycle won’t come along for 5 years, 10 years, or 15 years (no one knows when). Yes, in real estate, there is such a thing as the investment opportunity of a lifetime.
Please comment with your thoughts about where the real estate market is going in 2021.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].