It takes a long time to add new inventory to the real estate market once it’s needed – but it does happen. 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 the cycle from recovery to the next recession is very long (but it always happens) and that real estate never goes out of vogue.
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.
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 of the cycle but will remain robust for some time to come.
Phase 3. New construction comes to market and vacancy rates begin increasing. Rent and sales profits slow before declining into recession.
Phase 4. Recession. An excess of new construction is available to the market. Vacancy rates increase. Rents stagnate and force concessions to encourage occupancy. Strong completion exists as sales decline.
We have passed completely through the most current recovery phase. 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 was also the lowest price point and offered the best opportunity to get in at the bottom of the recovery cycle.
Today, we are well into the expansion phase although it may not be clear to many people because it takes considerable time to produce tangible assets. High rents, high sales profits, and scarcity of inventory attract new development of vacant land or redevelopment of existing properties. However, 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. Early adaptors are already invested in the most promising deals that will come to market sooner rather than later.
There is also increasing risk to investors during this phase. The seemingly unrelenting rent and price increases encourage majority adaptors to pay inflated prices in anticipation that future income will recover the capital investment. This is most notable by slim or nonexistent positive cash flow from newly completed deals.
Coming next is a substantial increase in available inventory. As more and more inventory finally makes it to market, rents and sales prices become stagnant. As vacancy rates increase, concessions begin and rates may even decline. At the very least, rent growth decelerates. Those that bought at inflated prices will not see increasing rents rapidly repay the capital expense. Wise developers and investors will already have started existing the market.
Finally the recession phase. The supply-demand cycle comes full circle. Vacancy rates steadily increase. Sales are at a standstill. Late adaptor projects deliver inventory to a market that does not need it or projects in work are abandoned. This is again a time to buy for the astute investor that is cash rich.
The critical question is how long each of these phases lasts. Almost certainly, there is still time for the early adaptor during the current cycle. However, that window will close and wise investors will have to wait for the next recession to again invest at the bottom of the cycle. Because the real estate cycle is so long, that could be in 5 years, 10 years, or 15 years. Yes, in real estate, there is such a thing as the investment opportunity of a lifetime.
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Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for seven years. He also draws upon 35 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. In the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.