What is the Real Estate Cycle?
The real estate cycle is a graphical representation which demonstrates how the market tends to work.
Historically, the cycle repeats itself. By knowing where in the real estate cycle the current market is, a consumer of real estate may make educated decisions as to when to buy and when to sell.
How does the cycle work?
The cycle can be explained by following its progression as indicated by the arrows. Our most recent experienced in of the real estate cycle began in the early 1990s following the crash in 1988-89.
Note: as you are reading through the progression of the cycle, consider the law of supply and demand.
- Absorption of Excess Supply (…, 1971, 1984, 1993): Real estate is often targeted by investors. Investors, sometimes referred to as “bottom fishers,” are extremely astute have an incredible understanding of the real estate cycle and the indicators that prove that the cycle is in the position they believe it is in. After declining rents, prices and construction, news articles and word of mouth stories perpetuate a general anti-real estate sentiment. This emotion is what wise investors completely ignore. This is why Warren Buffet remarks, “Buy when everyone else is selling.” Thereby, any point along the bottom third of the real estate cycle (if a line were drawn horizontally, would refer to the bottom of the market. Not only are interest rates generally lower as the Fed attempts to prop up the market with cheap money, but the market is often saturated with distressed sales (short sales, foreclosures, etc), which can often be spectacular deals for investors or first-time home buyers. This is similar to what occurred in late 2011.
- Low Vacancies: In most recent history, this stage of the cycle occurred between 1996-2000. Investors and home owners enjoyed moderate growth and prime loans.
- Increased Rent and Prices ( …, 1972, 1987, 2002): Prices increased dramatically during 2000-2005. For instance, one home on a corner lot in C Street in Oxnard, CA sold for $550,000 on May 28, 2004. Less than 8 months later, in 2005, the same property sold for $670,000 in the same condition. That’s 33% annual appreciation. Real estate was the hot topic. Everyone wanted to be a part of it. The desire to be a part of the real-estate craze created demand for more competitive loan products. The looser lender guidelines became, the easier it was for people to qualify, and — as a result — more properties could sell and prices rose even more; the bubble began to inflate. By 2006, prices had started to fall in Ventura County and we advised investors we worked with to consider selling their properties. The signs of an economic turn around were beyond evident. They were glaring. Why did people buy then? The rationalization of the time was, “The housing market is bullet proof. Prices will continue to rise exponentially! Anyone would be able to refinance if they were no longer able to afford their mortgage.” Unfortunately, when the market finally fell, as it historically always has, refinancing or selling was no longer an option for those who had just bought; they were underwater.
- Accelerated New Construction ( …, 1973, 1981, 1988, 2007): Builders stepped in. 2002-2006 marked an incredible time for new developments, both planned and built. Unfortunately, many of the planned developments never came to fruition upon the collapse of the market. Many existing construction projects were abandoned as financing opportunities dried up. A famous example is the Riverpark development in North Oxnard. The project broke ground in 2007, only to stall through the recession. Riverpark had become an eyesore as buildings sat half-built, until the market changed directions in 2012.
- Oversupply: The developments that were completed too late ended up incomplete or vacant.The market had become saturated with new homes and buyers had either already bought or could no longer afford the extremely appreciated prices of homes. In addition, in 2007, people began having difficulties paying the incredibly expensive loans they had acquired in the early 2000s.
- High Vacancies(…, 1975, 1982, 1991, 2008): The over saturation, in addition to changing factors in other markets, such as soaring oil prices, a collapsed stock market, and reduced ability to lend lead to a crisis with a climax in September of 2008 (even though signs of this climax had been clear since late 2005). As the Leman Brothers company collapsed, other financial institutions followed. Homeowners with subprime loans were no longer able to afford their still young mortgages because their rates adjusted upwards, they lost their job, or something else. People then began losing their properties. When someone stops paying their mortgage, it’s not the person who made the loan who initially gets hurt. Mortgages are almost always sold by the loan originator to a secondary mortgage market. These newly bought mortgages are then bundled up and sold as bonds, like Mortgage Backed Securities (MBS). MBS are rated and then on the open market. Towns in Sweden and other far away areas invest in these securities. Companies that sell these securities encourage lenders to create more loan products so that they have more mortgages to buy, package, and resell. Some companies sell the securities and then offer an insurance against their failure to a buyer. These companies then collect premium payments through products sometimes called a credit default swap or CDS. When mortgages begin to fail, they affect the entire market.
- For a simplified and humorous explanation of the financial crisis, watch this slideshow: Evolution of the 2008 Financial Crisis.
- Declining Prices, Rent, and Construction: Prices of real estate free fell. The overinflated real estate bubble burst sending millions out of their new homes they likely weren’t able to afford for the long run in the first place.
The real estate cycle is predictable. However, there is no set amount of time that the real estate cycle takes to repeat itself. It could take 20 years, or 7 years. Either way, the cycle follows a set path every time it occurs. By following the indicators that determine where in the cycle the market is currently located, one can make an educated decision in real estate and make money.
Here’s the bottom line though: If you love a property, can afford the property for the long haul, and your agent believes that you are paying fair market value, then you’re getting the best price possible.
Don’t wait to buy real estate; Buy real estate and wait.