You probably heard it many times: real estate is a cyclical business Each cycle presents opportunities and risks, and knowing where we are in the cycle can help you evaluate the risk in each market and determine the worthiness of deals. The general economy goes through similar cycles, but the ones that are specific to real estate are the ones you need to learn about.
It’s also important to note that different markets can be in different cycles at the same time, meaning that not all markets are in the same real estate cycle, so, for instance, San Francisco can be in a Hyper Supply stage while Jacksonville can be in Expansion stage.
The Four Real Estate Cycles
What are the key real estate cycles? There are four that are often referenced:
3. Hyper Supply
These cycles follow market conditions and interact with each other, so they are fluid. The cycles are tied to long-term vacancy rates, and impact investment opportunities as they transition from one cycle to the next.
How can these different cycles impact real estate investments? It depends on whether the cycle is occurring when vacancies are declining or increasing, and whether new construction is happening. Let’s look at each cycle and its unique impact on real estate investing.
When there is minimal demand and no new construction occurring, you’re in the Recovery cycle. There is not much growth in rents either. To compound the problem, it’s hard to determine whether it’s the start of the cycle or not. This matters because if it is in fact early in the cycle, investors can still find bargain-priced properties that would be ideal “value-add” assets that could be repositioned and become profitable.
You should realize that while pricing on value-add properties may seem attractive, there might not be a quick lease-up until late in the Recovery phase or early in the Expansion cycle. There will be many opportunities to increase rents after repositioning or remodeling, but the rate at which new tenants sign leases may be slow until later in the cycle.
Purchasing core properties during the Recovery cycle can be quite profitable. For those not familiar with the term “core properties,” they’re the least risk investment available, as they are usually fully leased to quality tenants and require little or no major repairs or renovation (though often have lower yields than value-add deals). Some investors choose to purchase a core property in the Recovery cycle and then capitalize on the coming rental growth that will occur during the Expansion cycle. When fully leased, the property is then either refinanced or sold at a profit.