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The Real Estate Cycle

What does a real estate cycle mean? How do you buy property when the real estate cycle is down? When does a real estate cycle go back up? Nobody can see into the future, but let's see if we can figure out when to buy and when to sell property as we try to understand how real estate is cyclical:

Ideally, you want to buy your income or rental property when the real estate cycle is down - when the desire for housing is low or there's been a crash. Timing this is hard, but you don't want to buy property when there's a frency of buyers and it's a sellers market.

There are ups and downs in the real estate market, try to buy when the cycle is in a down trend and its a buyers market. Buy real estate when everyone is desperate to sell and there are a number of foreclosures.

And these real estate cycles can be localized. The overall real estate market might be strong, but there are still areas that may have suffered do to a series of layoffs at a large company in the area or an industry starting to fail. And remember it might take time for the real estate market to come back, especially if you buy a property in an area that's going through changes in terms of industries and jobs that are available.

Currently, there are a lot of changes going on in parts of the U.S. where coal mining is the main industry. Also, there are changes in areas where fracking for oil and gas saw a surge in the need for homes. These are big changes to the local real estate market, where the cycle shot up and now is going down. Are there properties in those areas that are good buys for the long term?

Many economists consider the real estate cycle as a reflection of the economy because the demand for real estate is necessary and crucial for economic growth. (In fact, land is among the three major factors of production, with labor and capital being the other two.) Real estate is considered a cyclical industry because its demand side is impacted by economic cycles, and also because demand has historically outweighed supply.

The typical pattern for the real estate cycle is actually quite simple and straightforward. First, there must be expansion in both the population and the industrial sectors, which are all facilitated by the government. These expansions result in an increase in demand for housing and other buildings, which eventually will exceed supply.

But a lot of time is needed so that supply, i.e. building construction, can catch up with demand. During this time, construction increases demand for land, which in turn is followed by an increase in rent and land values. Then, the rate of increase rises and the demand for housing surges. This is what is known as a real estate boom.

Here are some indicators of supply and demand that you will want to look at when considering a new area:

  • Employment growth – New jobs are made available by the emergence of new businesses.
  • School growth - and the quality of the schoools.
  • Regulation – This includes all sorts of regulation, such as federal, state, and local taxes; environmental regulations; lending laws; and local zoning and building codes.
  • Uniqueness of the area – What attractions are around? What other incentives are available that will solidify one’s decision to stay in the area?
  • Political activity – The national government is the largest borrower in the country, so its actions have enormous effects on the economy. For example, deficit spending by the government makes less money available towards loans and construction.
  • Impact of other investors on the market – Are other investors crowding the scene? What kind of deals are they making, and how much of the area are they covering?
  • Mortgage funds – Most times, a buyer lacks sufficient funds to finance a house, so most homes are built and purchased with borrowed money. The availability of this money directly affects both supply and demand.
  • Social attitudes – How old are the people of the area? Both baby boomers and their children are buying housing, which therefore increases demand. Divorces also increase demand since there are fewer people per household.
  • Interest Rates - low interests draws in more home buyers and increases the demand for housing overall.

Although factors such as these may indicate expansion, you need to ask several important questions in the meantime, many of which will change your confidence in the area. Many issues you’ll need to address are whether or not the new businesses are transitory or secure; if these businesses are well-known and likely to hold their own; if the area has long-term expected growth; if you notice the development and/or improvement of major highways; and so on and so forth.

Weigh these factors carefully and talk them over with other people whose judgment you trust. The peak of the real estate cycle can be spotted when you notice a high volume of real estate transfers. This is the interval between the peak of real estate prices and of the value of construction. Once this period hits, the supply of new houses surpasses the number of occupants, or demand.

After the boom and subsequent peak, there will be a correction, or a bottoming out where real estate prices drop below market value. The reason why prices plunge is because too many homes have been built, or in other words, supply outweighs demand. The onset of this period signals that the opportunity has arrived to take advantage of cheap, but high quality real estate. It’s time to buy, buy, buy with the money you’ve saved and maybe with the partners you’ve gathered in the meantime.

All indicators must still be scrutinized, perhaps now more than ever. Ask more questions, modifying previous inquiries with specific details that reflect the progression of the area and the value of property.

  • What are the contingencies and future implications of these indicators? Are they stable?
  • How has the progression of the aforementioned supply and demand indicators evolved, if at all?
  • Has this area been over-developed?
  • Does the area rely on one source of employment, or are there multiple companies that offer work for the community?
  • What is the breakdown of the population now?
  • What are the current rents in the area - at a high or lower than normal?

At the heart of your questioning and scrutiny, however, you should perpetually wonder, “Have a bunch of builders simply come into the area and overbuilt it just because the area is there? And are investors merely responding by rushing in as the market seems to bestow great promise?”

In other words, if it appears too good to be true, it probably is. The take-home lesson is that you need to dig deeper into the local markets that are unknown, and then determine whether there's a diamond in the rough or just a lump of coal dressed up with fancy attire.

After the Great Recession, and the housing crash of 2008, the real estate market dropped and we went into a down turn in the real estate cycle where home owners where trying to sell at any price - many had to foreclose on their properties too.

This huge downturn in the real estate market means we are unlikely to see another when in the near future, sure there will again be a real estate market crash, but I'd guess that not for some time. Instead, there might be more local real estate market crashes, and that's where you need to look if you're trying to buy property during a downturn in the real estate cycle.

If one thing is true, due to greed and over-confidence, real estate market prices usually rise higher than they should and then shoot down lower than the should. Real estate cycles often rise too high but then over correct and go lower than they should.



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