The 4 Phases of the Real Estate Cycle

They say history repeats itself... that's true even when it comes to real estate 

Hello Everyone! I hope you are all doing well. It's been a few weeks since I last reached out. Things are busy in my household lately as we prepare for our second babies arrival in just a few months. We're preparing the nursery, attending childbirth classes and refocusing our time blocking schedule to do as much as we can in our Note business before his arrival. It's an exciting time but one thing that I have remained adamant about is trying to learn everything I can about the financial world. It's become even more important to me as I get ready to introduce another life into this world for a few different reasons. 1) Finances control our world and the less you know about what finances are and what they do, the more impact they usually have on you 2) I want to be able to set my kids up for success right out the gate. The more they learn about the financial world (whether they plan to be in it or not) the more they can secure their future and make smart decisions with their money. Speaking of money, let's dive right into cycles. From a healthy market to a recession, There are some key things to keep in mind. I think this is an extremely important topic and one that people understand the least. 

There are 4 phases in the Real Estate Cycle according to a man named Henry George in the 1800's. Do you know what they are and how to identify where we are in the market? I am going to do things a little bit backward here and start with Phase 4. 

Phase 4 - Recessions

There have been approximately 47 recessions in the United States. Now not all of these are real estate backed but real estate was impacted by these recessions. When we are in phase 4 we see rental growth at 0 or negative numbers. Occupancy rates have fallen below the average. We have a massive oversupply which causes rents to be lowered and losses to occur. Due to this, the federal reserve hikes up interest rates which makes it harder to buy or build a new home. Construction slows down and investors stop making moves as the inventory is too slim for profit margins. This ends up affecting jobs causing layoffs and then homeowners aren't able to make their payments. Foreclosures began to occur. This ends up impacting the entire economy. However, once the market hits rock bottom there is nowhere to go but up leading us to our next phase. 

Phase 1 - Recovery 

I think we are all pretty familiar with this phase after our last recession. That house down the street from you that was being sold for $450,000 a few years ago is now selling for $150,000. Housing is cheap and many people are underwater. There is an oversupply of inventory. Spec homes from all the excess construction have been sitting vacant. Some even for years. Slowly but surely buyers are coming out from behind the covers and purchasing real estate again. Investors are able to pick up homes at a steep discount and vacancy rates fall allowing rental rates to stabilize and eventually increase. At this point, new construction really isn't in demand as the real estate market absorbs the existing oversupply. The Federal Reserve has dropped their interest rates to allow for more homeowners to saturate the market. Property values start to increase. It's a grim time for the real estate market but things are finally looking up. 

Phase 2 - Expansion 

Your market may currently be in the expansion phase or slowly going into phase 3. Demand growth increases as do property values. Due to the tight supply, rent rate spikes may occur. Once rents raise high enough, new home construction appears to be more cost-effective for buyers. Vacancy rates continue to fall until the need for an affordable rental home is hard to accomplish. Historically expansion cycles are a slow uphill climb and can be long-lasting. Sellers began pricing their land at a premium in anticipation of what the future value will be and a real estate bubble begins to form. "However at some point, supply finally catches up with demand. This key point is called equilibrium and marks the end of the expansion phase. Unfortunately, since occupancy rates are at their highest possible levels, most real estate participants don't recognize when this occurs." 

Phase 3 - Hypersupply 

I call this phase "The calm before the storm". At this point, we have a huge supply of new construction but not a whole lot of demand. Property values are high and buyers seem to be sitting on the fence for a lot longer. The real estate market is generally quieter. This causes occupancy rates to fall and rental growth to slow down. Rentals and Suppliers of New construction now began to heavily compete for occupancy. Once the market realizes that a downturn is inevitable, new home construction virtually stops. Determining when that downturn happens is the key to figuring out if and for how long we will enter into a recession. 

Regardless of what your investment vehicle may be it is important to know where we stand as an economy in the market cycle. Do you know what phase we are in today? Have you secured your investment? Is it recession proof? If the answer is no to any of these, I encourage you to start taking a good look at the market and how you can ensure you're not set up for failure. 

One of the main reasons I chose notes as one of my investment vehicles is because of the impact my business can have on those who have been impacted by a recession. When the real estate market costs are high, note prices are high. When they are low, note prices are discounted. Having a private note holder vs a bank can make a world of difference to the mortgagee. Private note holders have the ability and generally are more likely to work with you to be able to stay in your home vs a big box bank where they may start foreclosure on you right away without giving you options. My core value at Ironside Investments is to make every situation a Win-Win situation.