The economy strongly influences the real estate market. As investors, it’s important to understand the economic cycles and how each phase ties with the real estate cycle. The 4 stages of the economic cycle, known as the expansion, peak, recession, and trough, significantly affect the performance of the real estate market. By understanding how these cycles impact real estate investments, investors can make smarter decisions to help them succeed through the highs and lows of real estate.
In this blog post, we will break down the 4 stages of the real estate cycle and the best strategies for real estate investments during each phase.
What is meant by an Economic Cycle?
The economic cycle, also known as the business cycle, refers to the fluctuations in economic activity that an economy experiences over a period. Each of its phases impacts real estate market performance differently.
Expansion: Economic activity and employment increase, and consumer confidence grows. Real estate markets often experience increased demand, higher property values, and new development projects.
Peak: The economy is at its maximum output. Unemployment is low, and inflation may be rising. Real estate markets tend to experience high property values and rental rates.
Recession: Economic activity slows down, unemployment rises, and consumer spending decreases. The real estate market may see declining property values and higher vacancy rates.
Trough: The economy hits its lowest point. Real estate markets may bottom out, presenting opportunities for investors to buy properties at lower prices.
What are the Life Cycles of Real Estate?
The real estate cycle specifically pertains to the fluctuations in real estate markets. It also consists of four phases, but these phases directly affect real estate performance.
Recovery: This phase occurs after a market downturn. Demand starts to improve, occupancy rates slowly increase, and rental rates begin to stabilize. However, new construction is minimal, and property prices remain relatively low.
Expansion: Similar to the economic expansion, this phase sees rising demand for real estate, increasing occupancy rates, and rising rental and property prices. New construction projects are starting to meet the growing demand.
Hyper Supply: The hyper supply phase occurs when the market becomes oversupplied with new developments. Vacancies begin to rise, and the rate of rental growth slows down. This phase often happens before a downturn in the market.
Recession: The real estate market experiences declining demand, increasing vacancies, and falling rental and property prices. Developers pause new projects, and the market waits for the recovery phase to begin again.
How does the Economic Cycle Affect the Real Estate Cycle?
The economic and real estate cycles are interconnected. During an economic expansion, increased employment and income levels boost demand for residential and commercial properties, leading to a real estate expansion phase. An economic recession reduces demand for real estate, leading to higher vacancies and lower rental rates, which may trigger a recession phase in the real estate cycle. The real estate cycle typically lags behind the economic cycle because real estate investments and developments take longer to plan and execute compared to other economic activities.
How to Invest in Real Estate during the Four Phases of the Real Estate Cycle
Understanding the real estate cycle is crucial for investors who want to enjoy long-term success. As the market goes through its various phases, different investment strategies become more or less favorable.
Recovery
During the recovery phase of the real estate cycle, investors have the opportunity to capitalize on the early signs of market improvement for future growth and appreciation. Common investment types during this phase include wholesale, property rehabilitation, long-term property ownership, multifamily ventures, and engaging in hard and private money lending. Investors should focus on properties with strong upside potential or high rental demand.
Expansion
As the real estate market transitions into the expansion phase, investors can leverage market growth and rising demand for space. Typical investment approaches during this period involve holding onto properties, acquiring multifamily and commercial assets, and engaging in property development. Thoughtful choices regarding asset distribution, funding, and exit plans can boost profitability amid the expansion phase. Investors should stay attentive and monitor indications of the upcoming phase, preparing for possible shifts in market trends.
Hyper Supply
In the hyper-supply phase, investors should prioritize a defensive approach aimed at safeguarding capital while looking for properties with strong potential for success in the next cycle. While some investors may choose to retain buy and hold properties, others may choose to sell certain properties for cash. This choice depends on your immediate needs and financial situation.
Recession
In the recession phase, the real estate market experiences high vacancies, negative rent growth, and a need for increased perks for buyers. Common investment options during this phase include private and hard money lending and investing in foreclosures and bank-owned homes. Investors should keep a close eye on market indicators and signs of recovery, allowing them to position themselves for future growth.
How Long is the Average Real Estate Cycle?
The average real estate cycle spans around 18 years, though this can vary widely. Factors such as economic policies, demographic changes, and external events can influence the length and dynamics of each cycle phase.
What Factors Affect the Real Estate Cycle?
Demographics - Changes in population and composition can drive demand for different types of housing. For example, a growing population often leads to increased demand for residential properties, while an aging population might boost the market for retirement communities and assisted living facilities.
Interest Rates - When interest rates are low, borrowing costs decrease, making mortgages and loans more affordable. This typically leads to an increase in home purchases and investments in real estate. When interest rates rise, borrowing becomes more expensive, and fewer people can afford to buy or invest in property.
General Economy - Economic indicators such as GDP growth, employment rates, and income levels directly influence consumer confidence and spending. A good economy with strong job growth and rising incomes boosts demand for real estate, as people feel more secure to make important financial commitments. On the other hand, during economic downturns, uncertainty can lead to reduced spending and investment, causing the real estate market to stagnate or decline.
Government Policies - Tax incentives, subsidies, and homebuyer programs are tools that governments use to stimulate or regulate the market. For example, tax breaks for first-time homebuyers or subsidies for affordable housing projects can increase demand and drive market activity. On the other hand, changes in property taxes, zoning laws, and housing regulations can either encourage or discourage real estate development and investment.
What Phase of the Real Estate Cycle are We in 2024?
It is important to understand that real estate cycles do not occur in equal periods. Geographic location and asset class also impact cycle phases differently. As of now, some regions may be experiencing expansion while others may be in hyper-supply or recession phases. It depends largely on local economic conditions and asset-specific factors.
If you want to be ahead of the real estate cycle in your region this 2024, make sure to monitor GDP growth, employment rates, and interest rates. Look for shifts in demographics, technology adoption, and urbanization. Staying informed, proactive, and strategically diversified can help you succeed in the real estate market, ensuring sustained growth and profitability through different market conditions.
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