The Real Estate Cycle
Real estate markets, cities large and small are subject to the simple economics of supply and demand. Every city goes through a natural ‘heating up’ and ‘cooling off’ period. Historically, the real estate cycle is approximately seven (7) years long, peak to peak.
This natural heating up and cooling off is simplified and described below.
For more information about each phase, please place your mouse pointer over the dots around the image.
EARLY GROWTH PHASE
- SUPPLY TREND - DOWN
- DEMAND TREND - UP
Early Growth phase is the catapult into the next market cycle. In-migration and job growth begin to accelerate rising demand. Construction actively remains generally low as supply is over-run by demand very rapidly. Rents begin to rise and vacancy approaches its low point of the entire cycle. Real estate values begin a steady hedge upward. At this point in the cycle, the local area through local media coverage begins to hear tremors of possible growth, but, growth is not yet the topic of general conversation.
MIDDLE GROWTH PHASE
- SUPPLY TREND - DOWN
- DEMAND TREND - UP
The longest segment of the Growth phase, the middle Growth phase is the peak for the momentum of the upward cycle. The recent in-migration of people and the generally late start to new construction places a significant strain of the availability of supply causing prices to rise rapidly. New development, construction and annexation permits reach their peak to accommodate this demand. The low of rental vacancy balances slightly as new construction supply becomes available for purchase by the incoming workforce. Coverage by the local media trends toward the boom time that will never end. The recent, swift and generally large population increase begins to place significant strains on local infrastructure and government.
LATE GROWTH PHASE
- SUPPLY TREND - DOWN
- DEMAND TREND - UP
Nearing the top of the market cycle, the late Growth phase is the steady calm before the next economic imbalance. Real estate values continue to rise steadily and the in-migration of people remains steady. Due to higher real estate values resulting in fewer qualified buyers, rents begin to rise once again. Alternative, lower cost housing such as condominium and town home properties becomes attractive and in greater demand resulting in the number of multi-unit and conversion permits increasing significantly. The strains on local infrastructure and government continue many times being addressed through an increase in real estate taxes creating a further unbalance, in conjunction with higher real estate values, the affordability and cost of living indices.
EARLY SATURATION PHASE
- SUPPLY TREND - UP
- DEMAND TREND - FLAT
Entering the Saturation zone of the Growth phase, indications of slowing economic drivers begin to surface. Construction activity remains high but results in slightly longer days on market, a slowing pace of appreciation and, for the first time is several years, enough supply to meet the requirements of demand. These indicators are subtle; they are not large jumps in an analytical trend line but rather slight deviations from recent results that go relatively un-noticed by the local area. A refinance boom is common.
LATE SATURATION PHASE
- SUPPLY TREND - UP
- DEMAND TREND - DOWN
The late Saturation zone is the first time the impact of changing economics begins to be felt. Real estate values begin to flatten; marketing times increase sharply and rents level. The availability of new construction supply becomes abundant and builder / developer incentives surface for the first time in years as a means to maintain cost controls. Extremely strong recent appreciation figures coupled with new and marketable investor packages lure unwary buyers that may lack an understanding of the recent, current and upcoming market cycle impact.
EARLY DECLINE PHASE
- SUPPLY TREND - UP
- DEMAND TREND - DOWN
During early Decline phase, the supply of available owner and non-owner occupied properties begins to rise. New demand and in-migration has dramatically decreased resulting in flat real estate values, rents generally remain flat, but vacancy figures begin to trend upward resulting in the first direct impact of the impending rising cost of ownership. High real estate taxes further affect owner occupants and investor cash flow setting the stage for the first wave of foreclosure exodus from the marketplace.
MIDDLE DECLINE PHASE
- SUPPLY TREND - UP
- DEMAND TREND - DOWN
The middle Decline phase is headlong into the down cycle. Supply is high and rising, demand is low and falling and out migration of people and jobs is apparent. Rental incentives, discounts and negotiation are common place. A significant rise in the cost of ownership can be expected as no economic catalyst is positioning the market for entry into the next transition phase. Job loss is causing foreclosures to increase steadily causing lender non-performing asset ratios to spike. Construction activity is extremely low if not virtually non-existent.
LATE DECLINE PHASE
- SUPPLY TREND - UP
- DEMAND TREND - DOWN
Late Decline phase is the bottom of the cycle. Real estate values have flattened and may have lost value, vacancy is at its peak and rents are low. The available supply is high and demand remains low while job loss and foreclosures have peaked. Extended marketing times are normal for owner and non-owner occupied property in both the rental and sale categories. Due to its affordability, an increase in apartment living becomes noticeable. There are no economic indicators leading toward a market catalyst, yet, political discussions turn toward corporate attraction, job growth and economic recovery.
EARLY ABSORPTION PHASE
- SUPPLY TREND - FLAT
- DEMAND TREND - UP
The focus on a political economic recovery begins to breed results. After having been through a recent Decline phase, local real estate values once again become comparatively affordable within the nation. Political incentives become a standard means of attracting job growth and the results of infrastructure improvements during the last Growth phase all offer an edge to the local community in its efforts to attract business. These catalyst efforts are generally behind the scenes, occasionally mentioned in media coverage and predominantly politically driven. The focus is in the creation of new jobs in order to catapult the next wave of in-migration.
LATE ABSORPTION PHASE
- SUPPLY TREND - DOWN
- DEMAND TREND - UP
The efforts to attract an economic migration begin to work. At this point in the cycle, the local population (excluding commercial real estate professionals and political participants) is generally unaware of the impending growth. Supply begins a slow trend downward, then flat, and then downward once again as indications of rising demand begin to blip on the radar screen. Construction activity remains low. Marketing times slowly begin to shorten and rental incentives begin to disappear. Real estate values and rents remain flat as vacancy slowly drops. This all happens very slowly and without great exposure in the public eye.
As demand increases and supply is constrained, real estate values rise. The point in time that this occurs, i.e. prices begin to consistently rise, is known as the entry into the Growth Phase of a real estate cycle. The Growth phase of the cycle generally last, depending on the market classification, between one (1) and three (3) years.
After a period of rising values, a natural balance between supply and demand is restored and the pace of appreciation slows as a city enters the other major phase of the real estate cycle, this is known as the Decline Phase. The entrance to the Decline phase of the cycle is the point at which real estate values flatten and the cost of ownership begins to consistently rise as vacancy increases and rents fall.
Between the two phases of the real estate cycle are two Transitional Zones. First, the Absorption zone of the market cycle is the bridge from Decline (flat values, higher vacancy and low rents) to Growth (rising values, lower vacancy and higher rents). Through the Absorption zone, economic conditions are changing and setting up a positive imbalance with higher demand and short supply. Second, the Saturation zone is the bridge from Growth to Decline. Through the Saturation zone, local construction activity generally remains high. While this period of time closely resembles the Growth phase, a closer look begins to expose less demand, longer exposure times on market and an increasing supply.
Many times this increasing supply during the Saturation zone is a result of the new builder home inventory generated and still available from the recent Growth phase. Because demand is now slowing and new construction supply is rising, builders often begin offering incentives and opening the sale of their inventory to investors. The question must be asked: Is the Saturation zone of the cycle where an investor really wants to buy investment real estate? Before you answer, remember, the Decline phase (flat values, higher vacancy and low rents) comes shortly after the entrance into the Saturation zone!
Strategically investing in multiple markets and timing your acquisitions during the transitional Absorption zone and early Growth phase, you can diversify your portfolio while potentially maximizing the return on your invested dollar, building equity quicker and, following the 4-Phase process, increase your residual real estate cash flow.
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