Understanding the Real Estate Market Cycle and Uncovering Hot Emerging Markets

No study of real estate investing would be complete without a comprehensive understanding of markets and how those markets are affected by economic conditions. Only through an understanding of this critical topic can the Investor properly understand their risk exposure and implement strategic investment planning and effective risk mitigation techniques.

Market Cycles

The following section will provide an overview of the four major phases of a real estate market cycle. Although each of these phases have specific characteristics that make them stand apart from one another, unfortunately, the initial transitions in and out of each phase may not be plainly obvious. The four market phases are listed below:

– Sellers Market I (Expansion)
– Sellers Market II (Equilibrium)
– Buyers Market I (Decline)
– Buyers Market II (Absorption)

Each phase of this cycle can present the Investor with both challenges to overcome as well as opportunities to benefit from. The well informed and action oriented Investor will know what strategies to utilize during each of the phases. The following section will provide an overview on each of the market cycles.

Sellers Market I (Expansion)

During a Seller’s Market phase I (also referred to as the Expansion Phase), many of the key economic indicators are telling a compelling story that includes the following:

Due to the strong economic conditions, builders and developers regain their confidence that new construction now makes sense; significant increased activity is seen in the building permit application process. As construction levels begin to increase, it will also stimulate the need for primary and secondary workers.
The general population feels that times are good and discretionary spending increases; this in turn will help to stimulate the economy.

Market sales price and market rents are at the highest levels due to the high demand for housing; this increase in demand absorbs the available inventory and creates sometimes fierce competition among home buyers who are bidding against each other for the same property. This bidding frenzy can result in multiple offers being presented to the sellers and in some cases, bidding up the list price.

Investment Strategy

The Investors who have been holding properties coming into this phase will be benefiting from significant appreciation of their real estate holdings; this market cycle could be a great time to leverage your equity by selling at the top of the market and re-invest the proceeds in other perhaps larger properties. In order to maximize your available re-investment capital, an IRC 1031 Tax Deferrered Exchange should be considered.

Warning! It is strongly recommended that you seek advice from your Accountant prior to implementing any tax reduction strategies.

In a market with high demand, you should expect to pay strong sales prices; the higher demand may also set the stage for sellers to be less motivated in agreeing to creative deals like seller financing, assignments, or Lease Options.

In this market, you will also see Investors who are purchasing properties just for the appreciation and are not concerned with the cash flow. For Investors who are considering this approach, it will be critical that they have adequate cash reserves available to them in the event there is an interruption of rental income resulting from vacancies. In addition, not having cash flow could make it difficult to maintain the property effectively in the event repairs or replacement is required.

During the Sellers Market Phase I, there will be numerous opportunities to take advantage of the aggressive buying activity that can exist. Outstanding profits can be realized from business models like flipping and wholesaling. This market phase will allow the Investor to get the property turned over without the concerns of a dropping market price. The fact that the property is appreciating will help create a cushion for the Investor in the event the exit strategy does not happen in accordance with the schedule and cost goals established for the project. In fact, if delays do occur, it may be possible that it could relate to more profits in the Investors pockets! At the tail end of this phase, the growth rate will start to cool down.

During the Sellers Market Phase I, Lenders will tend to be more lenient with their underwriting and approval ratio due to their confidence in the strength of the market. This can be a double-edge sword, as we have seen leading up to 2006, Lenders were approving loans for people who weren’t really qualified and as a result, when the market started to nose dive, it took many homeowners with it.

Sellers Market II (Equilibrium)

In a Seller’s Market II (also referred to as the Equilibrium Phase), many of the economic indicators are no longer exhibiting explosive growth and are heading towards national averages with regards to new construction starts, migration movement, sales price, and appreciation. Most people now recognize that the market has peaked and those who didn’t sell in the prior phase will now consider putting their property up for sale. Towards the end of this cycle, added inventory along with diminished economic incentives will reduce the demand and therefore, owners who are strongly motivated to sell will need to consider aggressive pricing strategies and open to creative deal making.

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Understanding the Real Estate Market Cycle and Uncovering Hot Emerging Markets

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