Real Estate Cycles
Understand Real Estate Cycles and Growth (Advanced) Real Estate Strategy Courtesy of Signil Wealth The 4-Phase Process Strategically investing in real estate consists of a taking advantage of demand, selecting the appropriate property platform setting up an applicable exit strategy and doing this all in the right order in order to minimize your invested capital, reduce your exposure to risk and achieve the maximum equity build-up and cash flow-Maximum Benefit. Rather than chasing cash flow one house at a time, implement a strategic plan to accomplish your wealth building and cash flow needs. The phases of real estate portfolio planning are presented below: Phase I, Create A Real Estate Plan. This phase of your investment real estate portfolio planning process is considered an active step. It is the point at which you determine your roadmap and plot your course from A to Z. Phase II, Grow Equity. The second phase of the investment real estate portfolio planning process is considered a passive phase where your real estate purchases are timed in capture market demand as demand is outpacing supply and your portfolio is passively working for you. Phase III, Compound Growth. Phase III of the investment real estate portfolio planning process is based on actively re-leveraging your growing equity into additional growth markets by selling in one city, using a 1031 tax deferred exchange and reinvesting in additional cities by timing the real estate cycle. Phase IV, Convert Equity to Cash Flow. The final phase of completing your investment real estate portfolio is to convert your equity to cash flow. By building equity first and then converting to cash flow, the true potential to achieve income replacing cash flow is enhanced. The conversion of equity to cash flow is accomplished through the sale of residential real estate holdings (equity building real estate) using a 1031 tax deferred exchange and the acquisition of commercial real estate holdings (income producing real estate) with higher net operating income. As you move through the four phases of real estate portfolio planning, it is important to remember that this is not a single four step process. Most investors will cycle through Phase I through Phase III several times in order to build equity before converting to cash flow. Once equity is converted to cash flow, the process may simply be started again with Phase I. Market Cycle Phases Real estate markets, cities large and small are subject to the simple economics of supply and demand and each and every city goes through a natural supply and demand cycle. Historically, the real estate cycle is approximately seven (7) years long from start to finish. As a result of national and global influences, recent cycle trends have been slightly longer. 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. Real Estate Demand Nationally, the demand for residential and commercial real estate is increasing and is projected to continue to outpace supply. The astute investor explores this fact and identifies that for over 200 years, real estate has appreciated at approximately 6% nationally. Regionally and locally, during this 200 year period, certain cities have appreciated at a much greater rate because of the economics of Supply and Demand. In order to participate in these growth markets, most investors rely on 'getting lucky' and hope to live in the right place at the right time. Demand can be observed and by tracking the economic conditions of over 12,000 cities nationwide, Signil identifies opportunities nationwide so that you can participate in expanding real estate cities rather that waiting and hoping. Here are the facts that are driving national demand: (1) overall population growth, (2) an increasing number of households, (3) shortage of supply, (4) largest segment of the population at their peak earning years (5) the second largest segment of the population leaving the nest and entering the renter and first time home buying age. First, according to research done by the Brookings Institution and from data obtained in the 2000 Census the population in the United States is expected to increase by nearly 33 percent by the year 2030. That's approximately 94 million more people than were counted in the 2000 Census. Second, because of the changing social influences in America, and with fewer people getting married or at least marrying later in life and the influence of increasing minority homebuyers, the expected demand on housing will continue to rise. Remember, rising demand results in rising prices. Third, it is estimated over half of the homes, office building, stores and factories needed in the next 25 years do not exist today. With urban and suburban limitations on the availability of land, the supply of water driving regional growth and government initiated slow or no growth initiatives, the fight for this required real estate space will be an ongoing battle and will force growth to happen in very strategically located areas of the country. Fourth, the Baby Boomer generation, people born between 1946 and 1964, have reached their peak earning age, incomes the highest ever and more discretionary money exists than in any other generation. Those born in 1946 are 59 years old today and those born in 1964 are only 41 years old in 2005. This population, the largest generation at approximately 78 million people continues to increase demand for second homes in cities offering affordability, health care, good transportation systems, mild climate and cultural activities and vacation homes in resort market areas. And fifth, the Echo Boomer population, approximately 76 million people between the toddler and college ages are leaving the nest and will be out on their own, in their own homes and with their own jobs over the next 20 years. This real estate demand is captured by monitoring job growth, wage scales and affordability values and rents in cities across the country. Market Types In order to track approximately 12,000 cities across the country, Signil separates real estate markets into three very simple categories: Rental Markets, Retail Markets and Resort Markets. By categorizing market types, we are able to analyze demand, determine which phase of the real estate
cycle a city is in and help identify appropriate investment property platforms to achieve Maximum Benefit. Each market (or city) type is defined below: Rental Market - Is a city with an abundance of long term rentals with low enough home prices that rents cover debt service and all expenses. Investing in a rental market is based on economic demand derived from local economic conditions suggesting rapid increases in value. Retail Market - Is a city where home prices have risen so that rents no longer cover debt service and all expenses. Investing in a retail market is based on economic demand derived from local economic conditions suggesting sustainable growth. Resort Market - Is a city with an abundance of short term rentals, well anchored as a vacation destination. Investing in a resort market is based on economic demand derived from national and occasionally international influences. For more information on finding the "sweet spot" in the next "hot spot" contact clint@erealestate.com .
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Posted by Dan Auito on May 12th, 2007