It's All About Timing: Understanding Cycles & Trends in Real Estate Investing and Development
Rey Villar (GMail)
It's All About Timing: Understanding Cycles & Trends in Real Estate Investing and Development
Don’t laugh, but I’ve grown to believe that romance and real estate are similar in many ways. I’m not a cynic, but I don’t believe that there is necessarily one true love waiting for us out there. Similarly, I don’t believe in once in a lifetime opportunities in real estate. True love and great real estate opportunities happen all the time. The big question is whether we’re ready for them when they come.
Successful real estate investment and development, much like romance, requires good timing. Fortunately, many elements of timing can be learned. This chapter discusses two categories of elements that go into timing your investment:
-
The real estate development cycle
-
Trends affecting the cycle
1. The Real Estate Development Cycle
Centuries of experience and decades of modern study have confirmed a clear pattern that seems to govern most real estate markets, assuming they are exposed to normal market conditions.
Understanding this cycle may not necessarily help your love life, but it will help you make better investment decisions. The duration, shape and severity of the different stages of the cycle will vary for each area and market, but industry professionals tend to recognize a four-part cycle that controls the supply of real estate:
-
Absorption. Coming out of the down cycle, when construction has slowed or ceased, the market is able to absorb existing supply of real estate. This period is marked by stable supply of real estate, increasing slowly or not at all. The market has absorbed the previous oversupply. As occupancy rates increase and supply tightens, prices may begin to follow. For investors, this is a great time to sell property so as to get the best prices possible. Low surplus (perhaps even low supply) coupled with rising demand offers great opportunity for increased prices.
-
New construction. Many beginning developers and investors may not be able to predict areas or periods of future high demand, but they usually know it when it finally arrives. The new construction cycle generates construction to meet rising or perceived demand. More astute developers can sense it, as vacancies drop and prices rise. Real estate investors must take caution not to get caught up in the frenzy. Speculation investors must understand that they are making a gamble if they invest or develop in this period because the saturation period is just around the corner.
-
Saturation. This stage begins as soon as supply has clearly overshot demand. Vacancy rates begin to increase and prices may begin to plateau or actually decrease, as it has become a buyer's market. This is obviously not a good time to start a project that will only add unneeded supply in the face of lackluster demand. Investors who want to buy or start projects during these periods must have strong reserves, as the down period is around the corner and may be prolonged.
-
Down. The line between saturation and down cycle stages is a blurred one, but investors know when they are in a down cycle stage. There is already too much supply to meet existing demand. High or increasing vacancy rates will force developers to slow or stop new developments. However, this may be an excellent time to start buying undervalued properties, especially in anticipation of an upcoming absorption market. The best time to buy is ideally at the end of the down market. Investors should also look for fall-off properties from unlucky (or unwise) investors and developers who are forced to sell below value because they have run out of money.
Real estate investors, especially developers, must understand where their target area falls within this development cycle before they invest in existing or new supply. Even if demand is high, values can stagnate or still depreciate if the incoming supply is too great in relation to that demand.
Investors must understand this cycle when seeking to buy investment property. The investor's objectives and tactics must be grounded in this understanding.
A quick read of the cycle might lead you to think that you should only invest during the absorption or new construction stage. That would be a narrow interpretation of this cycle. There are actually opportunities to be found in every stage, depending on your plan, strategies and objectives. If the investor is seeking an investment with strong rental income, the best deals are often found during the new construction and early market saturation stage.
Investors seeking appreciation profit can find potential investments in all four stages, but the thinking must adapt to each stage. Nevertheless, many speculative investors focus on areas that are in the absorption stage or late down markets—when there is strong potential for new development and construction. Savvy investors will also enter during the new construction stage, if they can time their entry just right. Few investors will enter the late saturation stage, unless they spot an under-performing property or are speculating on an isolated upward trend.
Knowledge is a weapon. But like any weapon, knowledge is only beneficial if you actually know how to use it. So how do you apply this condensed review of the real estate development cycle?
For the rest of this article, please go to: http://www.dignitymortgage.com/Investing/Guide03a-Cycle.htm