Do you know which phase the market is in right now? The market has seen an exceptionally long bull run, but what does that mean in terms of real estate cycles? If you’re not familiar with the market’s cycles, you could invest at the exact wrong moment.
Just as wide-scale economic trends can be broken down into cyclical patterns, so can the real estate market. The real estate cycle consists of four phases, each one helping investors decide on the next best move.
Here’s a breakdown of each of those four phases, along with some tips to help you identify them to take full advantage of the opportunities that will come your way as the market shifts. Let’s dive in.
What are real estate cycles?
In reality, it would be beneficial for anyone involved in real estate—including agents, sellers, buyers, and investors—to understand the four phases. For those unfamiliar, the real estate cycle is far from subjective.
While experts certainly predict when we’ll move from one phase to another or how long we’ll stay there, the phases are based on real-world observations, current conditions, and historical data.
With that in mind, the four phases are incredibly informative for anyone who’s about to make a real estate-related decision. Ignoring the real estate cycles will only make your job unnecessarily difficult for investors who are always in the market buying, selling, or renting.
One thing to note is that, as economic trends, the real estate cycle is not necessarily the same for every state or town at once. The real estate cycle moves through its phases at a different pace depending on your locale, so you shouldn’t read a national article about hyper supply and assume it applies to your area.
Some towns lag behind the national cycle while others drive it forward. With the following information, you’ll learn the difference between the four cycles and get some valuable tips to help you identify them and use them to inform your next real estate decision.
Recovery phase
We often view the recovery phase as the first step in the real estate cycle, but it is, in fact, circular, so there is no “stage one.” However, understanding the recovery phase is fundamental to digesting how the other phases impact the market. As the name implies, the recovery phase occurs when the market is recovering from a recession phase.
The recovery period begins when the recession phase hits its low and numbers start slowly but surely ticking up again. This is marked by low occupancy and rental rates and very little new construction. After those numbers tanked during the recession phase, the recovery phase will see them level out and potentially start to increase again.
Some rental growth will occur during the recovery phase, but it will only happen below the inflation rate. Individuals will have a tough time realizing that we’ve moved from the recession phase into the recovery phase because it tends to happen slowly and subtly. However, experts who look at general occupancy and demand trends will be able to identify the recovery phase as it starts.
Investors who purchase property during the recovery phase will enjoy two advantages: First, they’re one phase away from realizing a good return (versus buying during the recession, when you’d have to wait it out for longer), and second, they are buying at a time when property prices are still low. The recession often produces several foreclosures and distressed properties, which offer a great opportunity in the recovery phase.
Expansion phase
The expansion phase begins after some recovery period where rates may seem near stagnant. This phase starts when the market has entirely recovered and is ready to show strong growth. As the market hits this phase, you’ll see high and rising rental rates, low vacancy, and increased property values. New construction generally begins again, sometimes at a rapid pace.
Most real estate investors begin buying when the expansion phase starts because they know that growth is on the horizon. You won’t get as good of a deal as you would have in the recovery phase, but it represents less risk since you know that the recession is over. If you have trouble identifying when the market has moved from recession to recovery, you’ll probably jump on a deal when the expansion phase starts.
Rental property is one of the best investments during the expansion phase since rental rates will increase. It’s also an excellent time to buy an old building to renovate, as demand is very high and tenants won’t be hard to find. The expansion phase represents climbing prices and more competition, so investors need to be fast on their feet if they’re buying and selling during this phase.
If you’re interested in selling property, the expansion phase is generally the best time to do it, but there’s an excellent opportunity to hold onto it and rent it out if you can.
Hyper supply phase
As the expansion phase continues with optimism, the market naturally hits a tipping point. Supply outpaces demand, and we enter the hyper-supply phase where the market listings exceed the area’s buyers. Construction projects will begin to wrap up, and the rate of new construction projects will slow. Vacancies will increase, and rental rates will gradually slow down.
Many investors like to buy properties during this phase because some companies are growing nervous about the impending recession. If you can find the right seller, you could get a property at an attractive price. However, you have to think about the entire cycle before making a rushed decision.
If you buy during the over-supply phase, you might get a great deal, but you need to be prepared to weather the value drop that’s to come. Investors who purchase during the hyper-supply phase will take the simple “buy and hold” approach, waiting out the recession and recovery phase to sell during the next expansion.
Suppose you’re unsure whether you can afford to hold onto your investment through the recession and recovery period that’s to come. In that case, you should wait until the following recovery period to make your purchase. Alternatively, you could follow another popular strategy where you invest in a tenant building with multiple long-term leases and hope that your tenants stick around through the phases to come, which will generate more steady income.
Recession phase
Almost everyone dreads the recession phase, especially homeowners. The recession phase in the real estate cycle is marked by high vacancy rates and rental rates dropping below inflation. Some investors will buy during the recession, but only those who can wait for the cycle to come back again.
You’ll enjoy the market’s lowestuy during the recession prices if you buy. But it comes with its disadvantages. Property crime may go up during this time, and if you’re renting, you’re at a higher risk of dealing with a tenant who defaults on their lease payments.
Generally, investing during the recession phase is best reserved for investors with strong financial backing. If one or two deals not going right could put you into a difficult situation, you should avoid buying during the recession just because it’s likely so long to wait until you can turn a profit.
How long does each phase last?
When investors start learning about the real estate cycle, the most common question seems obvious: How long does each phase last? The trouble is, there’s no set time limit. Historically, the average cycle has spanned 18 years, but the time in each stage varies depending on many factors.
Additionally, it’s important to remember that the cycle moves at a different pace across the country. While, in general, the news headlines might say that we’re in a hyper-supply phase, some locales will continue to have extremely high demand and remain in the expansion phase for some time to come.
For this reason, investors must learn how to look at the state- and town-level numbers to determine what opportunities are on the horizon. You wouldn’t want to purchase a rental property right as your town moves into the hyper-supply phase, as it would make it that much harder to find a suitable tenant at a reasonable rate.
This real estate cycle began after the 2008 recession, and we moved through the recovery period into the expansion phase. We are now in the tenth year of the “bull market” (i.e., the expansion phase), where prices continue to climb. This alone is a prime example that the real estate cycle is unpredictable.
Even experts had predicted over the past couple of years that we would be hitting a point of oversupply and we’d see the growth slow down, but that has yet to happen. Significant events, such as the pandemic, only seemed to drive change forward as investors witnessed suburban and rural expansion at an unprecedented pace.
So, where do you go from here?
Using the cycles to your advantage
As an investor, it can be extremely frustrating that the real estate cycle is not predictable, but that shouldn’t hold you back. When evaluating the market and its cycle, every investor is working with the same knowledge. What’s going to give you an upper hand is choosing to do your research to understand the numbers better.
While no investor can predict the future, keeping an eye on the local numbers and being aware of the historical trends and performance will help you make smarter financial decisions. When you identify a phase that you are not comfortable investing in, or if you remain unsure of how the cycle is moving, it may be best to create a layer of separation between you and the market.
Final thoughts
Today’s investors have various opportunities to help them reduce their risk while still taking advantage of what the market has to offer. Suppose you are unsure about the hyper-supply phase that may be on the horizon, or you’d like to diversify your portfolio without investing a lot of capital. In that case, it could be time to look into an alternative investment method.
Aside from buying properties outright, real estate investors can tap into the opportunities of the cycle by getting involved in tokenization and crowdfunding projects. Fractional real estate allows you and a pool of investors to purchase a property and reap the rewards without owning it outright and taking on all that risk.
If you’re unsure, it’s better to start small. At Ark7, you can purchase real estate shares to help you build a passive monthly income. The risk is significantly reduced compared to buying and managing properties yourself, and you don’t have to put in nearly as much capital. You’ll also see better results with the chance to diversify, even as the market turns
