The real estate market goes through a cycle of what most professionals agree to be four stages. The entire cycle moves as periods of boom and also periods of decline. Understanding the cycle and the progression of each stage can give you a mental model that can help you know where the market is at any time.
Of course, I teach that you can invest in any market using my Niche2Wealth strategy, as our approach works well at any stage. However, it can benefit you to learn about the real estate life cycle, so you can better correlate it with exit strategies.
- Recovery Stage
The recovery stage is usually the lowest point in the cycle. In this stage, there is typically an oversupply of inventory due to the previous stage’s expansion or growth. There will be excess construction due to the boom of the last cycle. In this stage, the number of new developments is very low, if there are any at all. In the recovery stage, the demand for homes will grow slowly, which will help with the oversupply. Rents will begin to stabilize, and landlords may gradually increase rents. In this stage, you may hear people say that they’d never invest in real estate at this time, but it can be a great time to invest. There’s usually a high number of foreclosures, which means there are plenty of motivated sellers. Once rental growth is on the same ground as inflation, the market will fall into the next stage.
This stage is the growing stage. The stage where the market is expanding nicely. You’ll see more newer construction, higher property values, higher rents, and lower cap rates. People’s confidence in the market will be growing, and you’ll have more demand. Occasionally, “rent spikes,” or rapid rent growth may occur. This is the stage where a bubble can form when rent growth and prices increase even further. Historically, the expansion stage is a slow, long-term climb over years and years until the market reaches the point where supply reaches demand, which then propels into the next stage.
- Hyper supply
The hyper supply stage is when demand falls, but construction continues. Occupancy rates will decline.
In the recession stage, there will be massive oversupply and demand will fall significantly. This will affect the rent, which will be lowered. These things combined will have a decent sized impact on the market and the economy. The Federal Reserve will increase interest rates. This stage is where you’ll see the number of foreclosures increase quite a bit, with people struggling to pay their mortgage or perhaps experience job loss. Once the recession hits its lowest point, the cycle will move into the recovery phase.
Understanding the phases can help you choose the right investment strategy to use for each situation. You can better determine what your exit strategy may be, as well as your holding periods. Though there’s no way to predict what the market will do accurately, you can look at history and the current market and economy to gain insight and make educated investing decisions.