The real estate market can be confusing and complicated, particularly when examining the market from an economic and strategic perspective. Those in the market want to plan for the future, but because there are so many factors influencing the real estate market, this can be very difficult. However, an understanding of the four phases of the real estate cycle can help experts better understand the real estate market in order to develop an effective strategy for the future of the market.
The Phases of the Real Estate Cycle
A complete cycle occurs when all four phases have taken place and the market moves back to the first phase again. The four cycles can be divided into two categories: up-cycles and down-cycles. The first two phases, recovery and expansion, are up-cycles, while the second two cycles, hyper-supply and recession, are down-cycles. Here is some more detailed information about the four cycles.
PHASE 1: RECOVERY
Recovery begins at the lowest point in the market. When this phase begins, there is already an oversupply of inventory due to the previous demand for new construction and growth. However, the beginning of this phase occurs when the new construction stops due to the recognition of oversupply. During recovery, the demand for homes slowly grows, which reduces the oversupply that exists. Vacancy rates decline and rental rates stabilize.
PHASE 2: EXPANSION
The market shifts to expansion when the market reaches its long-term occupancy average, and the growth rates begin to match inflation. In the expansion phase, demand increases more rapidly, calling for more space. As this phase progresses, the demand reaches a point at which it is cost-effective for new construction to begin again. Expansion continues as demand exceeds supply and there is a continued need for more space. Typically, this phase occurs slowly. However, rates begin to rise more rapidly, creating the real estate bubble. When supply catches up to demand within the market, called the equilibrium, the expansion phase ends.
PHASE 3: HYPER-SUPPLY
After the equilibrium, new construction typically continues because those in the market do not recognize that the equilibrium has occurred. When that happens, the supply begins to exceed demand, shifting into the hyper-supply phase of the real estate cycle. Occupancy rates begin to fall. Eventually those in the market begin to recognize the hyper-supply, and new construction begins to slow. The outcome of this downturn depends on many factors. For example, if the downturn happens quickly after the equilibrium, the market may revert back to a previous phase. It is also likely that the market remains in the hyper-supply phase for a long period of time.
PHASE 4: RECESSION
If occupancy falls below the long-term average, the real estate market shifts into the recession phase of the cycle. In this phase, the impact of the changes in supply and demand have a clear economic impact on the market and on society. In a recession, the costs to maintain and expand exceed what is available from mortgages and rents, which changes the economic dynamic in the nation. It is during this time that foreclosures occur more frequently. The recession continues until the market hits its bottom and shifts once again into the recovery phase of the cycle.
What does this mean?
Though there are many economic, social, and political factors that can have a dramatic influence on the real estate cycle, understanding the cycle and identifying factors that shift the market to the next phase can be used to try and predict the future of the market.
The most important indicators occur during the shift from the up-cycles to the down-cycles. By identifying this shift early, those in the real estate market can prepare for the next phases more effectively and understand how the market will progress. Experts may not be able to ensure a correct prediction of the market, but careful analysis of the market and a watchful eye on how it progresses can help increase the likelihood of how the market will progress.