I want to share an empowering real estate investment tool that many investors may be unaware. It is called real estate market cycles. Of course, you have heard of real estate market cycles, but I want to share it a different way. I wish I could say I figured this out on my own, but a fellow investor, David Lindahl, introduced this concept to me and I have been applying it to my investments ever since.
In fact, understanding how these cycles affect investment strategies has changed the way I do business for myself and my clients. Review this simple chart and allow me to further explain.
There are four real estate market cycles and there is no way to determine how long we will be “in” any one cycle. However, we can gauge the shift into the next market cycle based on what is taking place in the current cycle. I will explain this in detail so you can become confident in where and how to profitably invest your funds and even more importantly, when to shift and/or take your investment out…when to sell.
The blue line in the chart indicates fluctuation in value within the cycles. Specific criteria identify each market cycle. I have labeled each of the four market cycles MC 1, 2, 3 and 4. I will explain each cycle, including which strategies work best. It is important to understand that there are only 4 market cycles and they vary by location.
That means that we should study each geographic area’s market indicators to determine which market cycle is occurring. This can apply from neighborhood to neighborhood, county to county, city to city, state to state, etc. Do not assume that just because you are investing in one particular county, that every neighborhood in that county is experiencing the same indicators.
Knowing which market cycle we are in, which strategies to apply in each market, the timing of the next shift and which strategy to apply next, helps us ensure investment profitability.
For investors, knowing exactly when to sell, when to buy, when to lower price and how this affects profit and avoid loss is crucial to success. Most investors do not realize what is taking place in the market until the mainstream news outlets announce it. However, once the media shares market news, it is too late to profitably pivot. Only those investors keeping tabs on market cycle indicators will know in advance what is taking place and how to pivot to make the most profit and avoid potential loss. Doing so at the right time allows them to shift strategies before the public is aware that the market has or is changing. This is the best time to shift.
For example, as an investor in Market Cycle 1 recognizing the shift into Market Cycle 2, I should reduce prices on my retail flips and quickly unload inventory because prices will decline. If I wait until all sellers must reduce price, I will earn less profit, if any, or may need to completely change my exit strategy to profit.
You will learn that there is a huge advantage to properly using this information and having the ability to shift to the most profitable strategy at the perfect time.
I want to share the indicators that define each market and which investing strategies to apply during each cycle. I will use the Market Cycle acronyms (MC) moving forward.
Market Cycle 1
As you can see, values seem to be going up during this MC. The following are the indicators for MC 1:
· Number of properties on the market reduce.
· Properties sell quickly.
· Unemployment rate is low.
· Real estate prices and rental rates increase.
We can see that the first two bullet points indicate that demand is high which implies that supply is low. There is not enough supply to meet demand. The unemployment rate is low, so the economy is doing well, and real estate prices and rental rates are increasing.
During this MC, we are going to see these indicators occur simultaneously, and we will watch values increase until the shift to MC 2 begins.
Every real estate investing strategy is likely to be profitable during this cycle. Even novice investors make money despite mistakes, giving them false confidence in their Midas touch. Since values are on the rise in this cycle, it is profitable to wholesale, fix and flip, grow a healthy rental portfolio, flip notes, and make money even while making mistakes.
Market Cycle 2
As you look at the chart, you will see values peak. The following are the indicators for MC 2:
· Number of properties on the market begin to increase.
· Unemployment rate increases slightly.
· Property sales begin to slow down.
· Sale prices still on the high side.
We see that in MC 2, the number of properties on the market increase, so demand is beginning to drop. Unemployment rate increases slightly as we notice a bit of a negative economic shift. Property sales begin to slow down, but sale prices are still on the high side because people do not realize a shift is taking place. Sellers want to get what their neighbors got. The public, and most real estate professionals, might not even notice anything taking place because the rest of the world, even investors, do not understand how and when real estate market cycles shift, especially when it happens subtly.
Profitable investment strategies to apply during MC 2 include wholesaling and quick fix and flips (do not purchase heavy renovation projects that take a long time to finish in this cycle). Keep in mind that prices and values have peaked and are now beginning to and will continue to decrease, so fix and flip strategies must be carefully calculated so that the retail sale price will be in line with values at the time of sale, which may be hard to determine. When investors have properties listed for sale during the shift from MC 1 to MC 2, the strategy is to quickly lower sale price and unload the property before all competing listings. Remember, when the shift is just starting to occur, the world is not yet aware, so this is the moment to take advantage of what you know and avoid loss. The longer you wait to reduce price or change exit strategies, the more likely the negative effect on profit.
I want to answer the question you may be thinking right now. “How do I know when these shifts will take place?”
The best way to monitor these MC indicators is to watch the data. For every geographic location you invest, simply create daily searches for this data. I find that the Multiple Listing Service provides the most up-to-date and accurate data to monitor. Ask your real estate agent to “set up” electronic searches based on the criteria you provide. These electronic searches can be automated to email you daily. Investors must monitor sale and rental price fluctuations, as well as days on market, by geographic location.
I want to answer the next question you may be thinking. “What am I looking for?” When this data hits your inbox, view each listing, and make note of the following information.
Days on Market (“DOM”)
Look at the average DOM in the area you are monitoring. Days on market is the number of days from list date to contract date or sale date. As you begin to track these indicators, you will notice how many days it takes for properly priced retail listings to sell. When you notice that DOM are increasing overall, take note.
Number of Active Listings
When you see the overall DOM number increase, keep an eye out for the number of active listings to increase. Determine if the prices are still consistent with original list price of if you are also beginning to see a trend in price reductions.
One price reduction here or there is not a market shift. Research further to find out of if the properties with reductions are over-priced or outdated. Answer this question: is it a property problem or a market indicator?
Price Reductions
When we notice a trend in price reductions and think these listings look good and are priced right, then what does that indicate? We must determine the reason and whether we have multiple indicators occurring simultaneously. If so, investors may need to reduce price and sell any inventory they prefer not to hold while prices are still on the high side.
List Price vs. Sold Price
When monitoring closed sales, look at how closely to list price the closed homes are selling and when there is a large disparity, investigate further. This is especially important to do when noticing a large difference between list price and sold price on multiple
properties in the same area. Remember, a few of these sales may not indicate a market shift but when multiple indicators are occurring simultaneously, it is time for further investigation.
Market Cycle 3
As you look at the chart, you will see values going down. The following are the indicators for MC 3:
· Prices begin to drop.
· Desire for buying drops – demand down.
· Unemployment rate increases.
· Real estate values are low and keep falling.
In this MC, prices begin to drop and supply increases due to less demand. Once public awareness occurs, sellers begin to reduce price and we enter the race to sell inventory. Investors monitoring this shift would have already reduced price and sold their inventory.
The investing strategies at work during MC 3 include wholesaling, keeping rentals until the market cycle shifts again, OR putting well-priced rental purchases into a long-term retirement portfolio. The beginning of MC 3 is not the best time to buy.
Market Cycle 4
As you look at the chart, you will see values begin to increase. The following are the indicators for MC 4:
· Property begins to sell.
· Unemployment rate decreasing.
· Real estate and rental values increasing and prices rising.
MC 4 is an exciting market, especially when you understand what happens next. Property begins to sell with less time on market. We will recognize this at the beginning stages because we are monitoring the indicators. The unemployment rate is decreasing, and the economy is improving. Real estate values and rents begin to increase, and sale prices are rising. As you begin to see this occur gradually, then you are aware that this shift has begun.
Profitable strategies include wholesaling and fix and flips; however, savvy investors will buy as much property as they can get their hands on because values are still at the bottom. Inventory is easier to obtain because there is much less competition at this time – the masses are not aware the market is shifting. Investors can still purchase property
at a discount, sit on them (perhaps renting), and ride the wave back up through MC 1 before selling, earning the most profit.
Please keep in mind that all real estate investment strategies, when done correctly and bought at a deep discount, will work to a certain degree in any market cycle. However, knowing why a specific strategy earns more profit during a specific cycle allows investors to take advantage and dramatically increase earnings.
When investors apply this knowledge, they make confident investment decisions. I encourage you to study this information and review past successes and losses. Look at history and see how this information proved accurate and could have been used to change the outcome of your investments. Once you are satisfied, then apply it moving forward. I believe it will change the way you invest.
Disclaimer: I am not a CPA or financial adviser, and these trends are only predictions based on historical patterns.
Sharon Restrepo, Author
Broker & Investor www.32WestRealty.com
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