Buying can be down right terrifying. The real estate market is volatile. It changes every single day. Trying to time a purchase precisely in fear of not buying at the exact bottom of a market can be a ridiculous waste of time. As a long term home owner, in 10, 15, 20 years, any small variation in price of your home will have amortized to almost nothing. There are however, times to buy, and times not to buy. And that’s where the real estate cycle comes in.
What is the Real Estate Cycle?
The real estate cycle is a graphical representation that evidences what is occurring in the real estate market at a particular time.
Historically, the cycle repeats itself. By knowing where in the real estate cycle the current market is, a consumer of real estate may make educated decisions as to when to buy and when to sell.
How does the cycle work?
The cycle can be explained by following its progression as indicated by the arrows. Our most recent experienced in of the real estate cycle began in the early 1990′s following the crash in 1989.
Note: as you are reading through the progression of the cycle, consider the law of supply and demand.
- Absorption of Excess Supply (…, 1971, 1984, 1993): Real estate is often targeted by investors. Investors, sometimes referred to as “bottom fishers,” are extremely astute and have an incredible understanding of the real estate cycle and the indicators that prove that the cycle is in the position they believe it is in. After declining rents, prices and construction, news articles and word of mouth stories perpetuate a general anti-real estate sentiment. This emotion, as described in the Stand Out, Buy a House post, is what wise investors completely ignore. This is why Warren Buffet remarks, “Buy when everyone else is selling.” Thereby, any point along the bottom third of the real estate cycle (if a line were drawn horizontally, would refer to the bottom of the market. Not only are interest rates low, but the market is saturated with distressed sales (shortsales, foreclosures, etc), which can often be spectacular deals for investors or first time home buyers. This is similar to what is occurring now (2012).
- Low Vacancies: In most recent history, this stage of the cycle occurred between 2000 and 2004. Investors were in and soaked up desirable residual income: rent. Housing prices and rents began to increase. More people considered buying homes and began to start demanding competitive loans from banks. Competitive loans, rates, and terms can come in the form of negative-amortization loans (amount owed increases over time) or even “no-doc” loans (no verification of income), which came to be known as sub-prime loans. There was an inherent pressure, even by the Federal government, to get more people into houses. Unfortunately, many homebuyers were just under qualified.
- Increased Rent and Prices ( …, 1972, 1987, 2002): Prices increased. 2004-2006. For instance, one home on a corner lot in C Street in Oxnard, CA sold for $550,000 on May 28, 2004. Less than 8 months later, in 2005, the same property sold for $670,000. That’s 33% annual appreciation. Real estate was the hot topic. Everyone wanted to be a part of it. Many excited and ambitious buyers took advantage of competitive loans and purchased homes at high prices. Someone may ask, “Why would someone buy at the top of the real estate cycle?” The first reason: lack of education. In 2006, we advised investors we worked with not to purchase property, because the signs of an economic turn around were beyond evident. They were glaring. Why did people buy then? The rationalization of the time was, “The housing market is bullet proof. Prices will continue to rise exponentially! Anyone would be able to refinance if they were no longer able to afford their mortgage.” Unfortunately, when the market finally fell, as it historically always has, refinancing loans was no longer an option, as property values were now less than their original amount.
- Accelerated New Construction ( …, 1973, 1981, 1988, 2007): Builders stepped in. 2005-2006 marked an incredible time for new developments, both planned and built. Unfortunately, many of the planned developments never came to fruition upon the collapse of the market. Many existing construction projects were abandoned as financing opportunities dried up.
- Oversupply: The developments that were completed too late ended up incomplete or vacant.The market had become saturated with new homes and buyers had either already bought or could no longer afford the extremely appreciated prices of homes. In addition, in 2007, people began having difficulties paying the incredibly expensive loans they had acquired in the early 2000s.
- High Vacancies(…, 1975, 1982, 1991, 2009): The over saturation, in addition to changing factors in other markets, such as soaring oil prices, a collapsing stock market, and reduced ability to lend lead to a crisis with a climax in September of 2008 (even though signs of this climax had been clear since late 2005). As the Leman Brothers company collapsed, other financial institutions followed. As homeowners with subprime loans were no longer able to afford their still young mortgages because the rates increased, they lost their job, or some other reason, people began losing their properties. When people stop paying their mortgage, it’s not just the servicer (the lender a person got their loan through and payments are made to) of the loan who is affected. Mortgages are almost always sold by the servicer to a secondary mortgage market, which is in turn traded against in global markets, such as to secure bonds in other countries, like Italy. This way the servicer/lender has more cash to lend to more people. Mortgage backed securities (bundles of mortgages from property owners) are traded on the secondary market. For example, if a bundle consists of 10 mortgages and 1 mortgage fails (the borrower stops paying), the other 9 secure the bundle and keep it viable for trading. If 4, 5, 6 mortgages in a bundle fail on the secondary market, then problems begin to exist in the secondary market, which further perpetuates the collapse of the market. Real estate is virtually entangled with almost every other market in existence. In the mid 2000s, it was common place for subprime loans to blend in with AAA and BBB rated mortgages, leading investors across the entire international financial community to be affected by failing loans in America. When an owner stops paying, the entire market is affected. For a simplified and humorous explanation of the financial crisis, watch this slideshow: Evolution of the 2008 Financial Crisis.
- Declining Prices, Rent, and Construction: Prices of real estate free fell. The overinflated real estate bubble burst sending millions out of their new homes they likely weren’t able to afford for the long run in the first place.
The real estate cycle is predictable. However, there is no set amount of time that the real estate cycle takes to repeat itself. It could take 20 years, or 7 years. Either way, the cycle follows a set path every time it occurs. By following the indicators that determine where in the cycle the market is currently located, one can make an educated decision in real estate and make money.
Here’s the bottom line though: If you love the property, can afford the property for the long haul, and your expert broker believes that you are paying fair market value, then you’re getting the best price possible.
Don’t wait to buy real estate. Buy real estate and wait.