You probably clicked on this article because you are hoping for some “insider information” on how to make money by predicting where real estate markets will go. Everyone assumes that they are smart enough to read a situation correctly, but the truth is that no one can guarantee a correct prediction on a market change in any direction. Any seminar that explains how you can time entry points into the real estate market is a get rich quick scheme to steal your money. The reasoning is simple. If anyone could predict price movements in advance with 100% accuracy, the value of knowing the market timing is worth well in the billions if not more. The first thing they would do is hire private security guards to keep their secret hidden from public view, not put it out in a seminar to share with the world.
Instead, our belief is that by taking a detail oriented approach and considering things like job growth, path of progress, population growth, and new upcoming construction, one can make a strong educated guess on whether or not local real estate prices will go up or down in the next 3-5 years. The goal is not to try to time the market and sell at the exact peak; it’s to have a general idea of whether the current trends suggest a downturn or an upswing in the near future, so you can react accordingly.
I'll be your guide to the local Real Estate market
To begin, we will take a look at the 4 phases of the local Real Estate Cycle. These are “phases” that most local real estate markets in America adhere to and are mentioned in countless books written by authors far more knowledgeable than myself. I am merely summarizing their existing information into one easy to understand article. Please note that no phase of the cycle is inherently good or bad. There are potential risks and rewards at every phase of the cycle and the only limit is with what choice the individual homeowner or investor decides to make.
Hypersupply: We will start by looking at hypersupply, which occurs when the market has too many properties for sale and not enough people who want to buy them. This tends to occur when there’s a mass exodus of jobs from the area (think Detroit) or when overly optimistic developers see so many opportunities that they build enough properties to saturate the marketplace (think Las Vegas). The end result tends to be a downward spiral where there is not enough demand for housing in the area, forcing property owners to lower rents or offer other incentives to attract renters, which in turn lowers their property value further and further.
To make matters worse, you have to consider the fact that new construction projects often have lead times of 1-3 years. This means that even when the market is oversupplied and jobs are leaving the area in droves, there will still be a constant trickle of new inventory hitting the market. Overall, this is a good time for an investor to come in and snap up properties at a discount as desperate property owners compete with each other to sell off their properties and abandon the sinking ship.
Recovery: In order for a local real estate market to recover, certain things need to happen: jobs need to be created, vacant spaces need to be fixed up and filled in again, and people need to start moving into the community. For all of these to happen, the most critical factor to consider is what the local government is doing.
If the local government is not committed to increasing job growth in the area, no amount of blaming or hopeful optimism is likely to change the market for the better. You need to look for things like revitalization zones and other economic incentives for development and job growth (just make sure to confirm that they are actually spurring business growth and not just all talk).
With strong leadership and strong economic rewards in place for business expansion and formation, new jobs will inevitably hit the market, meaning people will begin to migrate back into the city to take advantage of the new employment opportunities. A positive feedback loop now emerges where rental units start filling up, leading to increased property values, and causing investors to swoop in and renovate vacant and distressed buildings because they see how fast property values are rising in the area.
To compound the job growth, consider the fact that it takes 3-4 service level jobs to support a working professional. So as the number of professional jobs keeps expanding, the total number of jobs expands at an even faster rate as food services, dry cleaners, and other service jobs move in as well to fill the rising demand of the growing population of the area.
All in all, this is still a buyer’s market as new inventory has yet to hit the market and the painful memories of the previous bad rents are still fresh in the minds of local property owners.
Expansion: This is the natural state for any local recovering real estate market to eventually find itself in. As more and more jobs are created, more and more people move in to fill those jobs and all those people need housing, meaning increased rental income for property owners. Eventually, owners will be making so much money from rents and leases that it makes monetary sense to start building new properties to meet the rising demand. Thus, a crucial plateau is crossed and the market can begin a phase of expansion.
In this phase, you will start to see new construction take off. Properties will sell quickly, often triggering bidding wars where multiple buyers compete to snap up properties that hit the market, sometimes even offering more than asking price to secure a piece of real estate in this booming market. People are so optimistic about the future, that you will start to see raw land and obsolete properties get snatched up right away by investors and developers who want to quickly convert them to profitable residential or commercial buildings.
At this phase of the market, the seller has the advantage as more and more homebuyers enter the market, from the faraway investor seeking riches in the booming market, to the young professional who just moved to the city to find a job in this vibrant new community. This will be the point where speculators will start entering the market, relying heavily on their predictions of future growth in the market when running the numbers on whether to buy or develop a property in the area rather than sound fundamentals like rental income and expenses.
Maturity: Finally, the market will hit the maturity phase, which will have mixed results for buyers and sellers as uncertainty begins to creep in. The good times continue but cracks in the matrix can be seen everywhere. Prices and rents keep skyrocketing upwards but there’s now a definite end in sight. After all, they can’t keep rising forever… at a certain point, it becomes financially unsustainable for new migrants and jobseekers to keep moving in and renting at now greatly elevated prices.
Construction projects keep going up, which will lead to hypersupply in the future as speculation is a way of life and builders start erecting structures based on their predictions of the market’s future value instead of solid financials like how much income the property will generate and what its expense sheet will look like. Ironically, it is at this point in the market cycle that most investors jump in. They stayed far away from the market when it was in hypersupply and prices were in free fall. They were not bold enough to make a prediction on the market based on favorable local government policies and job growth in the recovery phase, and they were too scared to make a move when things looked like they were starting to look up in the expansion phase. It’s only when they’ve gotten so inundated with all the reports from the media and from friends and family who have made millions investing in the local real estate market that they decide that NOW is the time to make a move.
Ironically, and unfortunately enough for the overly cautious buyer, this might be precisely the wrong time to get into real estate in that market. Builders are paying so much for land and construction that sooner or later, they won’t be able to keep raising rents and people won’t be able to keep coming in and buying these overpriced properties. Meanwhile, house flippers scour the area for mediocre deals, not even doing anything to improve the property like fixing it up or redecorating the interior, simply relying on pure speculation of future market prices .
Final remarks: And that’s it. Those are the 4 phases to a local real estate cycle. There are really only 2 phases if you really drill down to the fundamentals, a buyer’s market and a seller’s market. Any phase of hypersupply or recovery will be a buyer’s market, a great time to purchase properties but a bad time to sell. Any phase of expansion or maturity is a good seller’s market, a great time to sell but a bad time to buy. And that’s it really. As mentioned previously, you are not looking to time the market exactly, just to have a rough idea of whether you should be making a home purchase or selling your home. For more information on navigating the ever-changing real estate environment to structure the ideal transaction to meet your goals, feel free to fill in the “contact us” form.
Written by Brandon Lor