Economic cycles and real estate investing depend on one another. The economic cycle is an important part of the real estate investing process as economic factors can change the frequency of real estate investing. Likewise, real estate investing can change economic outlooks. The economic cycle shows how the market changes over time and what you can expect from your investments. This article will help you understand economic cycles and real estate investing, as well as how to take advantage of cyclical markets.
4 Phases of the Economic Cycle
Economic cycles and real estate investing go together. A typical economic cycle has four phases: expansion, peak, contraction, and trough. These phases are not always in order, the economy may share traits of two stages, and they also have varying lengths depending on a variety of factors. The length of each phase may vary depending on the economic strength. For example, an expansion phase in a strong economy will be longer than an expansion phase in a weak economy.
You can think of the phases as boom-bust cycles in which each phase has its own characteristics that affect real estate investing.
How do Economic Cycles and Real Estate Investing Correlate?
An economy is a complicated machine and there are many factors that affect it, but in general, we can say that there’s a strong correlation between economic cycles and the real estate market. While the real estate market may correlate with the economic cycle, they don’t always line up. However, economic cycles and real estate investing are dependent on one another.
As we’ve mentioned, economic cycles affect the economy as a whole and cause changes in many areas. For real estate investors, this means that there will be more changes in property demand and inventory count. It will impact asset management costs and marketing strategy for leases. and it will impact how prevalent good deals are.
The economic cycle is a factor that every real estate investor needs to consider. The good news is that there are ways to use the cycles to your advantage. You’ll want to know about these economic indicators when you’re deciding what real estate sector will succeed, your investment strategy, the class of investment property to buy, or when you consider capital strategy.
- Interest Rates and Fed Funds Rates
- Capital Availability
- Tax Rates
- Discretionary Income
- Consumer Debt
- Employment Rates
- Consumer Confidence
- Business Investment
- Consumer Price Index
- Oil Prices
- Government Regulatory Policy
As a result of all this, rents and prices will often go up during these periods. However, there are many other factors that can affect rental rates or sale prices too!
Minimizing Macroeconomic Effects Through Market Selection
It’s important to remember that not all localized markets react similarly during each phase of the macroeconomic cycle. For example, some markets have historically been more sensitive than others—for example, Florida has been known for being slowest off both ends of its expansionary/contracting cycles (i.e., it takes longer for prices and rents to drop).
Most markets do follow similar trends over time, so understanding how certain indicators move with respect to one another can help inform your decision-making process. Any given localized market may be better suited for your investment strategy depending on the economic phase.
Economic Expansion Phase
The expansion stage is characterized by an economy that is growing at a 2-3% rate. The stock market enters a bull run, as well as many other financial markets. Unemployment rates are low and total employment growth is stable. Interest rates are falling, which makes it easier for individuals to borrow money cheaply. Inflation remains stable in this period due to low-interest rate policies set by central banks during the prior economic downturn.
The expansion stage creates high consumer confidence and increases discretionary income. Therefore, in this stage, there is an abundance of investment opportunities as the economy expands and consumer demand increases. Real estate investing becomes more popular with increased financing availability and investors predicting growing income streams for multiple years. Property development opportunities are also prevalent during this stage because of the lack of supply relative to demand thanks to the prior recession.
When the economy is in an expansionary phase, there will be more demand for properties, and competition for them will be higher. Rents and Prices will increase to account for the increased discretionary income. This is when prices are rising quickly while construction is increasing rapidly so there will always be opportunities to find deals during this period if you know where to look.
Economic Peak Phase
The Peak Stage is characterized by an economic growth rate greater than 3% and all other factors that support continued growth. The stock market rises to all-time highs, with almost irrational price-earnings ratios. Low unemployment rates make it difficult for businesses to find employees and increase production levels. The availability of capital at mostly reasonable interest rates means that more money can be borrowed for long-term projects such as real estate development.
The main concerns in this stage are speculation, inflation, and lending standards. During this period high property valuations could fall if interest rates rise due to inflation fears from rapid growth. Nevertheless, investors have been making money for many years already so they feel comfortable buying now despite high prices that may fall later. They believe that their investment will pay off enough by the next crash hits. The greed from years of economic prosperity can cause overvalued property, so it is extremely important to compare investment opportunities with previous years’ good deals.
Landlords may be seeing enormous increases in property values as we’re currently experiencing now; however, a landlord who buys property during this time should consider whether he or she has enough cash on hand to cover unexpected expenses like repairs or vacancies (tenant turnover). If an investor can accurately budget for the imminent turbulent economy, then long-term investments, such as the buy-and-hold strategy, may be safe. However, speculative investors involved in short-term investments, such as the value-add strategy, need to tread carefully during this economic stage.
Banks minimizing lending standards is another area for concern during a peak. Carrying debt through a peak into a recession may be an unnecessary risk. Poor lending standards eventually led to the 2007 housing bubble. While it does depend on your real estate portfolio strategy, many investors believe that valuations will not matter if price growth can maintain. Banks practicing greed will minimize standards to allow speculators to use the debt and when economic factors change and vacancy grows, the investor who did not plan for the rainy days will fail.
Contracting Economy Phase
The contraction stage is a time of low economic activity. GDP growth is negative, and the economy is in recession (i.e., two consecutive quarters with negative GDP growth). The employment rate may be growing slowly or not at all, while unemployment may rise. Because of this, stock markets enter a bear run; it’s possible that real estate investments will see a similar trend as investors move their money away from speculation and into safer assets like gold or cash.
The contraction stage can last for several quarters or years before moving into the recovery stage. If you’re looking to invest in real estate during this time, it might be good to focus on properties with stable demand and income—that way you won’t be negatively affected by economic fluctuations during recessions or depressions that occur during contractions! Residential investments and affordable multi-family properties have consistent demand as people always need to live somewhere. Also, self-storage investments can be profitable during this time since people will need storage if they recently downsized their homes.
Trough & Recovery Economy Phase
The trough stage is considered the “rock bottom” of a business cycle and is characterized by negative economic growth and negative employment growth. Consumer confidence is very low, and people begin to feel the financial impact of the recession. If economic conditions remain the same as they are now, it is very possible that these conditions can evolve into a depression. However, there are two unique features that can indicate the bottom trough and recovery is around the corner.
- The interest rates are expected to fall soon to spark the economy.
- Inflation rates have stabilized because of the pent-up demand and supply increases during the recession.
Once an economic downturn has been identified, it is time to act. This can be an exciting and rewarding time for real estate investors. To take advantage of this downturn period and find good deals on properties that will appreciate once the expansion stage begins, you will need cash on hand.
Cash flow from other assets or income from your primary business should be used for purchasing investment properties during this time because you’re going to want something substantial available when things turn around.
The ideal investment property during this stage would be one that has the potential for appreciation but doesn’t require large capital expenditures upfront because money won’t be readily available until after the market turns around again!
Finding Deals During a Trough
Here are some tips for finding good deals and tenants during this stage:
- Buying commercial properties that have experienced a downturn in their market due to economic conditions or a change in industry trends can be rewarding because these types of sales tend to be discounted more than resident-based property.
- Identify what type of tenant you want before you start looking at properties or even begin investing in real estate at all. There are many kinds of businesses that could potentially rent space from you depending upon your location and goals for investment property ownership (e.g., single-tenant office building vs strip mall).
- Find out what kind of lease terms are available by contacting local brokers/realtors who specialize in commercial real estate transactions (they should know!). You also may want to consider using tools like LoopNet which provide information about current listings such as price range & square footage among other details necessary so that buyers can make informed decisions about whether particular listings meet their needs.
Taking Advantage of Cyclical Markets
Economic cycles and real estate investing go hand in hand. The economic cycle is a pattern of boom and bust in the economy. This cyclical nature affects real estate investing because it means that you can expect good times and bad times in real estate markets. The best way to take advantage of this pattern is to stay ahead of the curve by being aware of what’s going on in your market, looking at market data such as vacancy rates, or asking sales associates how many houses have been selling recently—and then act accordingly by buying when there are bargains available or waiting until sales pick up again before selling if it looks like prices will rise soon
- Buy low, sell high. The core principle of investing is buying low and selling high.
- Buy when few others buy. As Warren Buffet said, “Be greedy when others are fearful, and fearful when others are greedy.” Few buyers mean there are more opportunities to negotiate the buying price.
- Buy in improving areas. Buy when the area is on the way up.
- Diversify your real estate portfolio by location, property class, real estate sector, and target market.
- Buy during periods of low-interest rates. When banks offer lower interest rates, this means they’re willing to lend money at a lower cost than usual—which means investors can afford higher-priced properties without having too much trouble paying off their mortgages each month!
Other Considerations for Economic Cycles and Real Estate Investing
To take advantage of cyclical markets, you also must have a well-defined capital strategy, investment strategy, entrance strategy, and exit strategy. You must make sure these strategies are conducive to the economic indicators and the outlook of the economy. If you do not have these things defined for each property that you consider buying, then your investments likely will not succeed.
The economic cycle is something to be aware of when investing in real estate. By understanding this cycle, investors can make more informed decisions when investing in property and have better chances at a positive return on their investment.
For help predicting the economic cycles and real estate investing, you can always reach out to us at invest@eikoninvestments.com.
Happy Growth.
