What are the 4 Stages of Real Estate Cycle

In 1933, American economist Homer Hoyt discovered that each real estate cycle on average lasts for 18 years and each cycle consists of 4 stages (and their respective characteristics): 

(source: via realvantage.co)

1. Recovery (declining vacancy and no new construction)
2. Expansion (declining vacancy and some new construction)
3. Hyper-Supply (increasing vacancy and more completions)
4. Recession (increasing vacancy and less completions)

The typical 18-year real estate cycle can be influenced by factors such as overall economy, government regulations and policies etc. The most recent examples are the Fed’s quantitative easing program during the coronavirus pandemic and interest rate hike in 2022, influencing interest rates and people’s willingness to buy properties. 

How to determine the current stage

Just like economic cycles, real estate cycles are shown through several indicators. For real estate, we often look at:

• Occupancy/Vacancy Rate

When the real estate market is at the Recovery and Expansion stage, occupancy is growing and vacancy rate is declining; During the Hyper-supply and Recession stage, vice versa. 

• Property Prices/ Rental Rates

At the Recovery stage, property prices and rental rates tend to remain low due to the excess supply of housing from the Hyper-Supply stage. 

As we move to the Expansion stage, prices begin to grow and reach a peak entering the Hyper-Supply stage. Then, prices are gradually increasing at a slower pace and eventually dropping during the Recession stage.

• Sales Volume

Sales volume indicates the level of demand and buyer enthusiasm. Normally, sales volume reaches its peak between the Expansion stage and the Hyper-Supply stage.

As prices skyrocket in the Hyper-Supply stage and intimidate buyers, sales volume decreases and continues to do so in the Recession stage. In the Recovery stage, sales volume slowly climbs. 

• Unemployment Rate / Income

Another factor influencing the demand is unemployment rate and income. Real estate is one of the most capital-intensive assets, therefore the real estate market is expanding with a lower unemployment rate and higher income level, vice versa. 

• New Construction

When real estate developers see the opportunities in a growing market, they construct new housing to meet the demand. This often is the main indicator on the supply side of the equation. 

As shown on the graph above, as the market goes from the Recovery to the Recession stage, new construction swells, leading to an oversupply of housing and a surge in vacancy rate.

So which stage are we at now

Using some of the indicators discussed above, we can get an impression of which real estate cycle stage we are at now:

• Property Prices 

According to FRED, Median Sales Prices of Houses Sold for the United States had been declining during the 2008 global financial crsis and the 2020 COVID-19 pandemic as sales prices tend to fall during economic downturns.

As of Q3 2022, median sales prices in the US have still been climbing since 2020. But we have seen home prices in many cities across the US declining for the past 3 months (the darkest color represent the most drop in home prices):

For example, San Francisco has seen a 4.33% drop and Austin has seen a 5.01% drop in home prices for Q3 2022.

As many economists predict we are entering a recession, this suggests that we are likely at the intersection of the Hyper-Supply and Recession stage of the real estate cycle.

• Sales Volume

According to TradingEconomics.com and NAR, sales volume has been declining since January 2022, signaling the cooling of the inflated US real estate market. This downward trend suggests we are entering or already at the Recession stage.

• New Construction

Let’s look at the supply side of the equation: new construction. According to FRED, new construction in the U.S. (in this case, we refer to New Privately-Owned Housing Units Completed: Total Units) have been consistently declining during almost all past recessions. 

And we haven’t seen the downward trend this year just yet – in fact, the macro trend suggests that new construction has been increasing since 2011; perhaps there is a recession looming on the horizon.

Summary

Taking into consideration the three factors we mentioned above – high yet recently dropping property prices, shrinking sales volume and increasing new construction, it is reasonable to infer that we are likely at the Hyper-Supply stage now and entering the Recession stage of the real estate cycle. 

How can we invest in real estate at the current stage

During the Hyper-Supply stage and the Recession stage, you will see property prices falling, vacancy rate increasing, sales volume shrinking and new construction ramping up, leading to an oversupply of properties. 

When panic selling starts, property prices begin to fall sharply and it can be more risky for investors to buy properties because they might have to wait for a long period of time before seeing house prices rise again. 

But this also represents opportunities for investors to buy properties during this stage. Here are some ideas and investment strategies:

• Buy properties at discounts

When the Recession stage arrives, high prices drive a lot of buyers and owners out of the market, causing their inability to pay for mortgages and thus foreclosures of homes. 

Pay attention to these foreclosed properties and you might be able to find bargain deals that are great investment properties. 

• Adopt a buy-and-hold strategy

Buy-and-hold strategy refers to a strategy when investors purchase a property and hold it for an extended period in order to reap the benefits of recurring rental cash flows and property value appreciation. 

In fact, this strategy works well during all stages of the real estate cycle if you are patient.

• Be flexible in your investment strategy

Whether you can be a successful investor in real estate throughout the 4 cycle stages also depends on your ability to adapt and react. For example, if you are focusing on investing in short-term rentals and flips in the past, you might consider switching to long-term rentals to avoid rising vacancy rates and low liquidity in the market.

After all, the best deals and the most agile strategies shine throughout all 4 real estate cycle stages.

Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational and entertainment purposes only.