Real estate market cycles - where we are today and how things will continue

 

seasons and cycles. Things repeat themselves in biology, astronomy, time, and many other aspects of life. Real estate is no exception.

Market analysts have shown that real estate markets go through recurring cycles. In 1933, in his book 100 Years of Land Values ​​in Chicago, Homer Hoyt showed how real estate goes through different phases. Used copies of the book can still be purchased from Amazon.com. In his research, Hoyt found that real estate goes through cycles of about 18 years.

Consider the non-residential construction boom-bust cycles in the chart below. Each peak is followed by a decline that coincides with an economic recession. In the same years that the real estate market booms and busts, the stock market has experienced similar booms and busts. What does a typical real estate cycle look like? Let's start at the bottom of the curve.

recreation

The recovery occurs at the bottom of a market swing. Investor sentiment is pessimistic. Few think about investing in real estate. The occupancy rate is low. The construction of new houses, apartments and commercial properties has practically come to a standstill. A joy for lateral thinkers, right?

In the upturn, there are signs that the economy and the real estate market are improving. Monthly job counts are improving, rental income is rising and property valuations are starting to rise. The credit institutes grant more loans and the construction of formerly undeveloped plots of land begins. When the recovery phase has matured, previous losses have been recouped.

Mid-cycle slowdown

Sometime midway through the recovery cycle, the stock market and gross domestic product (GDP) fall, but real estate holds its value. Gas, oil and electric utilities are rising, the bond market is witnessing yield inversion and the Federal Reserve is raising interest rates.

boom

In this phase, a real estate boom begins due to the rapidly increasing real estate prices. Municipalities are increasing their spending on building new and improved public facilities. The real estate market is heating up. Interest rates for borrowers are starting to rise, but it's easy for investors to get credit.

Eventually, however, the cost of real estate begins to exceed real values ​​because the demand for land and buildings has become a frenzy. Real estate activity is beginning to slow, but confidence in the economy and in generous investment returns remain high.

Real estate: high

Eventually, the economy grinds to a halt and housing supply exceeds demand. Vacancies are falling and rents are falling. The first peak is the housing market, then the stock market peaks, and finally GDP goes negative. A recession follows. A crash occurs—usually the stock market first, then GDP, and finally the housing market. Credit from financial institutions is drying up, unemployment is rising to new heights, and decline and pessimism reign.

How to predict a real estate market crash

Many years ago miners kept canaries in cages deep in the mines where they worked. When the canary died from toxic gases or lack of oxygen, the miners knew they had little time to get out of the mine alive. Just as miners had their canaries, real estate investors have other signals that can warn them of an impending crash.

Land spikes: Watch for a broad and rapid rise in land prices and construction activity. The St. Louis Federal Reserve Bank is an excellent source of such data.

Interest Rates: Interest rates are rising. The yield curve inverts (when short-term interest rates are higher than long-term interest rates). An inverted yield curve indicates that an unstable economy is imminent because the short-term risk is higher than the long-term risk.

The sectoral balance is changing in GDP: as economic activity in firms and government slows, the share of households in the GDP pie increases.

Budget surpluses: If the state collects more tax money than it spends, there is a surplus. Budget surpluses may indicate that governments have underestimated economic activity when planning their budgets. The economy is developing better than expected.

Where are we today?

Due to life after COVID-19 and the current war in Ukraine, market signals seem confused at the moment. Or maybe it's not confusion, but rather market cycles occur on a much shorter time frame.

On July 27, 2022, the US Federal Reserve increased the federal funds rate by 0.75%, the second consecutive hike. This increase was intended to stem high inflation rates of 9.1% in June and 8.5% in July, the highest rates since 1981. Despite high inflation and rising interest rates, the US reported a 528,000 increase in nonfarm payrolls and a fall in the unemployment rate to 3.5% in July. Those numbers far beat the Dow Jones' estimates of 258,000 and 3.6%, respectively. The July numbers brought the unemployment rate back to pre-pandemic levels, posting the lowest unemployment rate since 1969.

What about housing construction? In June, housing starts fell 2% mom, hitting the lowest level since September 2021. Home sales in July fell nearly 6% mom and were almost 20% down year-on-year. The median price for a home in the US was $403,800 in July, up 10.8% year-on-year.

Real estate: what now?

Inflation is high and interest rates are rising, but the job market is booming. Right now, the negative GDP numbers mean little. Construction starts and sales are gradually slowing down, but property prices continue to rise. The geopolitical situation is uncertain due to the Russian war against Ukraine and increasing tensions between China and Taiwan. Political disunity in the US continues to grow.

What should an investor do in relation to real estate? The real estate market may be at the end of an upswing and nearing its peak. If your property's valuations have risen sharply in recent years, it might be a good time to consider selling. If you are a new investor you may still find good deals on real estate at reasonable prices, but you will have to search long and hard. In either case, however, you should always proceed with caution.

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