When to enter a Real Estate cycle

We are bombarded daily with sound bytes about cycles. Today we have the “economic cycle,” “business cycle,” “recovery cycle,” “stock market cycle” and recently the “climate cycle.” We have “natural cycles,” “energy cycles,” “commodities cycles” and “currencies cycles.” Cycles can be short-, intermediate- or long-term, as well as seasonal. Wall Street analysts, governmental agencies and talking heads assign the term “cycle” to all that can’t be quantifiably explained or that which needs a catchy phrase to be explained. We have “vicious cycles” and “theoretical cycles.” We have notable business consulting gurus who use phrases such as “cycle time” or the “customer cycle.” Very sophisticated computer models at many universities and colleges seek to “quantify” business cycle theory (with the hope of a prediction), and one can blog and/or communicate with others 24/7 regarding economic cycles.

The issue with the term “cycle” is that it mandates an acknowledged beginning and an end, thus creating the endless challenging dilemma of knowing when to “get out” or when to “get in.” A cycle is generally defined as “an interval of time during which characteristics, or often regularly repeated events or a sequence of events occur.” However, regardless of what cycle you are in, no two cycles have the same start or finish date, and no two cycles have precisely similar characteristics. Cycles are both business and human multi-dimensional mosaics of varying duration. Predicting a precise date or time for a cycle to begin or end is next to impossible. With cycles, there is only one certainty—they exist, and they ultimately will have a significant impact on success or failure. The key is to not try to control but to take advantage of the cycles.

Whatever the “natural” life cycle of business or economic cycles might be, on occasion they have been interrupted by government intervention as policy makers seek to lessen, correct, enhance, extend or reduce the impact or eventual outcome of cycles. Unfortunately this intervention (regardless whether political or well intentioned) inevitably results in a deferral of a cycle’s natural course or the creation of a new economic bubble that inevitably creates its own set of consequences. This further highlights the fact that cycle theory is often the historic offspring of technical analysis and modeling, based not on “natural” cycles, but emanating from monetary and fiscal policy decisions.

Real Estate Cycle

Real estate cycles tend to follow a fairly consistent 10-year pattern. Obviously it is not a precise 10-year period—one cannot pick specific beginning or ending dates; and real estate cycles vary by asset type, market factors and location.

The length of time within a period is typically uniform. However, the “Plateau” and “Crisis” periods can be shorter in duration. It appears that, as the real estate industry nears its peak during the Growth Period, the level of denial, misguided expectations, blind optimism and “one more day” mindset appears to creep into the C-suite.

How many times have we heard, “I know it is probably time to get out, but I just need to get this deal done,” or “I’m not sure I believe these numbers, but debt is cheap, and this opportunity is just too good to pass up.” A good time to exit is probably 6–12 months before or 6 months after the peak of the Plateau Period. A good time to enter is in the Transition Period. A good time to be very cautious is near the end of the Growth Period.

Because real estate cycles tend to work on 10-year cycles, it is important to note that all asset classes or markets do not begin or end a cycle at the same time. The impact of global, state and regional economic and government activity does affect the length and severity of a real estate cycle. For example, the Tax Reform Act of 1986 eliminated/removed many tax shelter-based investments and probably contributed to the savings and loan crisis that sent the real estate industry into a rapid downturn by the late 1980s/early 1990s. The aftermath of 9/11 delayed the economic recovery for 12–18 months. The current financial stimulus and bailout programs may contribute to a slower recovery of the non-residential real estate market.

Interestingly REITs tend to cover two “normal” real estate cycles. REIT real estate cycles tend to last 18 years with two-year transition periods. This closely parallels our findings regarding the 10-year “normal” real estate cycle. Most real estate cycles have begun around the third year of a decade (1973, 1983, 1993, 2003, 2013) and usually end by the eighth year of that same decade (1978, 1988, 1998, 2008, 2018). Between the finish and start of a new cycle, a period of transition occurs (1989–1992, 1999–2002, 2009–2012, 2018-2022).

While there are many “fundamental” drivers of real estate cycles, no single factor determines a real estate cycle. CEL & Associates, Inc. has identified nearly 50 “cycle drivers;” however, 20 “core” or “fundamental” drivers tend to dominate a real estate cycle. Since all drivers are not created equal or their weighted impact the same, they can be divided into the two groupings shown below:

Primary Drivers:

• ·         Federal Policy & Priorities
• ·         Access To/Cost Of Capital
• ·         Job Growth (Quantity & Type)
• ·         Commodity Prices
• ·         Demographic Shifts
• ·         Consumer Confidence/Spending
• ·         Labor Force Productivity
• ·         Supply/Demand Ratios
• ·         Infrastructure Investments
• ·         Economic Growth

Secondary Drivers:

• ·         International Trade
• ·         State/Local Regulations
• ·         Population Migration
• ·         Small Business Performance
• ·         Consumer Credit/Savings
• ·         Business Start-Ups
• ·         Advancements In Technology
• ·         Competitor/Industry Factors
• ·         Household Formation/Characteristics
• ·         Household Income/Net Worth

The study of real estate cycles will never be complete. The unexpected and predictable outcomes of national and global events will impact the start, end and duration of a cycle. In the years ahead, the continuing study and understanding of real estate cycles will be important in setting strategic priorities and direction. However, one fact is very clear, real estate cycles exist … and are predictable. How will you take advantage in the current and next real estate cycle?