How to Benefit From Commercial Real Estate Cycles
Making big money in commercial real estate is all about managing risks. Understanding and gaining knowledge of real estate cycles helps you lower your risk. Even though predicting real estate cycles is largely a game of luck, it gets downright dangerous if you know nothing about the trends in the market in which you’re investing.
Real estate cycles are like traffic lights. When you see a green light, you go. When you see a yellow light, you might go, but if so, you proceed with caution. When you see a red light, you stop. The trick, however, is knowing when you’re facing green, yellow, or red lights.
Here are some examples:
* A green light in commercial real estate investing may be spotted when you notice upcoming job growth due to a factory expansion. Or when the demand to build exceeds the supply of available properties. Most likely, you’ll also see a lot of undeveloped land sales activity.
* A yellow light may be indicated by interest rates creeping up suddenly and causing you to examine your costs of new money to borrow. Or it could be when you see vacancies and “lease specials” increase. What if your newsfeed reveals many struggling businesses in an area? That has yellow light written all over it.
* A red light may be revealed by a halt in new construction, which may be caused by overbuilding in the area. An increase in foreclosures and a decrease in property values is a sure red light.
Here’s the Six Phases That Commercial Real Estate Goes Through
* Expansion phase: During this phase, population increases, incomes rise, employment is good, vacancies are decreasing, and rents are rising. New buildings are planned. The human emotion here is excitement.
* Peak phase: This is the time to sell for maximum profit. This is a seller’s market, and in this phase, you see new building projects increasing and bidding wars between investors. Listings are on the market for only a short period of time. The human emotion here is sheer confidence.
* Contraction phase: Most likely, you’ll see a bunch of new projects on the market now, and you may see evidence of overbuilding. Inflation is up, interest rates are increasing, vacancy rates begin to creep up, and prices begin to level. Foreclosures generally grow during this time. The human emotion here ranges from mere concern and denial to utter shock.
* Recession phase: Real estate in this phase is becoming more difficult to sell, and so properties stay on the market for longer periods of time. Property values decrease, interest rates are high, and landlords are competing for tenants because of overbuilding. Foreclosures are usually rampant. The human emotion here is complete panic.
* Bottom phase: This is the best time to buy. However, this is the scariest phase there is: Unemployment and inflation are high, and the demand for apartments is decreasing. This phase separates the men from the boys, the women from the girls, and the true investor from the stock market refugee. The human emotion here is plain old depression for most folks.
* Recovery phase: This phase is the breath of fresh air. The local economy shows signs of life, vacancies decrease, rents level off and start to trickle upward, speculation starts again, and money begins to flow back into market. The human emotion here is pride, because you’ve waited out the storm.
So When Should You Buy or Sell?
* When is the best time to buy? The truthful answer is that it depends. If you’re a smart investor, you should buy in the bottom or middle of the expansion cycle. That way, you’re buying on trends and following the market and other investors. You’ll likely feel safe because you’re following what everyone else is doing.
* When is it the best time to sell? The best time to sell is at the peak phase, right at the top of the market. And the biggest problem with selling here is knowing exactly where the top is. Here are two clues that have never failed us yet: Watch the rents and vacancy rates separately. After rents level off and become flat for three straight months or more, you’ve reached the top. Or for another indication you’ve reached the top: After vacancy rates are at a three- to five-year low, you’ve reached the top. It’s that simple.
* When is it the best time to go bottom-fishing? If you aren’t a bold risk taker, you may find this advice uncomfortable (so consider yourself forewarned!). Maverick investors buy at the bottom phase or at the front end of the recovery phase. This is called “bottom-fishing” for deals. This is where the big, big money is made. Maverick investors are brave and courageous trendsetters. They’re usually the first investors in the worst part of town, and they’re usually banking on the area to come back big time. If they play their cards right, they come out on top, and if they don’t, they simply walk away with an “aw, shucks.” Now that’s bravery!
* Job growth: This trend makes perfect sense: Where the jobs are, people are. And where the people are, demand exists for apartment rentals, office space, and consumer goods. Job growth is an excellent indicator of a healthy real estate market.
The best place to start in researching job growth is to contact your local economic development department or chamber of commerce and ask for historical and current job growth data.
* Development: This trend is all about supply and demand. After all, if a shortage of office space or apartment housing is evident, you clearly have a demand for new development. On the other hand, if you see that the city is overbuilding, it’s an indication for you hold off and reassess.
* In the path of progress: It isn’t too difficult to spot this trend with your own eyes. Whenever new building and development is either coming your way or surrounds your property, you’re in the thankful path of economic development. You can feel the “buzz” of prosperity around you.