Imagine if you had sold all of your real estate in 2007, right before the historic crash? Understanding the predictable phases of every real estate cycle can empower the average person to make incredibly prescient decisions about their real estate far ahead of the curve, cashing in when others are losing money.
In part one of this blog, we outlined the first two phases of every real estate cycle, Recovery, or Phase I, and Expansion, or Phase II.
We’ll now explain Phases III and IV, and answer the trillion dollar question: When will the next real estate crash happen?
Read on to find out!
Phase III of the real estate cycle
In Phase III of the real estate cycle, we see a pronounced rise in rents, as the demand for affordable housing to rent outnumbers supply, driving up costs.
Rising rents makes the building of new units more attractive and financially feasible again, so more builders break ground on new projects.
As long as this upward pressure on rent is exerted, the demand for new construction is hot, with builders scrambling to meet that demand for financial gain.
This expansion of new units and rental housing is characteristic of both the expansion and hyper-supply phases of the real estate cycle, as building projects take a long time to initiate and finish.
The first sign of trouble in the real estate cycle
At a certain critical point, the amount of new inventory for both rental and owner-occupied real estate units will start to saturate the market.
Prices on rentals and homes have also been driven up by demand, but now supply has finally caught up with demand thanks to two cycles of consistent building and expansions, reaching a point called hyper supply.
That brings the first leak in the boat or indicator of a downturn in the real estate market: increases in unsold housing inventory and higher vacancy rates for rentals.
As all of these builders finish the new home and new rental unit projects they started back in the expansion phase, the number of available units bypasses the need, so we see the occupancy rate climb above the long-term average.
However, rental process and home prices are still rising, although their rate of growth begins to slow, as the saturated market no longer can justify these prices.
At this point, the market is at a crossroads. What happens next will determine the severity and timing of the inevitable recession, or Phase IV of every real estate cycle
If builders and developers pay attention to the declining growth in rental rates and demand and choose to stop building, the market correction begins. The same can be said for home sellers pricing their houses for sale, although the home buying market finds its true value and corrects itself much faster as there needs to be a willing buyer (and appraisal) for every single transaction.
However, if builders ignore the warning signs and keep churning out more apartments, condos, townhomes, and new home subdivisions, they further flood the market at the worst possible time.
Unfortunately, few builders or developers hit the OFF switch themselves, as they’re motivated by squeezing out every drop of financial incentive possible and not wanting to be the first one to leave the party.
Phase IV of the real estate cycle
With that critical sign of trouble, we’ve now moved into Phase IV of the real estate cycle, or recession.
As the market shifts from hyper supply to recessionary conditions, we face the second warning sign of trouble as occupancy rates fall below the long-term average.
Builders and developers are forced to stop new construction, but the multitude of projects they began during the hyper supply phase are still reaching completion.
This additional unneeded inventory leads to lower occupancy rates but also lower rents (and home prices), as buyers and renters have more and more to choose from, which start devaluing real estate.
The third warning sign is upon us, an increase in interest rates, which acts like a match thrown on a pile of dry timber to ignite a full-on housing recession.
Sooner or later, the Federal Reserve is driven to increase interest rates to fight inflation brought by the rapid expansion of prices we saw through the expansion and hyper-supply phase.
As interest rates climb, developers and builders slam on the brakes and stop building any new projects, as an increase in borrowing costs doesn’t make new development feasible or attractive.
However, the market is suffering through dropping occupancy rates, lower rents (and housing prices) because of oversupply, and higher interest rates for home buyers.
In combination, this quickly creates a negative ripple effect across the real estate market and affiliated industries, from builders and developers to home sellers desperate to cash in on the (missed) high point of their equity, landlords, income for realtors, loan officers, bankers, appraisers, title company reps, inspectors, attorneys, construction companies, laborers, etc. all the way down the line.
When vacancy rates start plaguing landowners, sellers, and builders, values plunge, with foreclosures soon following. The real estate cycle has come full circle.
How long do these real estate cycles last, and how often do they come around?
While it may seem like prices drop and the market changes overnight, the real estate cycle is as predictable as clockwork. By carefully studying the real estate market and every pattern of ups and downs throughout our history, respected economist Homer Hoyt discovered that the real estate cycle gone through this course of the four phases once every 18 years, all the way back to 1800.
The only two exceptions to this rhythm were in for World War II (he earlier noted that wars and world events could disrupt the cycle) and when the Fed inexplicably double the interest rates in 1979.
So according to Hoyt’s research, when will we see the next real estate crash?
The housing crash of 2008 and subsequent Great Recession definitely triggered our movement into Phase IV of the real estate cycle.
The market moved from the recovery phase to the expansion phase around 2014 or so. In fact, some major metro markets like Boston, New York, Denver, and San Francisco, etc. are already seeing a hyper-inflated rental market, accompanied by builders scrambling to meet demand and cash in as quickly as possible
So according to those projections and the typical pattern of this cycle, real estate values will peak in 2024, after which the recession phase begins anew.