According to historical market cycles, when will the next real estate crash occur? (Hint: not for a long time!)

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!

Hyper supply

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.

Recession

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.

The Four Phases of the Real Estate Cycle (and when we'll see the next crash)

The Four Phases of the Real Estate Cycle:

“The next major bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war.” — Fred E. Foldvary (1997)

If you want to read the ups and downs of the housing market, there may be no better place to turn than the venerable halls of Harvard University to check in with some of the most noted economics and real estate minds in the world.

Just like the cycle of any market, what we do know is inevitable – some call it a downturn or a correction; others a bubble or even a crash – is that what comes up must come down, and then up again.

In fact, these same Harvard economists accurately predicted the financial crash in 2008, or at least the timing of it if not the severity. They didn’t know some complex algorithm or hidden financial secret that the rest of us don’t, they just understood one thing: that any real estate market cycle goes through four phases.

In fact, as early as 1876 an economist named Henry George noted that all real estate cycles move through four phases.

Understanding these market shifts, what causes them and what happens next can empower the average person to make incredibly wise decisions about their real estate holdings far ahead of the curve of public sentiment or knowledge.

Imagine if you had sold all of your property in 2007 before the historic crash? What would it look like if you had kept liquid in anticipation of the Great Recession and had the means to snatch up properties so discounted the banks almost couldn’t give them away? If you knew these signs of a housing market ready to expand and appreciate wildly, you could certainly take advantage of that and when you could ascertain the warning signs that the roller coaster was at its peak and about to go on a wild ride, you could sell, sell, sell way ahead of your unsuspecting and vulnerable neighbors.

Believe it or not, all of that information is readily available. So when will the next real estate crash happen? Read on to find out!

Recovery:

Phase I of the real estate cycle

Having gone through the dark days of the last economic downturn, we all understand the characteristics of a recession, at least anecdotally. Recessions are characterized by:

High rates of unemployment

Decreased levels of consumer consumption

Downturn in corporate investment and expansion into buildings, factories, machinery, etc.

The price of land is depressed. In fact, property and real estate are at their lowest value any time during the four-phase cycle.

But during this phase, the population doesn’t stop increasing, and that means a higher demand for goods and services.

The government typically intervenes during this phase, aiming to spark the economic recovery in the form of lowered interest rates.

While demand inevitably marches on and the cost of borrowing money and investing is lower than ever, smart companies start looking to expand their businesses. There might be some small businesses that have to close their doors, but the larger corporations see this valley as a golden opportunity to expand and snatch up invaluable market share.

This expansion includes hiring new employees, building new factories, plants, stores, etc., and investing in new technology, machinery and infrastructure.

At the latter end of this phase, the extreme rates of vacant offices, retail spaces, plants, and homes starts to decrease. There is just too much inventory, prices and interest rates too low, and demand too high for economic expansion not to start in earnest.

Expansion:

Phase II of the real estate cycle

The real estate market leaves Phase I and enters Phase II of the cycle once companies and consumers have started to purchase or rent most of the available properties, easily tracked by low vacancy rates and shrinking inventory. In fact, occupancy rates surpass long-term averages during this period.

With vacant or available properties becoming far scarcer, opportunistic landlords start to raise rents. Most real estate expenses are fixed so their revenues and profits also increase with these inflated rents. With rents unprecedentedly high, buying vacant land or existing properties for development is more attractive than ever.   

New construction and development begins to boom, but the problem is that these projects could take a long time to get underway and reach completion – sometimes several years. In fact, the average new development takes two to five years to finish. So we still have strong demand but supply to fill that demand can’t be built or developed fast enough, resulting in increased upward pressure on rents, land and housing prices.

So by the time this new supply becomes readily available, the climate of high demand, high rates, low occupancy rates, low interest rates and low supply has been active for five to seven years, a period of robust economic expansion. 

But very soon, people start overpaying for existing homes, land and properties. “Investors” and consumers alike start basing the price their willing to pay on the scarcity of supply and the anticipated growth of rent and housing prices – not actual market conditions.

This is a critical point in the real estate cycle where perception of future growth outpaces the facts, and setting up the perfect storm of conditions for the next phase in real estate – the boom, the bubble, or, as economists call it, hyper-supply.

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Tune in for part two of this blog coming soon where we examine the two remaining phases of every real estate cycle – and share these Harvard economists’ predictions for exactly when we’ll see the next real estate downturn.

15 Things you should know about the mortgage meltdown before watching the movie, The Big Short.

Have you seen the movie, The Big Short? Released in December of 2015, the film is based on the book by the same name by author Michael Lewis – who also wrote The Blind Side. The Big Short is a true life retelling of four outsiders who saw the 2008 mortgage meltdown and financial collapse coming – and bet big on its failure against incomprehensible odds.

The movie has gotten nods for Oscar nominations, with an all-star cast including Steve Carell, Brad Pitt, Christian Bale, Ryan Gosling, Marisa Tomei, and others. But far from just an entertaining movie, The Big Short is the best two hour layman’s summary of the unfathomable circumstances and happenings in the U.S. financial markets during the boom years, and the greed, oversight, and bad decisions that were so prevalent, they are far stranger than fiction.

Filled with simple explanations for terms like “Mortgage-Backed Securities,” “Credit Default Swaps,” and “Collateralized Debt Obligations,” the movie is a great primer on the financial crash and subsequent Great Recession in the U.S. – as well as a stern warning why history may repeat itself.

We could easily fill a book (or volumes of books!) - not a blog - on the mortgage meltdown and financial crash. You’ll learn all of the essential definitions, concepts, and events about the mortgage meltdown when you watch the movie, but today we’ll do offer something far better than popcorn to chew on while recline in your cinema seat:

Here are 15 statistics about the mortgage meltdown and financial crash that you should know before watching the movie, The Big Short.

1. Before it was called a Great Recession, banking collapse, or financial crash, many people referred to the economic event as a mortgage meltdown. In fact, the proportion of low-grade subprime mortgage originations climbed from a historical average of 8% to over 20% between 2004 and 2006. About 90% of those subprime mortgages had adjustable-rates.

2. Despite the increase in real estate values and a booming economy, Americans didn’t accumulate wealth or savings but took on more debt than ever before. Our ratio of debt to personal income rose from 77% in 1990 to 127% by the end of 2007, most of it due to huge mortgages.

3. How steep of a cliff did our economy fall off? By 2009, U.S. housing prices had dropped nearly 30% and the stock market had lost about 50% of its value compared to only two years earlier.

4. Between 2007 and 2009, The U.S. economy lost nearly 9 million jobs, about 6% of the entire workforce, and saw 40% of our gross domestic product disappear.

5. Emboldened by seemingly never-ending rising home prices, a flood of easy home equity and cash-out loans, and, let’s face it, greed, U.S. consumers treated their homes like “ATMs” for the first time. In fact, home equity extraction doubled from $627 billion in 2001 to $1,428 billion in 2005, a figure that equaled a shocking 11.5% of our entire GDP!

6. Between 1994 and 2004, the U.S. homeownership rate increased from 65.4% - the typical historical rate – to an all-time high of 69.2%.

7. U.S. home prices fell by over 20% between mid-2006 and September 2008. By 2012, they had fallen by almost 40%.

8. With decreasing real estate prices and over-burdened mortgage debt, more U.S. homeowners were underwater on their homes. In fact, by 2010, 23% of all U.S. homes were worth less than the mortgages on them.

9. Foreclosures soon reached epidemic proportions across the country, with 4 million completed foreclosures between 2008 and 2012. In September 2012, 3.3% of all homes with a mortgage were in some stage of foreclosure.

10. During the real estate boom, the average American homeowner had multiple properties at unprecedented levels as they looked to cash in on rising equity. In 2006, 22% of all homes purchased were for investments (rentals) and another 14% were second or vacation homes. That means at least 40% of all homes bought during that year (and there were far more bought as owner-occupied homes but never lived in) were not primary residences.

11. By 2009, more than 40% of all subprime adjustable rate mortgages were past due or in foreclosure.

12. In 1995, only 5% of all mortgage loans were of the subprime variety, totaling $35 billion. But by 2006, 20$ of all loans were subprime, adding up to $600 billion.

13. In addition to standard subprime loans, many “alternative-A” lending products allowed interest-only, no money down, no income verification, and even negative equity (option arm) loans. In the heart of the real estate and lending boom, the typical home buyer invested only a 2% down payment (compared to the standard 20%) and 43% of all buyers put no money down at all!

14. During this period, about 25% of all loans were interest-only, one-third were short term adjustable rate mortgages (ARMs) and one in ten new mortgages were option ARMs. A jaw-dropping 68% of option ARM loans originated by Countrywide Financial and Washington Mutual had low- or no-documentation requirements!

15. The rate of mortgage fraud grew by about twenty fold between 1996 and 2005 – and then DOUBLED between 2005 and 2009, causing an estimated $250 billion in losses during that period.

These are shocking statistics, but still just scratch the surface of the magnitude and impact of the financial crisis, more of which had to do with Wall Street than Main Street. We promise to post another blog soon with more facts and stats about the banking collapse, until then thought to be “Too big to fail.” 

8 More reasons why we're absolutely not looking at another real estate crash

It may seem like just yesterday that we were in the midst of the dark days of the real estate market with little reason for hope, but things are looking downright rosy now. While it’s true that these cycles usually go through 7-10 year trends, we’re here to tell you with 100% certainty that we’re not looking at another real estate crash like in the mid 2000s.

In part one of this blog we spelled out the first five reasons why we’re absolutely not looking at another impending real estate crash.

Here are reasons five through seven:

6. The Millenials are coming as first time buyers

The demographics of homebuyers will change dramatically in the next years and decade, but it’s not just the Baby Boomer selling, retiring, downsizing, and facing new needs that will change the face of real estate. In fact, there are about 80 million Millenials – those aged 18-34 who will make a significant impact on housing. So far, they have been reluctant to buy, perhaps jaded by what happened to their parents during the Great Recession and, more likely, saddled with unprecedented levels of student loan debt. But as time goes on, their jobs will stabilize, incomes increase, and the black hole of rent payments will swing them to home ownership en masse.

7. Housing affordability is solid – and a realistic goal

Not only are interest rates still hovering at very enviable levels, but also banks are lending money again. The strength of loans sponsored by the Federal Housing Administration still allow borrowers to put far less than 20 percent down for a home. Additionally, the FHA reduced its annual mortgage insurance premiums by up to $900 per year, a smart chess move that will most likely spur first time and younger buyers. The National Association of Realtors predicts the dropping of FHA premiums alone will increase sales by up to 5.6 million homes and lure 140,00 new buyers into the market – a diversification that points to cash, not crash.

8. New-home construction remains low

We’ve come a long way, baby, but the levels of single-family new home starts still remain 60 percent below where they stood at the peak of the market in 2006. Those numbers aren’t just anomalies – our current new home inventory is also about 25% less than the average for the last 15 years. Add to that the fact that the supply of existing home sales is lower than it was in 2000 despite a 14 percent increase in population and you have a heavy indication of demand without over-supply.

9. Our banking system is recapitalized, re-regulated, and reloaded

The circus of bank affairs before the mortgage meltdown and financial crash fired most of it clowns and started over. These days, banks are on a much tighter leash, no longer allowed to rapidly grow their balance sheets and make risky bets with borrowed money. A key indicator of the new and improved of the banking system is the fact that credit losses are running at generational lows and U.S. banks are enjoying unprecedented liquidity. If the banking industry hasn’t learned their lesson then the people watching them has, and we won’t see reckless and wanton abuse of the system that facilitated the house of cards collapse again.

10. Savings down, debt up

At the peak of the real estate bubble, the American personal savings rate fell to an all-time low of 1.9%. Those numbers were equally as bleak after the bubble burst and into the financial crisis in the late-2000s. But now, our savings rate has more than doubled to a rate of 4.8%.

While this is still small potatoes compared to the average national savings rates in through past decades and then 10% financial advisors suggest, more personal savings means more money for down payments, mortgage instead of rent, and paying down debt – all key elements of home ownership.

11. Stocks may be in for a bumpy ride

The stock market and real estate market are usually like two trains running on opposite tracks – when one is speeding ahead full throttle, the other is chugging along in the opposite direction. Right now, there are signs of some volatility and over valuation in the stock market, with near record-high corporate profit margins and a slow down in earnings growth something to keep our eye on, as well as the threat of trouble in foreign markets like Europe and China sending shock waves through stocks.  In fact, the S&P 500 has now retraced about 17 percent of its gain since the Great Recession trough of March 2009. All of that is good news for bonds, mortgage rates, and the real estate market – a train that looks to keep its momentum and not be derailed.

12. Our economy has stabilized

Overall, we don’t have much to indicate any sort of crash or volatility to come. The economy is growing at 2 to 2.5 percent per year, jobs numbers are up, debt is down, fuel and energy costs are low, housing affordability is up, and interest rates are still low, with the Fed expected to start a gradual increase of rates to temper inflation. Like we said, there will always be ebbs and flows to the real estate market just like any market or our overall economy, but looking ahead they appear to be gentle hills, not sharp cliffs.  

Bonus: How sound is our real estate market in Sacramento?

Certainly the economic and market factors we just outlined still apply in Sacramento, with some even more pronounced. Right now, the Sacramento region has one of the lowest new construction rates in the country, which is putting huge upwards pressure on rents. Homes have risen in value over the last five years but are still within realistic ranges compared to other areas and options in California. Furthermore, the new down town arena project is likely to boost the economy in coming years – or at least invigorate it enough where a real estate crash is highly unlikely.