 |
Many economists consider the real estate cycle as a reflection of the economy because the demand for real estate is necessary and crucial for economic growth. (In fact, land is among the three major factors of production, with labor and capital being the other two.) Real estate is considered a cyclical industry because its demand side is impacted by economic cycles, and also because demand has historically outweighed supply.
The typical pattern for the real estate cycle is actually quite simple and straightforward. First, there must be expansion in both the population and the industrial sectors, which are all facilitated by the government. These expansions result in an increase in demand for housing and other buildings, which eventually will exceed supply.
But a lot of time is needed so that supply, i.e. building construction, can catch up with demand. During this time, construction increases demand for land, which in turn is followed by an increase in rent and land values. Then, the rate of increase rises. This is what is known as a boom.
Here are some indicators of supply and demand that you will want to look at when considering a new area:
- Employment growth – New jobs are made available by the emergence of new businesses.
- School growth - and the quality of the schoools.
- Regulation – This includes all sorts of regulation, such as federal, state, and local taxes; environmental regulations; lending laws; and local zoning and building codes.
- Uniqueness of the area – What attractions are around? What other incentives are available that will solidify one’s decision to stay in the area?
- Political activity – The national government is the largest borrower in the country, so its actions have enormous effects on the economy. For example, deficit spending by the government makes less money available towards loans and construction.
- Impact of other investors on the market – Are other investors crowding the scene? What kind of deals are they making, and how much of the area are they covering?
- Mortgage funds – Most times, a buyer lacks sufficient funds to finance a house, so most homes are built and purchased with borrowed money. The availability of this money directly affects both supply and demand.
- Social attitudes – How old are the people of the area? Both baby boomers and their children are buying housing, which therefore increases demand. Divorces also increase demand since there are fewer people per household.
Although factors such as these may indicate expansion, you need to ask several important questions in the meantime, many of which will change your confidence in the area. Many issues you’ll need to address are whether or not the new businesses are transitory or secure; if these businesses are well-known and likely to hold their own; if the area has long-term expected growth; if you notice the development and/or improvement of major highways; and so on and so forth.
Weigh these factors carefully and talk them over with other people whose judgment you trust. The peak of the real estate cycle can be spotted when you notice a high volume of real estate transfers. This is the interval between the peak of real estate prices and of the value of construction. Once this period hits, the supply of new houses surpasses the number of occupants, or demand.
After the boom and subsequent peak, there will be a correction, or a bottoming out where real estate prices drop below market value. The reason why prices plunge is because too many homes have been built, or in other words, supply outweighs demand. The onset of this period signals that the opportunity has arrived to take advantage of cheap, but high quality real estate. It’s time to buy, buy, buy with the money you’ve saved and maybe with the partners you’ve gathered in the meantime.
All indicators must still be scrutinized, perhaps now more than ever. Ask more questions, modifying previous inquiries with specific details that reflect the progression of the area.
- What are the contingencies and future implications of these indicators? Are they stable?
- How has the progression of the aforementioned supply and demand indicators evolved, if at all?
- Has this area been over-developed?
- Does the area rely on one source of employment, or are there multiple companies that offer work for the community?
- What is the breakdown of the population now?
- What are the current rents in the area - at a high or lower than normal?
At the heart of your questioning and scrutiny, however, you should perpetually wonder, “Have a bunch of builders simply come into the area and overbuilt it just because the area is there? And are investors merely responding by rushing in as the market seems to bestow great promise?” In other words, if it appears too good to be true, it probably is. The take-home lesson is that you need to dig deeper into the local markets that are unknown, and then determine whether there's a diamond in the rough or just a lump of coal dressed up with fancy attire.
|
|
