If you’re a property investor or are looking to sell your home, the underlying trends in real estate will be of great interest. As an investor, ideally you will be looking to buy property when prices are at their weakest and the opposite is true for those that are wanting to sell in order to maximise their profit. These simple equations, however, don’t do justice to the economics that is behind real estate trends and house prices, so are it possible to predict when the next housing bubble will occur? Well, the short answer is yes according to Teo Nicolais – a US real estate entrepreneur and tutor at the Harvard Extension School. In fact, Nicolais argues that the origins of housing bubbles can be clearly tracked and can be predicted with a great deal of accuracy. He has identified four distinct phases in the real estate cycle. Let’s find out more.
This first phase is characterised by the typical signs of a recession: high unemployment, less consumption and decreased business investment in buildings, factories, and machines. In this phase the price of land is at its lowest point in the cycle. However, as the population increases so does the demand for goods and services. And this expansion is often hastened by government intervention in the form of lower interest rates, which is a key ingredient for investment.
The transition from recovery to the expansion phase happens when companies and individuals have bought up or rented most of the available buildings. Occupancy therefore begins to exceed the long-term average and encourages landowners to raise rents. Increased revenue translates into increased profits for landowners. This in turn attracts new development of vacant land or the redevelopment of existing properties.
3. Hyper supply
If the current occupancy rate continues to exceed the long-term average, then there will be upward pressure on rents. And so long as there is upward pressure on rents, new construction is financially feasible which can lead to the hyper-supply phase.
The hyper-supply phase moves into the recession phase when occupancy rates fall below the long-term average. When this happens new construction stops, but projects started in the hyper-supply phase continue to be delivered. The addition of this surplus inventory leads to lower occupancy and lower rents, which significantly reduces revenue for landowners and a recession sets in.
Those are the four key phases of the real estate cycle; however, Nicolais also identifies three key indicators that trouble is on its way.
First indicator: an increase in unsold inventory or a higher vacancy rate. This is the key indicator that marks the transition from expansion to hyper supply.
Second indicator: occupancy rates fall below the long-term average. This indicator is the delineator between the hyper-supply and transition phases.
Third indicator: an increase in interest rates. There comes a point when the increases in prices throughout the broader economy that accompany the expansion and hyper-supply phases will force governments to fight inflation by increasing interest rates. The good news is that this stops developers from continuing in hyper-supply mode because the increase in borrowing costs makes new developments financially unfeasible.
In essence, according to Teo Nicolais, real estate trends are cyclical and a careful examination of the current situation together with an awareness of the trouble indicators can help you determine where things are at in terms of the four phases. Use this inside knowledge to guide your real estate decisions.