The housing market may seem erratic and unpredictable, but the fact is, it always conforms to the same pattern of housing cycles we’ve been seeing for almost 200 years. Every housing cycle is comprised of four phases: recovery, expansion, hyper-supply, and recession. Researchers have estimated that the average housing cycle lasts 18 years, but that schedule is far from reliable.
The duration of housing cycles is influenced by numerous competing factors. While a strong economy usually translates to a strong housing market, there isn’t always a direct correlation. Housing cycles can operate counter to the rest of the economy. The events of 2020 are a perfect example of this, with a huge spike in housing prices amidst a backdrop of high unemployment and economic anxiety.
So, what are the factors that can impact the housing cycle?
Demographics play a strong role in housing patterns. If an area’s population skews younger, there is probably higher demand for apartments. If it’s mainly families, there will be a demand for single family housing. External events can also impact demographics. For instance, if a major employer relocates to an area, that will shift population demographics, increasing demand and driving up housing costs.
- Interest Rates
High interest rates drive down the buying power of would-be homeowners and are a deterrent to homeownership. Conversely, low interest rates stimulate buying.
- General Economy
Remember what I said above about how housing cycles can operate independently of the rest of the economy? That’s true… except when it isn’t. While the paths of the housing market and overall economy can veer away from each other, a robust job market and high consumer confidence will usually spur demand.
- Government policies
Sometimes, the government will institute policies that stimulate the housing market. That can include tax deductions, subsidies, or tax credits. This intervention typically occurs during an economic downturn.
So those are the factors that can impact a housing cycle. Now let’s look at each phase of the housing cycle and the strongest investment strategies for each period:
Recovery is a difficult time to pinpoint, as it can happen to real estate markets while other sectors of the economy are still struggling. This is a period when investors need to keep their eyes open for subtle indicators of improvement, because from a bird’s eye view recovery can still resemble recession. Declining vacancy is typically the first sign of recovery, even while new construction is at a standstill. For investors, recovery is an opportune time to buy properties that are in financial or physical distress. This will position investors to be ready to rent their properties as the economy shifts into the expansion phase.
During the expansion period, the economy is showing clear signs of improvement. There’s an increase in job growth and consumer confidence, which spurs an increase in demand for housing and also leads to new construction. When the market is in an upswing, it’s advantageous to value add to your properties to increase their market value.
Developers keep building new inventory until they enter the hyper supply phase, when demand begins to subside. The drop in demand can be a response to a weakened job market, a drop in consumer confidence, or simply because there is too much inventory. While there’s usually a lot of frenzied selling during this period, for investors it’s best to practice the buy and hold strategy. If you own a rental property, there’s no discernible advantage to selling your property if it’s still cashflowing. If your plan is to flip your property, it’s also best to wait for a sellers’ market.
During the recession phase, supply surpasses demand even more than it did during the hyper supply period. In a housing recession, there is high vacancy and rents remain stagnant. In extreme cases, landlords may even need to reduce their rents in order to avoid vacancy. For investors, recessions are a good time to buy discounted properties.
So there you have it. While it’s impossible to pinpoint when one phase will begin and another will end, they are always certain to occur. This is helpful to remember at every point in the housing cycle. Don’t get despondent during a recession, even a deep one, because it won’t last forever. In fact, recessions are a good time to position yourself for the next growth period. Similarly, boom times and expansion periods don’t last forever, so use this period to prepare for the next downturn.