The whole world moves in cycles.
Whether it’s the changing seasons (fall is the best), the phases of the moon, or our circadian rhythms, everything moves in a cycle.
And the real estate market is no exception.
Earlier this week, I saw an image making the rounds on REtwit (Real Estate Twitter) and immediately thought it would be good to share here. Credited to Glenn R. Mueller, PhD, professor of real estate and construction at the University of Denver, it shows the four major phases of the real estate market cycle:
Knowing the phases, identifying the current one, and executing strategies to take advantage of phase, are critical to success in real estate investing.
Phase 1: Recovery ❤️🩹
This is the bottom of the trough, so to speak. Vacancy is high, demand for rental units is low, and rent growth is flat at best. No one is building new units.
Pinpointing the transition from a Recession (Phase 4) into Recovery is difficult because things still feel bad. But a tell-tale sign is when things start feeling less bad. Relevant data might not be getting better yet, but it’s stopped getting worse.
The Recovery phase is a great time to buy:
- Prices are still depressed and there’s little competition among buyers.
- Acquiring “trophy” assets and/or locations during this phase is a great setup for a future refinance or sale during the Expansion phase (Phase 2).
- The early part of the phase is also a good time for opportunistic purchases, as distressed assets are usually still available at attractive prices.
Phase 2: Expansion 📈
The market is now clearly on an upswing. Demand is up, vacancy is improving, and rents are growing again. Developers start to step back into the market with new construction projects.
The latter half of Expansion is the sweet spot. At the macro level, the economy and jobs are growing, people have money, and are tired of having a roommate. But a lack of construction during the Recession and Recovery phases has more people chasing the same amount of rental units.
There’s more demand than supply. As a result, rent growth (and subsequently real estate values) takes off.
The Expansion phase is still a good time to buy, but requires more targeting:
- A “value-add” strategy shines during this phase. Acquiring assets performing below their potential and fixing the issues made a lot of people a lot of money during the last Expansion.
- New construction developments also perform well, as the lack of supply causes new units to be quickly leased upon completion.
Phase 3: Hypersupply 🤩
At the end of the Expansion phase, everyone wants in. There’s buying and building left and right as less experienced investors clamor for a piece of the action.
The building from the Expansion phase morphs into overbuilding, and now supply outstrips demand. Vacancies are rising and rent growth is slowing.
The risks during the Hypersupply phase are tilted to the downside, making it a much better time to sell than to buy:
- It’s a great time to realize the gains of the Expansion phase and start building liquidity.
- Some opportunistic purchases may be available, but they must be priced correctly. More people lose their shirt buying or building during the Hypersupply phase than any other.
Phase 4: Recession 📉
The music has stopped and everyone’s searching for a chair. All those construction projects that started during Expansion and Hypersupply are completing their new units, flooding the market with supply.
At a macro level, this usually coincides with a slowing economy and job losses. Friends are becoming roommates and everyone is looking for the cheapest rent possible.
Vacancies rise to levels not seen in years, and rent growth is flat or negative. For some investors, particularly developers who can’t lease-up their new units, panic sets in.
It can be a good time to buy for those with a strong stomach:
- A higher level of mortgage delinquencies and foreclosures turns previously-unwilling sellers into forced sellers.
- Bargains start showing up. Distressed assets can be purchased for less than it would cost to build them new.
While each cycle is different, most last 10-12 years. The last recovery phase started around 2012, so we’re pretty much on schedule. It’s also important to note that there is no one singular “real estate cycle.” Different asset classes and locations can be at different points in the cycle simultaneously.
So where are we now?
In my opinion, we’re in Phase 4, Recession. Not a spicy 🌶️ take, I know.
But here’s some spice: I think we’re closer to the end of Phase 4 than the beginning. Maybe not by much, but we’ve crossed the halfway point at least.
I think it’s a decent time to buy attractively-priced assets, including land/lots for development. New construction have dropped off a cliff, so those who own in the next ~18 months (by buying and/or building) will likely be rewarded in 2026-2027 when supply shortages appear again and rent growth takes off (the latter half of Phase 2).
Of course, there are challenges to pulling this off today, with a higher cost of capital being chief among them. But I strongly believe it’s worth the effort to find or create these opportunities, which is exactly what we’re doing right now at Big Spring Capital.
We all know the cycle. We can roughly gauge where we are now and we know what comes after it.
And in a few years, when supply shortages cause rents to accelerate and values to soar, we’ll likely look back at this period and think “it was all so obvious.”