When is the next crash or boom? When is the best time to buy or sell? As with any other sector of the economy, certain fundamental rules apply to the real estate market. It is impossible to predict with absolute certainty how a market is going to be affected by current events, or when it will rise and fall (or by how much), but like any market sector, real estate prices are cyclical, rising and falling continuously. So… what are the forces that cause the market to rise and fall?
Cause and Effect
Stated simply, positive events bring about positive trends. Conversely, negative events cause negative trends. A good example of how cause and effect works is to look at the correlation between gas prices and the real estate market. When gas prices are low, more people are interested in buying homes farther away from work, as commuting is relatively inexpensive. When gas prices stay high for an extended period, the same people might consider giving up their suburban home and looking for something closer to their job, where they can take the bus to work.
Supply and Demand
When there is a shortage of a given product, sellers have the advantage. Demand is higher than supply and buyers will have to pay more if they want what the seller has to offer. On the other hand, when supply is higher than demand, sellers will have to compete with each other, and buyers have the upper hand. In a down real estate market, sellers may actually have to take a loss in order to sell a property.
According to Investopedia, “A good or service is considered to be highly elastic if a slight change in price leads to a sharp change in the quantity demanded or supplied. Usually these kinds of products are readily available in the market and a person may not necessarily need them in his or her daily life. On the other hand, an inelastic good or service is one in which changes in price witness only modest changes in the quantity demanded or supplied, if any at all. These goods tend to be things that are more of a necessity to the consumer in his or her daily life.” In real estate, this might mean that the market for second homes or weekend cottages would be more elastic and the primary home market less elastic. This is because luxury items have a higher level of elasticity, as they are non-essential.
One important thing to remember about the laws of supply and demand, cause and effect, and market elasticity–they don’t apply evenly across the country, or even across your state. Local economies create real estate microclimates that vary considerably from neighborhood to neighborhood and from town to town. When a major employer closes in an area, people move in search of work and the supply of available houses skyrockets… and prices drop.
However, remember that there is one cardinal rule by which one must always follow when buying and selling real estate whenever humanly possible: BUY LOW AND SELL HIGH.
I’ll explain more about that in the next section.
The Four Phases of the Real Estate Cycle
According to an excellent article on the Harvard University blog: “As early as 1876, Henry George observed the curious cycle through which real estate markets inexorably move.” These four phases are Recovery, Expansion, Hyper Supply, and Recession. The duration of these phases may vary, but one unavoidably follows another. It doesn’t matter where we begin in the circular trend, so let’s just jump in:
This describes a period of growth. It may come after a recession, a war, or some other factor that causes a slowdown in the economy. Demand for products begins to rise, companies start to hire again, people get back to work, and begin to save money, and they begin to buy houses again. Supply of housing is high and demand is still relatively low (as are prices), so it is a buyer’s market.
Cheap housing has been purchased and,therefore, the need arises to build more, new housing. Home prices go up, but since people are back to work and feeling stable, they feel that it is the right time to buy. They have more money and supply is low, so the pendulum swings and the seller begins to gain the upper hand in the market, but it is still a good time for buyers to jump in as prices are still on the rise.
3. Hyper Supply
Oops! We’ve built too many new houses! Supply is beginning to exceed demand. However, real estate speculators are riding high, and they don’t want the party to end, so some end up staying in too long–they pay too much for land to build new homes or they pay too much for a house they plan to flip. Some homebuyers are going to get caught up in this frenzy too, as we saw in 2008. Talked into buying by slick salespeople, their blind optimism (or greed) lead them to buy homes because they thought the market would keep going up and up, but as Sir Isaac Newton taught us, “what goes up must come down.” This is the time to look for the leading indicator that the end is near: an increase in the volume of unsold properties.
The next signs of the downward trend are a fall in occupancy rates below the long-term average, followed by a drop in interest rates. This slows new construction and home sales, but the bad news is that those who are in the middle of building a new home or who just bought a new home will be sitting on something that they can’t sell for a long while.
And then, the cycle begins anew.
So where are we right now? Most indications show that we are in the expansion phase, seven years after the crash of 2008. Depending on where you live, it can still be a very good time to find a deal on a new home.
What Happens Next?
According to the Harvard University blog article cited above, the real estate cycle has been very regular over the last 200 years, cycling approximately every 18 years. However, there have been two notable exceptions to this rule. First, the disruption of the Second World War, and more recently in the 1970s, when the Federal Reserve Bank doubled interest rates. If the current cycle kept with the historical cycles, we can expect the next real estate peak about nine years from now. But remember: Times they are a-changin’! Cause and effect still play a big factor. Big changes, either for the better or worse, could disrupt the cycle.