Suppose you are considering moving forward on a commercial real estate investment. In that case, it's always wise to consider how the current real estate cycle will affect the profitability of your new project. The market's health can boost ROI or make it hard to break even, depending on the current trends. Timing is everything in real estate. So, understanding this cycle is critical to evaluating the investment opportunities in a market of any size, both small and large.

Measuring Cycles in the Real Estate Market

Similar to other industry sectors, it is normal and expected to see ups and downs in the real estate market. This cyclical movement means timing is everything if you want to maximize your investment.

In real estate, one way to measure the current cycle is by looking at the vacancy rate, which is a broad measurement of the demand in the area. This vacancy data point is an effective way to look at the supply in the area vs. the unmet demand. Suppose you break ground on an office building or multi-family housing complex. In that case, you must ensure that tenants will be ready and interested in leasing the available space.

Not only do you need to consider the current supply and demand, but it is also essential to evaluate historical trends. Analysts can help in this research phase by charting the decrease or growth in the vacancy rate in the area. Additionally, you should always look at the length of the average vacancy over time. This information can help you identify investment opportunities in areas with stable vacancy rates and potential profits.

4 Phases of the Real Estate Cycle

There are four notable phases in the real estate cycle:

1. Expansion: In this cycle phase, the vacancy rate decreases while the demand increases in the area. Since there is increasing demand, it opens up opportunities for new buildings to supply the market. As real estate investors respond to the demand in the expansion phase, eventually, we reach a point where the vacancy rate starts to increase, ultimately leading to hyper supply.
2. Hyper-supply: Overbuilding in the expansion phase leads to hyper supply, and demand drops significantly. As a result, the vacancy rates go up, making it hard for building owners and investors to maintain profitability. Often, this phase is linked to a shift in the economy. This trend moves the real estate cycle into the recession phase.
3. Recession: As vacancy rates continue to rise and demand slows, construction slows since new supply is no longer needed. Eventually, everything bottoms out, and we experience low growth in both supply and demand. As a result, building owners resort to decreasing rent or offering concessions to entice tenants to sign a lease. At this point, the construction industry typically comes to a standstill.
4. Recovery: As demand increases, we head into the recovery phase, indicating that we are moving towards a new cycle. In this phase, it is common for no new construction, and the market usually has a rate of growth that is either flat or negative.

When the recovery phase finishes, it connects back to the beginning of the cycle: expansion. Looking at historical trends, you can see that the real estate market continues to cycle through these phases repeatedly.

Maximizing Investment in All Phases

The real estate cycle is unavoidable, so the most important thing investors need to know is what they can do in each phase. Recognizing the real estate cycle phases makes it possible for you to be strategic so you are ahead of the curve.

For example, the building should already be under construction in the expansion phase. When the hyper-supply phase is happening, the smartest move is to hold onto cash and be prepared for the upcoming recession. Then, the recession is an excellent opportunity to pick up assets and work on renovations that boost the value of the investments. Finally, the recovery phase is when you should look at future expansion plans to prepare for the next cycle.

As you can see, timing is critical to the success of the investment. Pouring money into a new investment in the hyper-supply phase could leave you cash-poor and without tenants if your asset is built in a recession phase. It is essential to watch the cycle, so you are ready to take advantage of opportunities at the right time. Additionally, maintaining a conservative approach in certain phases of the real estate cycle is essential to protect cash for future investments.

Is Your Strategy Designed Around the Real Estate Cycle?

The wisest decision you can make is to match real estate cycle trends to your investment strategy. As you design your timeline, it is essential to consider both holding periods and exit strategies. This information helps you dial in current investments and manage your expectations for potential returns. As a result, it is easier to be strategic with cash flow, so you are better positioned to take advantage of the best opportunities when the market changes.

Core and opportunistic strategies can bring significant long-term results. Still, it is essential to know where the market is at in the equilibrium of supply and demand. It can be beneficial to talk to a real estate investment strategist who can advise on the best way to move forward in the current and upcoming cycle phases.