Experienced real estate professionals generally reach a stage in their investment career where they believe they’ve acquired a firm understanding of how the economy progresses through its respective cycles, in addition to the ability to accurately determine their current position in the latest cycle. This self-confidence is readily apparent when they dissect their latest transactions and why they returned a sizeable profit, or when they can predict what can be a profitable deal. In reality, however, the intricate workings of the economy are not as clear-cut as these seasoned investors make it out to be. Both real estate and the economy operate on a cyclic basis which is innately dynamic and subsequently hard to forecast—regardless of experience level or socioeconomic status.
Picture the market as a big pendulum, always swinging above and below a set reference point that represents normalized long-term economic growth. These market swings are elicited by the concerted choices made by key market insiders, the aggregate impact of which directly impacts supply and demand, corrections and excesses, and a variety of other data points that are collectively used to gauge economic functionality. This threshold reference point of normalized, long-term economic growth possesses what is best described as an intrinsic magnetism—phenomena termed by economic researchers as mean reversion which is simply the concept that, notwithstanding transitory undulations up and down, the market (i.e. the “pendulum”) will inevitably trend back towards the threshold line when its behavior is expressed collectively as an aggregated average. The further the pendulum goes above the threshold, the greater it will travel below it when it oscillates in the opposite direction.
Generally, the market cycle can be discussed in uncomplicated terms. Favorable conditions and increased revenue lead to an increased sense of optimism amongst investors, which can elicit an upward trend of the economic pendulum. The economy exhibits additional upward momentum when investors become more active in terms of market transactions that subsequently increase prices.
Comprehending Economic Cycles Improves Investment Strategy
Correctly gauging the economy’s current position in its cycle provides investors the data required to determine whether their next move regarding their real estate portfolio should be ambitious or cautious. Investors should exercise caution when attempting to hedge any investment, big or small, premised on their estimation of when the economic pendulum will reach its apex or bottom out. The safest and most effective investment approach is to acquire a strong standing relationship with your lender and stay up to date with general knowledge pertaining to the present economic cycle—including the degree and speed of the upward or downward trend, which will allow you to base your real estate transactions accordingly. Many great opportunities can arise in negative market conditions, it’s important to be knowledgeable and understand the pros and cons of every investment.
Current Market Conditions
The sustained period of upward trajectory in the real estate market has recently been shuttered by the current pandemic; however, prices continue to rise. Returning once again to the pendulum metaphor, this means that right now the pendulum is above the threshold but is starting to trend in the opposite direction. When exactly the market will reach the threshold line is yet to be seen. The good news, however, is that the downswing should not be overly drastic as the initial rise was comparably gradual. Investor optimism within the real estate sector helped usher in the recovery phase, but it wasn’t misguided. A host of seasoned investors have referred to the trend as a ‘disciplined recovery’ in that the downward trajectory will not result in the sort of economic crisis that was seen in 2008.
Timing the Next Transaction
Keep close tabs on the ongoing downward trend by paying attention to reliable market indicators—particularly those exhibited in your local market. For example, dependable data is readily available to assist you in your next investment transaction. Be sure to factor in how long the property has been listed on the market and whether it has had any reductions to the initial sales price. Don’t overlook subjective analysis to complement your research—pay attention to the activity of other investors in your area and stay in touch with your existing contacts in the real estate agent industry to get an insider’s sneak peek of what potential buyers are currently looking for when purchasing a property. Constantly monitoring the mean reversion makes it easier to get an accurate reading of the market and where it is headed in the immediate future. Don’t be dissuaded from conducting transactions when there’s an economic downturn like the one we’re seeing right now—investment opportunities are there for the taking at any point in the economic cycle. Be knowledgeable and prepared to take on your next investment. Capitalize on the situation and invest with a lender that you trust because, at the end of the day, key relationships are what every business needs to truly scale.