The Natural Cycle of a Real Estate Market

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As the real estate market was rising nationally the last few years the media went hog wild over the frenzy and everywhere you looked there was someone or something telling you that real estate was HOT HOT HOT! Prices were going through the roof and there was unprecedented growth and people were becoming multi-millionaires from selling their homes. It was craziness.

Now the “national market” is going through a correction because it has to- there was too much too fast. In some areas prices and inventory levels are going to decrease. Is that a good thing? Yes, it is. It’s healthy for each market to go through it’s cycle. This ebb and flow is good and allows each market to grow and then collect itself and catch up, and then eventually grow again.

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Often when an area does go through a slowing or correction, the prices do not actually go down, but rather just don’t go up as fast. Usually the decline of a market is actually just a decline in it’s growth rate.

Areas can see rapid appreciation for different reasons. Usually it’s because of either speculatory (investment) buying or a major influx of people in a short amount of time. When an area has too many properties being bought and sold solely for investment purposes, the market values rise quickly, but this can create hollow values, because the values rise faster than the populations ability to afford them.

When an investor buys a home for $200,000, puts $70,000 into remodeling and then sells that home two months later for $400,000, that home gained 100 percent appreciation in two months. No worries. But if that happens to 20% of the homes being sold in an area over a year, and the prices are now growing exponentially while the area wages are staying the same, you have trouble.

Eventually this can catch up to the market when people are no longer able to pay the prices of the homes. The other thing that happens during this time is people begin to notice how much these neighboring homes are being sold for and they want in on the action. When a market heats up and prices begin to rise quickly everybody starts throwing their homes on the market and the market becomes flooded with property.

Eventually when the demand slows, but people are still wanting to sell for more and more, those home-sellers (who are always the last to accept the end of a growth period) will need to adjust for this and the market can correct itself. Historically this has happened through a period of prices staying relatively flat and growth slowing for a period of time until the demand increases again.

When both factors happen at the same time (investors flipping homes and people throwing their homes on the market to get the high prices), and when new homes are built rapidly in the area because of the demand and the construction brings jobs related to that construction it can really make things interesting. Because these jobs are created by, and sustained by, the real estate market.

This is what happened in Vegas between 2001 and 2005- people began to move into the area, then investors starting buying and flipping homes, and then home builders began building homes as fast as humanly possible and they were hiring people to help build all of these homes and to staff the expanding casinos and the market appreciated over 50% in a year. When the market reached the point where the demand was no longer there (everyone had bought a new home?) and all of these builders no longer needed the help and the construction crews needed to sell but couldn’t and the prices had been artificially driven up by the investors, what happened to the market? It’s now in a period of decline.

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According to Marc Garrison, founder of The National Association of Real Estate Investors (NAREI), there are four main components of the real estate cycle every area experiences. These are Expansion, Equilibrium, Decline and Absorption.

It’s important to note that this cycle not only applies to large geographic areas, but also applies to cities and even neighborhoods.

Expansion brings job growth, population growth and a high demand on the infrastructure of an area. Roads need to be built, restaurants open, hospitals expand and prices rise.

Equilibrium is when things begin to slow and settle. Prices have reached their limits, or beyond, and this period of time brings high prices and as a natural consequence less businesses move into, or expand in, the area. Governments are less likely to offer incentives to businesses to move into the area and job growth slows.

Decline then occurs as the job growth stops and businesses begin to relocate to save money and the demand for housing decreases. During this time, prices become stagnant or even decline as rents and occupancy go down. Usually this decline is merely a slowing of the growth rate, but in markets where the rise was too fast the decline must result in a correction (decline) of prices.

Absorption occurs as the lower prices and occupancy fall below the national averages and/or the area becomes attractive again to businesses looking to relocate. Governments again begin to incentivize business to move into the area and the population begins to grow again.

These four periods of time are all necessary and this is why real estate is so local. One market may be in a period of decline, which pushes another market into expansion. This helps explain why Utah always seems to follow California. As business move from the left coast into Salt Lake City, Provo or Odgen, the market here expands as their markets decline.

Currently the Salt Lake market is in a period of expansion while much of the country, especially along the coasts are in decline. Hopefully, with all of the job growth, our market will see this period last for another couple of years.

Just as nature has it’s seasons, real estate markets have a healthy way of transitioning from period to period. Experiencing these transitions and understanding them can give home buyers and sellers not only an understanding around them, but hopefully, more peace while trying to navigate through the moving process.

Originally posted August 27, 2006

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19 thoughts on “The Natural Cycle of a Real Estate Market

  1. I was having an interesting conversation about why the market become so smoldering hot, the causes and the like. I really think much of it was due to lending practices changing. Traditionally folks had to save up quite a bit money for a down payment, downpayment was hardly a consideration to sellers or buyers during the hot market. Lenders were doing low downpayment or zero downs and getting deals done with buyers who may not have otherwise qualified for a more traditional loan product.

    Of course investors got really involved and took advantage of the low interest rate and the creative financing options available to them (as well as what I call modern buyers).

    The only problem was that there wasn’t enough inventory of listings to meet the demand. Of course the builders stepped up as fast as they could and were able to name their price, AND were able to put pretty profits in their pocket as well.

    But like your article points out, there is always a limit and I think we’ve reached that limit for now. Rates are higher, lenders are a tad more stringent… but the sellers attitude of making large gobs of money still remains.

  2. Pingback: Homethinking - Real Estate Agent Search - » Blog Archive » Weekly Linkage

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  4. Damn Boy, You should be teaching college! I recall an email from you that you were going to try shorter posts, more often.

    Is this an example?

    This huge county I live in – Contra Costa has a wide range of disparity. Some areas have 1 year and a half of inventory while others only have 2 or 3 months of inventory. Foreclosures are booming 30 miles away from where I sit typing this. I saw foreclosure auction sign the other day in San Ramon – first one for me.

  5. Nice explanation of Real Estate. More importantly, where on the Real Estate Cycle chart would you place the Salt Lake and Ogden area?

    Where do you see those two areas in 6 months, 1 years and 18 month points.

  6. Onion,

    As of today I see the local market in Salt Lake (and surrounding areas) as a good, balanced market. Prices remain good so sellers are making money, but there is also a good amount of inventory so buyers have a great selection and can find what they want. Prices continue to appreciate, but at a moderate rate, I’d say this year the area will have an average appreciation rate of around 5-8%.

  7. Thought this might be of interest … The President/CEO of PMZ Real Estate in Modesto, California has a really straight-up, honest assessment of this market situation. Despite all the fortune tellers and clarvoyants out there, this guy tells it like it is. You might find his perspective interesting – coming from the highest foreclosure market in the US (San Joaquin and Stanislaus Counties of California). Here’s the link to video from a Real Estate Conference held this past week. It’s on their website and available for anyone to share, PMZBuzz.com or http://www.pmzbuzz.com/2007/06/14/218/

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  11. Thanks for telling the truth. So many Bank Presidents are just plain lying. The market is going through a correction.

  12. Along with this graph, also consider to keep the inventory in mind when you are calculating the ‘right time’ to buy. During the boom, in Florida there were only a few weeks of inventory and at the peak, there was a saturation of inventory, 30 months in some areas.

  13. Pingback: The Natural Cycle of a Real Estate Market - City-Data Forum

  14. Hi All,

    If it’s not too rude, I’d like to come in on your conversation and change direction a wee bit.

    What do you all think of the idea that full-time university students are in a position to be BUYING a property for themselves to live in during their student years. It seems to me that now especially since the housing bubble has burst there is an opportunity for students to get an early foot on the property ladder during their years in full-time education.

    It seems to be the next big thing that’s coming.

    What do you think ?

    http://www.propertyglasgow.biz/student_accommodation_glasgow/

    http://propertyglasgow.wordpress.com/

    Thanks,

    Francis

  15. Glasgow,

    Feel free to enter any conversation… Students certainly buy property, although not nearly as frequent as their parents do. Most kids in college struggle simply to get through, and many don’t have the income or career to qualify for home ownership.

    If they can buy, more power to them…

  16. I live in a small college town and I would have to say that there are some serious pluses and minuses to students purchasing for the short term. Pluses are it is building credit, they arent paying rent, and they can often rent out rooms and cover most if not all of the rent. Minus is they are now a landlord, if prices drop they can’t sell, and the short term loan payoff will most likely not help them.

  17. Feel free to enter any conversation… Students certainly buy property, although not nearly as frequent as their parents do. Most kids in college struggle simply to get through, and many don’t have the income or career to qualify for home ownership.

    If they can buy, more power to them…

  18. Pingback: Blue Roof Blog To Guest Blog For Us - Shakadoo

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