As home prices and rents fall, the real estate market tends to take 3–5 years to hit bottom due to the continued influx of oversupply created during the hypersupply phase.
- The first sign of major trouble is the deceleration of rental growth. Now by the time the rental growth is at zero or even negative, the next phase, the recession phase, will come fast. Here the transition from the hyper supply, the boom cycle to the recession occurs when occupancy rates fall below the long-term average. The glut of the new supply finally overpowers the market, driving rents and property prices down; and vacancies start to climb up.
And new construction stops, and the few new projects are going to start; but the many projects that started in the hyper-supply phase are still going to be continue to be delivered. The continued addition of inventory leads to lower occupancy and lower rents, which reduces revenue for the property owners. All right, to illustrate the point here, what we're lookin' at is the Case-Schiller Index, but the change, the percentage change every year. So the Case-Schiller Index is an index that measures the housing values over time.
So here, if it has a positive change, that means that year it grew from previous year by that percent. So housing values, you see, it was growing very quickly right by 2003, 2004, 2005, and even parts of 2006, it was still growing. But when we see that in the peak 2006, it quickly dropped down; and it went negative in 2007, and it started to drop very quickly into 2008, and nine, where it dropped the most.
And it was still dropping until, finally, it didn't change any more and started to go up a little bit in 2010, but it was only up for a little bit. And then we had a little second dip as part of the recession, and we didn't really have a true recovery here, but then we started to recover in about 2012. Okay, so what this is showing us right from the recession period, see right after the peak here already in 2007 and 2008, we have fewer projects comin' in.
There were pretty much, it was already known that we were in a recession already, the housing prices, everything was going down. But why did it take so long, almost til 2012, before we start to recover it? All right, that's because there's still a lot of supply during these boom years. There was so much extra inventory that even when there were very few new homes being added, very few new units being added to the market, it took a long time even at the lower prices to get rid of all that.
And when it's finally done, and the market is at the point where the demand is actually meeting the supply, where there isn't an oversupply, then we can start to recover, which is why it took many years, right, we didn't really hit bottom in a lot of the markets until 2011 or 2012. So that means during a downturn, you need to be patient.
And we look at some prior downturns, recessions, the bottom didn't happen very quickly. It usually took three to five years before we hit the bottom. So whenever the next peak is, which we're going to look at in the next lecture, know that the bottom will likely happen in three to five years afterwards. Finally, the last dagger's going to come from the feds when they're trying to finally curb the risks of high inflation due to the recent boom by raising interest rates, which will all but put a stop to any new projects because financing will become more expensive, making new projects no longer profitable to pursue.
The combination of lower occupancy, lower rents, and higher interest expense, which is a fixed cost, will quickly take profits off the table for many investors and property owners. Property values will begin a steep decline as prices fall, sometimes by as much as 50% from peak values. And over the course of three to five years, it will take before it hits bottom.
Now smart and savvy investors, those who have predicted and planned for this, would have exited from many of their real estate holdings prior to or during the peak and being conservative not to risk getting caught up in the crash themselves and would have patiently waited with their capital and cash to pick up properties, pennies on the dollar, during the lowest points. These investors were getting out as early as 2002 and 2003 and were sitting in mostly cash by 2005.
Now these same investors would have acquired properties at their lowest prices from 2009 through 2011. So how can we predict the next boom? And when will the next bust likely take place? Well, we're going to take a look at that next now that you've seen all four phases of the real estate cycle. We're going to see where we're at now, and where we're likely to be in the future.
Note: This course uses data and example properties from the United States, but the concepts taught and tools provided are just as useful for any market.
- Determining if real estate investment is right for you
- Choosing a market and a property
- Using financing
- Strategies for first-time investors
- Real estate market cycles
- Valuing a property
- Analyzing your market
- How leverage impacts investments
- Real estate investment case studies