Understanding and Preparing for the Next Recession: How Real Estate Cycles Work
August 15, 2018
by Colin Marcum
For many the 2008 Housing Crisis came out of nowhere, but for those with an eye for a history in economics predicted its occurrence more than ten years prior.
“The 18-year cycle in the US and similar cycles in other countries gives the geo-Austrian cycle theory predictive power: the next major bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war.”
This quote originated from Fred E. Foldvary’s paper entitled, The Business Cycle: A Geo-Austrian Synthesis and predicted the crisis back in 1997. His later paper entitled The Depression of 2008, whose 2nd edition was published in 2007, shows data that was subsequently compiled to reaffirm the prediction that 2008 would see our recession manifest. This prediction was not a shot in the dark, but an assessment based on historical real estate cycles dating all the way back to 1818. In the subsequent chart taken from that paper, we see an underlying pattern of about 18-year averages cycles starting to emerge within the United States. You will notice that 2008 was Foldvary’s prediction based on an 18-year interval since previous real estate depression of 1990.
You will notice the unique intervals following 1925 and 1979; which reflect the effects of both the Second World War as well as the 1979 Federal Reserve interest rate doubling. While these papers provide greater in-depth narratives as to why these cycles occur, we will summarize how each phase manifests for ease of reference.
Phase One begins with the recovery from depression that resulted from the end of the previous cycle. The economy is hurting, but the demand for housing is rising as the population continues to increase. Businesses and developers seek to expand in order to meet this demand, and the low cost of land; coupled with low interest rates from the Federal Reserve, stokes this recovery.
Phase Two begins once all preexisting vacancies for homes and offices have been filled, and the demand dictates the necessity for developers to begin new projects. However, development takes time and can’t be satiated quickly. Oddly enough, with all the development occurring during this phase, and the duration that it takes to get these properties on the market, prices and inventory are trending upwards toward a value greater than what the market will eventually be able to sustain. The bubble starts to form at this point.
Phase Three sees us entering into a time of excess inventory and inflated value for real property. New properties are having a difficult time filling vacancies, and developers are putting a hold on future projects. The bubble is now at its most inflated, and the market will no longer be able to sustain it.
Phase Four sees increased vacancy and property values and rents dropping. This is further exacerbated as previous development project are completed, therefore, adding to the vacancy issue. The Feds increase interest rates in order to counter inflation, and further economic development is stymied until the next cycle begins. The bubble has popped. Once stabilized, the cycle begins again at Phase One.
While Foldvary provides some decent triggers to assist you in detecting a recession before it is too late, Teo Nicolais from the Harvard Business Review succinctly provides three such triggers:
Increase in Unsold Inventory/Vacancies
Occupancy falls below the long-term average
Increase in interest rates
Nicolais, using Foldvary’s 18-year interval, subsequently predicts the year 2024 as the next high watermark for the real estate industry. By 2025 or 2026, we should begin to see those triggers being met, therefore signaling the next recession; like the earthquake before the tsunami. So what does this mean for our industry’s Realtors and real estate investors…?
For Realtors: We are currently in the upswing of a revitalized real estate sector. Development has increased and property values and rents are generally moving upward. We are indeed witnessing Phase Two, and it should persist until 2024. Afterwards, expect to see fewer real estate transaction opportunities being able to be successfully closed at previous market values as prices begin dropping. If clients are unwilling to sell at a discount then expect to see properties with high DOM populating the MLS. Since fewer closed transactions mean fewer commissions, we should expect to see Realtors having a more difficult time making a living at a level they previous enjoyed. It would be wise to prepare for this by doubling down your efforts now while the market is good, and building a savings that will supplement your future income during this dry spell.
For Investors:If you were planning on flipping a property then 2024 would be that year. Afterwards, prices will begin to drop, and your ROI will begin to suffer. However, this is also a boon as by 2026 properties should be at their lowest, and you can make a purchase on a property that a few years prior was 20% to 30% more valuable. Investing in commercial rental properties; like affordable apartment complexes and mobile park homes, will potentially set you into position to sustain a decent positive cash flow from people that would need to downgrade from more affluent dwellings. People always need to live somewhere, and this should secure you a higher occupancy percentage.