Starting with this post, I want to try to address the factors impacting the housing market due to COVID-19, the forced closures of certain types of businesses and changes in the behavior of people due to COVID-19.
Here are some questions I will try to answer:
- Where are we in the real estate cycle?
- Is now a good time to invest in housing?
- How will interest rates impact the housing market?
- How will COVID-19 impact the inventory of housing in 2020 and 2021 and beyond?
- How will COVID-19 impact the demand for housing in 2020 and 2021 and beyond?
- I’m sure I will raise additional questions to answer as I go through this series of posts.
To set the table for this series, I will start by describing the typical real estate cycle and describe where in the cycle I think we are and why?
The Typical Real Estate Cycle
The typical real estate cycle includes four phases.
Recovery Phase – this occurs after a recession. This is the period when the economy is growing. Employment levels are growing, but still below the total number of jobs at the peak prior to the recent recession. In this phase, the economy is still working to get everyone back to work.
During this phase in the housing market, banks are still working to sell off and unload real estate they own due to foreclosures during the recession. Because banks do not like to own real estate, they are usually selling at lower than market prices. This keeps a lid on prices. After the last recession from 2007-2009, the recovery period lasted from 2009 to roughly 2012.
Expansion Phase – this occurs after the recovery. Unemployment levels are low. Job growth is robust. The economy is generally growing.
During this phase in the housing market, there are no more bank sales of real estate. New supply of housing is coming on the market from new builds and re-models. Housing prices are rising due to increasing demand. Rental rates are increasing due to increasing demand and people are moving up to nicer housing as their income grows. In order to drive the Expansion Phase, there has to population growth and job growth leading to income growth.
Hyper-supply Phase – this doesn’t really apply to the economy in general, but is more specific to the housing market. Due to factors occurring during the Expansion Phase, such as increasing housing prices and rental rates, there is a very high level of investment occurring in the housing market. The result of all this investment is that the new supply is starting to grow faster than the demand for housing. There is a lot of new construction and you start to see a tipping over of the supply-demand balance.
Recession Phase – this is when pricing starts to decrease including rental rates because demand is not keeping up with supply. If the overall economy is in recession, that can also negatively impact demand. During this phase, eventually there is a significantly higher rate of rent concessions, such as one months rent free, then decreasing rent rates to keep people from moving to cheaper locations. A significant percentage of home-owners can’t make their mortgage payments and either sell fast to get out or lose the house to foreclosure. All of this leads to lower prices, lower rents and banks foreclosing and owning more real estate than the other phases.
When is the Best Time to Buy and Sell in the Traditional Cycle?
If you had perfect information, the best time to invest would be late in the recovery phase to early expansion phase. Most of the excess supply has been wrung out of the market through the recovery phase. This time point is when pricing and rental rates are just about to start increasing due to the supply-demand pressures of the expansion phase.
Again, if you had perfect information, the best time to sell would be during the hyper-supply phase, preferably late in that phase.
So, Where in the Cycle are We Now?
I believe we are currently still in the latter parts of the hyper-supply phase. In the housing market, we haven’t reached the recession phase yet because due to COVID-19, the government is currently supporting millions of people and millions of businesses. Governments have also implemented eviction bans and forbearance programs for mortgages and rental payments. Therefore, we have not yet reached a phase where overall incomes are decreasing, residents are forced out of rentals because they can’t afford rent and owners or investors are selling or getting foreclosed on because they cant’ make mortgage payments.
Based on my description above, this is the part of the cycle when investors should be selling, not buying.