Understanding market cycles is key to successful real estate investment

When markets are down and the economy weak, investors are understandably cautious, but experts believe that there are always profits to be made if one steps back and looks at the bigger picture which, in the case of real estate, is understanding the cycles of the market.

Claude McKirby, Cape Town Southern Suburbs Co-Principal for Lew Geffen Sotheby’s International Realty says: “The real estate market always works in cycles with upswings followed by downturns, regardless of the prevailing economy or political sentiment.

“And those who take the plunge during a downturn not only obtain a property they may not normally be able to afford, it’s also a rewarding investment when the market turns again.

“However, the key is being able to correctly identify each phase correctly as well as being able to recognise what property is a good investment and which is not.”

McKirby says that there are four phases, each with their own distinct characteristics:

Phase 1: Recovery

This is the first stage after a recession and typically the most difficult to identify. While the market is in recovery, demand is usually still slow so it can be difficult to pinpoint that recovery has, in fact, begun.

However, if timed well, there are many great investment opportunities to be found and those who are closely monitoring the data will notice upward ticks in factors like an increase in property viewings and sales and fewer new properties coming onto the market, signifying a break in the downward trend.

Remember that during a recession, interest rates either decline or, at best, hold steady at low rates so you want to make your investment just before they respond to the turnaround. It’s an especially good time to purchase if you’re a cash buyer.

Phase 2: Expansion

This phase kicks in when the market begins to show obvious signs of recovery, growth and expansion like growing demand, job growth is steadier, rental rates increase, new construction picks up and the balance between supply and demand is restored.

During this time, we see renewed investor confidence spurring spending across the board and lending criteria (which would have been tightened during the recession) often begins to loosen.

This is the ideal phase for risk-shy investors and for developers to capitalise on the higher demand. The risk here is of over-extending so make sure you don’t incur too much debt that is not sustainable long-term when the market swings again.

Phase 3: Hyper Supply

Here the market reaches a tipping point, moving from a balanced supply and demand to oversupply, often with new developments continuing as the downward turn sets in and the economy shifts into decline.

Market inventory remains high and rental rates remain high whilst demand decreases, so during this phase, astute investors look for solid assets with stable tenants and long-term leases already in place. This is not the best time to be buying so overconfidence and not heeding the warning signs can prove very costly.

Phase 4: Recession

The result of over-inflated growth, often accompanied by investors disregarding or not recognising the warning signs of waning demand, this phase is distinguished by heavy supply, high vacancy rates and reductions in rent, sale prices and new construction. Unemployment also rises and less stable businesses close their doors.

Real estate becomes a highly saturated market, but investors willing to take on higher risks can reap excellent rewards with acquisitions like distressed bank-owned properties and vacant land developments. Especially those who are liquid with available capital as they have a window of opportunity to buy properties at very deep discounts.

Jill Lloyd, Area Specialist in Claremont and Clarepark for the group, says that it's also important for investors to be aware of, and understand, emergent and current trends in order to make the best investment choices for each phase.

“It may seem impossible to believe now, but at one time avocado-coloured kitchens, carpeted bathrooms and sponge-painted walls were all the rage and would have appealed greatly to the majority of home buyers, possibly even motivating higher offers.

“These days tastes and trends are very different and certainly more varied, but what hasn’t changed is that they can greatly influence the returns realised.

She says that the features most commonly at the top of prospective buyer’s wish lists that are likely to remain there for the foreseeable future are open-plan living areas, lots of natural light and eco-friendly systems which save water and reduce the cost of energy.

“Low maintenance and convenience are also priorities for a growing number of buyers with low maintenance and water-wise in high demand.

“And don’t forget that security is at the forefront of most buyer’s minds, so factors like the garage being situated too far from the house could discourage buyers and also if basic security measures are not in place.”

Lloyd also cautions against investing in properties that veer too far from the norm and current standards.

“Buyers do look for a touch of the unique; something that sets a home apart from just the average box, but remember that the more unusual your property, the smaller your pool of buyers, especially during slow times.”

A veteran of 30 years, Lloyd has witnessed the ebb and flow of cycles, oftentimes influenced by the economic and political climate of the day, but the one constant has been that investors who understand the nature of the market and invested wisely during downturns almost always reap the best rewards.

A commonly quoted statistic is that 90% of the world’s US Dollar millionaires became rich by investing in property or including a significant amount of property in their investment portfolios and, as a medium to long-term investment, it’s still one of the best if one is willing to ride out the cycles.”