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Four Phases of the Real Estate Cycle

Canadian Real Estate prices have been rising steadily over the past few years, especially in the Greater Toronto and Vancouver areas.   Bidding wars have become common place, and it’s easy to get caught-up in the hype of a red hot real market.  Many families looking for a new home feel pressure to act fast, due to the fear of being priced out of the market.  While it may seem that prices will continue to rise indefinitely, the truth is that prices for Real Estate are well documented to be cyclical and have four distinct phases.

 

The first phase of the Real Estate cycle is Recovery.  This begins when excess construction from the preceding recession stops, and demand growth for real estate begins to soak up oversupply.  At this point new construction is very low or nonexistent.  In the second phase Expansion, demand continues to grow and a tight supply puts upward pressure on rents.  As rents increase this promotes further construction.  If demand is growing faster than supply then vacancies will continue to decline, and the expansionary phase will continue.  Eventually, the supply growth of housing will overtake the demand for new housing and this will be the beginning of the third phase known as Hyper Supply.  Suppliers of housing will have to compete for tenants as vacancy rates rise.  Due to the lagged nature of construction, market participants often do not slow or halt construction.  Hence, both rents and home prices fall and this leads to the final phase of the cycle which is Recession.  In this phase liquidity in the market deteriorates, and home owners can no longer sell their properties easily or without taking massive financial losses.  The rate of foreclosures will also increase as a result decreased liquidity.  Construction will slow and or halt and eventually demand for real estate will outstrip supply and we we’ll return to the Recovery phase of the cycle. 

 

Note it can take years if not decades to go through a full cycle, so it can be hard to see the forest from the trees.  Additionally government policies can also play a key role in the length and severity of the four businesses cycles.  For example, decreasing interest rates can work to promote new construction, and increasing interest rates can be used to limit oversupply.

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