Invest in Yourself

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The definition of ‘market cycle’ depends on the context. Today the term is broadly used in reference to national economic trends with respect to the supply and demand of single family housing. However, specific market cycles occur within every niche - retail, apartments, condos, commercial office space, rentals, hotels, recreational housing and by specific geographical area. Each segment has its own set of behaviors and repercussions and every type of market has its leading cycle indicators and goes through four stages with some regularity - discounting of course government intervention or natural tragedy.

Armed with data from the National Association of Realtors and Case-Shiller analysis of past real estate cycles and trends, one can make reasonably educated assumptions as to what the future may hold in any given market niche or area. When an economist refers to ‘the strength of the market’ be sure you understand the context or geographical area referenced, otherwise its akin to a single weather report for the entire nation, wrong somewhere.

While every real estate niche has a pattern to its cycles, it is not always easy to predict when it will evolve from stage to stage. The four stages are:

Recovery - While there is no formal start to a cycle, the market is in ‘recovery’ after the last downturn or retraction phase. This means the plunge in demand has slowed to a trickle and speculators are starting to consider opportunity in the segment. This is the time to buy if you have the resources and fortitude to hang in there in case the market trolls along the bottom for a while, like we did for several years from 2008 through 2011. In this instance, it’s OK to have a national perspective because we know the housing bubble was created and decimated over a 30 year period by government intervention in the form of forced lending to underqualified buyers and the overspending by almost everyone, everywhere.

Leading indicators for the recovery stage include low rental vacancies, high but stable unemployment, a high number of homes in foreclosure, and a general fear of the market. Recovery goes into full swing when contractors begin to build and investors are snapping up what the speculators left behind.

Expansion – When businesses start to hire, unemployment dips and consumer confidence starts to rise as people become optimistic about job stability. Consequently there is upward pressure on real estate demand and prices. Contractors will be in full swing and banks are again anxious to lend. Look too for new commercial building or renovations. Follow the number of building permits being issued and the expansion of related service industries that cater to the demand.

It can still be a good time to invest in the market as prices and rents are going up and foreclosures are still available for those willing to work to find them. As excitement and prosperity grows, the latter part of the expansion phase is characterized by the entrance of the unseasoned speculator. These are the people who jump in, wanting to take advantage of the growing market and need it to grow in order to make the numbers work for them. Some will pay too much and lead us into the next stage.

Over Supply – Look back to the early and mid-2000s, for a classic over supply model. Skyrocketing home prices, massive developments, condos, second and third homes, McMansions bought on the speculation that 12 to 18% increases were the new normal. Everybody wanted to buy something, anything.

Builders are anxious to accommodate the anticipated increase in demand and rents, and therefor pay too much for land and construction. Rehabbers also overpay anticipating someone else will pay even more after they pretty it up. Eventually the supply equals the demand, but like a locomotive, the construction started in stage two is hard to stop, so supply overtakes demand and vacant units grow.

This phase is hard to recognize because everyone is happily making money – at least on paper - and that is the key to look for. When the capital gains far outpace a reasonable increase based on initial numbers, the savvy investor will sell into this market, capture the gain and wait for the inevitable...

Retraction – Simply, a collapse in the market. The speculative projects don’t sell, prices drop suddenly and foreclosures start mounting with decreasing rents and underwater mortgages. This phase is typically tied to an economic recession, job loss, and overspending by government.

Looking for the bottom is like ‘trying to catch a falling knife’ as they say on Wall Street. Smart investors will wait for supply to drop below demand and then pick up some great deals, starting the cycle once again.

A corollary to Albert Einstein’s quote “Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn't, pays it.” is "Those who understand interest earn it; those who don't, pay it."

A person with a mortgage or someone with extra cash on hand can take advantage of Einstein’s insight to save or make thousands of dollars. While access to the stock market is easy, procuring mortgages (also called paper or notes) as an investment is not as straightforward. Let’s first examine the pros of quickly paying off your mortgage. 

While a $150,000, 30 year, 5% mortgage will only be $805/mo, the interest will be another $139,883 with $68,640 or 49% of the interest paid in the first 10 years, another $50,530 paid in years 11-20 or 85% of the interest due, and the last 10 years $20,800 or only 15% of the interest. (This is why banks market or sell their mortgage notes within the first 10 years).

So, with all the interest being front loaded, if you can make one extra payment per year, over 10 years, it would be $8,050 'invested' and would 'save' $15,630 in avoided interest or close to a 94% gain, far outpacing typical stock market gains over a decade and without the risk. And that one extra payment can be accomplished with a lump sum or by adding an extra $67 a month to your payment. This strategy could help the average millennial, whose savings rate is -2%, save for the long haul.

On the investor side, you can create your own note by holding the mortgage when you sell property. Buying market notes entails gaining access via investment clubs, private equity firms or secondary channels such as advertisements. Notes can be obtained at a discount depending on how long the note has performed and the due date. Be sure you are getting a performing note for armchair returns or you might have to go through a foreclosure – which will take some effort but could also be profitable.