Real estate investments react to economic cycles, as do all investments. The major points in the cycle¡ªfalling and rising prices, for example, are characteristics of supply and demand. The tendency dictated by this basic economic idea that prices rise and fall according to levels of supply and demand is the guiding force in selecting investments, timing purchases and sales, and selecting one investment over another.

In a pure market economy, prices rise and fall in accordance with the dictates of supply and demand. Higher demand places pressure on the supply, and prices rise; and lower demand softens the market, so that prices fall. The same features are found in the stock market, which often is called an "auction marketplace," That means that prices change specifically because the mix of sellers and buyers changes. When more buyers want a limited number of available shares of stock, that drives up the price; and when the number of sellers grows, it forces down the price of stock: An ongoing auction is underway when the market is open.

Real estate does not change hands on an auction marketplace. Stock exchanges are public and millions of individual trades result in tremendous share volume every day. In real estate, brokers are not bidding and negotiating from moment to moment; and real estate sells in large, single units rather than in millions of small shares. Offers are placed¡ªin writing¡ªthrough real estate agents and based on asked prices. Prevailing market conditions determine whether a potential buyer makes a full-price offer or tries to negotiate a lower price. The same conditions also affect the seller's response. A firm seller sticks to the asked price or stays close to it, but when the market is soft, sellers have to accept lower bids or their properties won't sell.

Although the rules of contracting for buy and sell prices and making and closing a deal are the same for stocks and real estate, methods are different In the minds of most investors, the rules are different as well. For ex-ample:

* Many people who can afford to buy 100 shares of stock would be faced with much more demanding financial arrangements to bid on real estate. Accordingly, the stock market is available to many more investors, and trading can occur frequently and in relatively small increments.

* Stocks are often bought and paid for in cash, whereas real estate more likely involves financing.
* Real estate prices are naturally higher than shares of stock, so the entire process of buying and selling - comparing, negotiating, bidding, offering, and closing tends to be more formal and take longer in real estate.
* Real estate does not trade hands as frequently as stocks, so the trading volume in real estate is much smaller, and indicators based on sales volume tend to cover periods of months and years rather than tracking methods used in the stock market, such as hour-to-hour or day-to-day volume.

Reasons for selling are different as well. Sellers of stocks often want to take short-term profits and move on to other issues, or simply want to move their money to another stock that they believe makes a better investment at that moment. The real estate seller mav be anxious to sell for a number of different reasons. A motivated seller wants to find a fast deal in order to get the equity out and move on. Motivated sellers may have made an offer on an-other house, be moving to another area, or be making other major life changes. The degree of anxiety to sell will dictate how much negotiation the seller is willing to undertake. In a very soft market¡ªin which many homes are for sale and few buyers are available¡ªit might simply be impossible to sell a property, a! least at the moment. In the auction marketplace of the stock market, there is always a ready buyer. The price may be low because demand is low. but shares of stock on a public exchange can be bought or sold at the current price, at any time.


The events and conditions influencing real estate values are referred to as the real estate cycle. While many factors affect the cycle, including population, the job market, interest rates, financing, construction levels, and many other economic changes, the real estate cycle moves in a fairly predictable sequence over time. The stages vary in length of time and rapidity of change based on the collective changes in market conditions; however, six distinct points can be identified in the course of the real estate cycle.

1. Demand begins to rise. Demand rises for many reasons, often for a combination of reasons. The fact that more buyers are looking for properties now than a year ago is a symptom of rising demand. It may be caused by growing population, job creation, and other factors. The forces that create demand cannot be isolated or easily identified; demand is usually a general trend involving many parts. One element of demand results from a de-crease in construction activity, leading to housing short-ages. In a truly efficient economy, developers would always build exactly the number of new homes required to meet the needs of the immediate future, while maintaining supply and demand in a healthy balance so that values gradually rise with moderate inflation. But that is the ideal world, and the real world rarely acts that way.

2. Construct I ion activity increases. Why do developers increase their rates of construction? At the beginning of the cycle, the general perception is that demand is on the rise. At that moment, the perception is correct. The trick, though, is to know when to stop building new creases, so do the construction rate and pace. That pace often exceeds actual demand, so that as the cycle tops out, the consequence is oversupply.

3. Demand slows. When we say that demand slows, we could mean that demand actually decreases or that the rate of new construction accelerates beyond a more moderate demand curve. As long as construction and demand are moving at the same pace, there is no relative change in the real estate cycle. When demand slows for either reason, this event signals that the top of the cycle is approaching. You will recognize this point by an in-crease in the time required for listed properties to sell. In literally faster than they're being built. But if builders start accumulating an inventory of finished homes that are not selling right away, that is a sign that demand is slowing (or that construction has outpaced that demand).

4. Supply exceeds demand. The cycle tops out and begins to decline at the point when property available and on the market exceeds demand. This does not mean that no real estate is selling. It does mean the supply is larger than it needs to be, and demand is not great enough to move the inventor)' of available properties. As a consequence, prices tend to level off or fall. -The cycle might stall¡ªmeaning that new construction is meeting demand, but prices do not rise because the inventor)' is perpetually higher than it should be.

5. Construction activity decreases. No market can sustain a holding pattern for long. When inventories of available property are too high, construction eventually falls off, at least temporarily. Builders and developers, like everyone else, do not always recognize the point in the cycle until it's too late. So at the point where prices have be-come soft and supply is too high, builders realize that they cannot continue to develop the market at the previous pace. Another problem in trying to watch and predict cycles, whether in real estate, the stock market, or other markets, is that you don't know whether specific signals indicate changes tomorrow, next week, or next year. Timing is the difficult part.

6. Demand bottoms out. At the end of the cycle, demand is at its lowest; construction activity has stopped for the most part; and no changes are in sight. A cycle might remain at its bottom for a few weeks, a few months, or many years. No two cycles follow identical wave patterns, and there may be numerous false starts along the way. The word "doldrums" appears in financial articles, and experts proclaim that the opportunities in real estate are over, once and for all. This statement is one of the predictable events at the bottom of the cycle. Remember, though, that such categorical predictions¡ªlike predictions that inflation is gone forever¡ªare always wrong. The end of one cycle is also the beginning of another one.

A study of the real estate cycle can be simplified in theory, but in practice the actual cycles for your region will be affected by many complex social, political, and even historical factors. Forgetting for the moment about outside influences, you can reduce the real estate cycle to a fairly straightforward comparison between supply and demand. The waves of the cycle can reflect sales volume, prices, or units for sale. For the purpose of this simplified summary of the cycle, we will use market value¡ªthe best under-stood and most widely recognized result of changing cycles. The question often is expressed in terms of the prices of homes. They suddenly rise, or they remain the same for many months, or they fall. Why? 

1. Supply rises and demand falls.

2. Demand rises and supply falls. 

This cycle, like all cycles, involves the cause and ef-fect of supply and demand. You are aware of the variables in the cycle and the complexity of influences that have to be added into this, but the basic equation remains the same. One way to better understand why cycles move the way they do is to understand that in ihe first half of the cycle¡ªwhen prices are rising¡ªthe price curve tends to run ahead of the demand curve. On the other side, when prices are falling, the price curve lags behind the demand curve. The trends run out. and the cycle begins again¡ª thus the wave effect. Changes in relative levels of supply and demand are nothing less than the sum of all influences in the market at that moment. If developers ceased building altogether because of excess supply, demand would eventually use up that inventory, and the cycle would he forced to begin anew, if employers came to town, demand for new housing would accompany those new jobs. However, we can never have absolutes such as construction levels stopping altogether or a complete turnover in the job market. Such influences tend to occur incrementally rather than in sin-gle motions. So in reality, when we talk about supply and demand, we are really describing a trend that involves all of the complex economic, social, and intangible influences at work in the community.

 

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