How to Tell If You are in the Last Innings of the Real Estate Cycle

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Moderators at every real estate conference ask their speakers to comment on what inning of the cycle they believe we are in. Howard Marks of Oaktree Capital says we cannot predict the timing of the cycle– we can only recognize where we are now. Unfortunately, we cannot predict the length of the latter stage. It is during this stage that excesses are produced and expanded upon. Up it goes until it blows.

Over the last 30 years, I’ve been able to identify certain events, signs and trends that have occurred at the latter stages of some cycles. Not every one of these indicators have appeared during all the maturing cycles.

1. Prices and rents soar substantially above their previous peak. The new records are discussed at parties, conference, and dinner conversations and described as “crazy.”

2. Property prices and construction costs are climbing but developers/investors count on rising rents or prices to make their projection. Worse yet, developers trend up their projected rents or prices.

3. A form of very high leverage debt enters the market shifting the risk from equity to credit and increasing equity yields. Worse yet, the debt is non-recourse.

4. There is noticeable jealousy between the guys doing deals or selling properties and making significant amounts of money. Some developers and investors are achieving spectacular results.

5. The Fed is raising interest rates.

6. New construction reaches very high historical levels in some real estate markets and/or real estate property types.

7.  Mortgages are easy to get, and there is a lot of competition among lenders.

8. Some lenders start to lend more on appraised value and are less restrained by cost on recently acquired deals or new construction.

9.  Politicians and activists become more focused on the problems of growth and inequality than on the creation of jobs.

10.  Architects are very busy, and it is hard to get things through the City.

11.  The high prices and high levels of new construction are justified by supply and demand projections and changes in society and demographics making this time different. Some justify the prices paid or low expected yields by reference to the long term.

12.  Few are predicting an imminent recession.

13.  Good acquisition people are in short supply and being paid increasing amounts of money.

There could still be remaining runway, even after these signs appear.  For example, the latter stages of the last housing boom in Los Angeles lasted from 2005 through mid 2008.   It is just a risk call. Indeed, the latter innings are usually the most glorious of all, and one can make a lot of money if they play it right– or crash.   For the risk averse, when the signs appear,  it may be time to leave the casino and enjoy the floor show.

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