How To Know When you are at the Bottom of a Real Estate Cycle...When to Start to Buy Again!!
Whether its stocks or real estate, we all heard that the time to buy is at the bottom of the market. In real estate that would be the bottom of any current "real estate cycle". And let me say that differing cycles exist in various parts of the country. Each local area is in a different stage in their own cycle. However the million dollar question for any real estate cycle still is... when is the "bottom" going to occur? How do we know when we are at the bottom so we can begin buying again? As real estate practitioners we are all faced with this question. Especially now where we are all witnessing unprecedented turmoil in the financial markets and we are seeing home values drop rapidly in many markets. This little essay will help answer this question for all your clients ...."when will the bottom occur and when will things get back to normal?....".
There are 2 aspects of this analysis/answer that I want to discuss. One is the concept of rapidly rising real estate values , and the other is its relation to the local housing affordability index. These two concepts intertwine together for a more definitive answer on real estate buy and sell triggers.
First lets discuss areas of rapidly rising house values. For the uninitiated, rapidly rising house prices are also called ‘real estate bubbles'. Where market values rise greater then 12% a year. Real estate bubbles are areas of high volatility. They are somewhat unstable. They can change rapidly. In other words...BE CAREFUL. But here is the point I want to drive home about bubbles; Real estate bubbles will have a greater propensity to fall as rapidly as the grew. That is, the quicker the rise in home value, the quicker the fall in home values. They are co-related. In the U.S. we can look at Southern CA and in Canada we can look at Alberta as an example- more specifically Calgary. Starting 2004 up to 2007 we saw a rapid rise in house values (15-30% a year). However starting in late 2007 to now ( late 2008), we have seen Calgary home values decrease just as rapidly as they grew ( about 30% ) Compare that with Barrie Ontario where house values have only increased marginally at 6-9% a year in that same time period. Barrie has also seen only a small decrease ( if any at all) of about 3-5% . Again please note that Calgary and Barrie are both in different "local" cycles. The point is this, whatever your local cycle, it is the speed of increase that will conversely affect the speed of decrease.
Now lets discuss part two of our answer; housing affordability index. This index is the "trigger" signal for our understanding of when to begin buying homes again and conversely when to begin selling in our local real estate cycles. It is the key to understanding the Buy signal and the Sell signal in real estate. Housing affordability is the percentage of income the average person makes that is used to afford a home. It is the amount of money required to spend on housing. It's what they can afford to pay for a house. When income is low and houses are expensive ( relatively)we will see the index around 45-50%. This is at the top of the cycle. It simply becomes too difficult for the average person to afford a home once the index reaches above 50%. Therefore people will no longer be able to buy homes because their average incomes are too low to sustain those home market values. That's when we see the "bubble burst". And home prices will fall because there are not enough buyers to pay for those high priced homes.
Conversely when incomes are relatively high and homes are relatively low we will see the index around 25-27%. This would be considered the bottom of the cycle. They can "afford" to buy homes, their income is high relative to the local home prices. That means people can afford homes and therefore houses will increase in response to higher demand.
So now lets wrap this up and combine the two for our million dollar answer; housing affordability with rapidly rising values. In areas that saw a rapid rise in home values ( a real estate bubble) that are now experiencing a rapid decrease in home values, the bottom will occur when the housing affordiablity index reaches below 27%. You can view that as your BUY trigger. This will happen by only one of two things. Either home values drop (relative to income) or incomes increase (relative to home values). And the opposite is true. The SELL trigger in a rapidly rising market is when the housing affordability index reaches approximately 40-45%.
In markets that are relatively stable and the housing affordability index is in between 27-42% , then there are no real BUY or SELL signals. It is a relatively good time to buy and good time to sell. The buy and sell triggers discussed that come from the housing affordability index only apply most dramtically when we see rapidly rising or falling house values (real estate bubbles).
( please note...there are many avenues to discuss ....this analysis can also lead to other fundamentals of market analysis such average incomes, average age, school enrollment etc... for a clear picture on real estate cycles...)
I have had many conversations on when this turmoil in the market will end. The above analysis is only in a perfect world. There are many economic factors to consider when analyzing market conditions. With the current credit markets experiencing a major overhaul and consumer confidence ( fear) crashing, there is no "one" answer. Time has proven that basic economics and common sense will prevail in the long run. By applying this method to your LOCAL real estate market you will be able to advise your clients on market triggers, and help them through some tough decisions when it comes to the "right time to buy or sell".
For more info: (705)-812-1033
Email: mark(at) manainvestments com
Mana Investments - www.manainvestments.com - We invest in real estate investing as well as buy houses in the Barrie, Orillia, Innisfil, Collingwood, Midland areas. We can show you how to use your RRSP's as a 2nd mortgage for real estate investing in Ontario
Homes by The Owner - www.homesbytheowner.ca Helping Buyers and Sellers in the FSBO real estate market in Simcoe County and surrounding Oro-medonte areas
The Six Steps to Success - www.sixstepstosuccess.com - Get to your financial goal quicker...Helping you achieve success in goal planning.
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