When is the Best Time to Buy Commercial Real Estate?
Historically, commercial real estate values have been cyclical and will continue to be so in the future. The availability and cost of financing is a key component of these cycles. Available capital is affected by the economy, interest rates, supply and demand, and the perception of the market. Real estate prices fluctuate as these factors exert their influence.
There are four distinct phases to the commercial real estate cycle: Recession, Recovery, Expansion and Contraction.
• Recession: The Recession Phase follows a market contraction, when the availability of financing becomes scarce or expensive and property prices have fallen. Properties experience higher vacancies and owners have difficulty refinancing, selling or leasing. Foreclosures increase. Prices can fall below replacement costs, resulting in many opportunities for those with the liquidity and fortitude to take advantage of the market weakness. The latter stages of this phase can be a good time to buy.
• Recovery: In The Recovery Phase, the market is improving and prices begin to recover, although some buyers are still hesitant to proceed. More tenants enter the market and property owners refinance as affordable loan rates become available. Owners tend to improve their property and work to maximize rental rates. Prices are increasing. This is a very good time to buy.
• Expansion: During the Expansion Phase, the real estate market is progressing and expanding and equity investors are plentiful. Financing becomes more readily available and the price of real estate may increase more than seen in previous history. Vacancies are at their lowest point and there is a general sense of well-being, prosperity and abundance. Everyone is talking about buying real estate. This is the time to sell.
• Contraction: The Contraction Phase is when vacancies are increasing and prices begin to fall from the peaks of the Expansion Phase. The market has become over saturated and financing is becoming more difficult or expensive. Investors begin to withdraw from the market as vacancy and delinquency rates rise and prices decline. Buying and selling decisions should be based on need, prime property availability, and specific submarket and individual opportunities.
The phases of the real estate cycle are always in the same order; the only variables are the depth and duration of each phase. By determining the timing of phases along with your own personal and business capability and goals, you can make the best decisions.
As a real estate investor, the most important question is, "When is the best time to buy?" This is when we realize we are either savvy decision-makers or merely “one of the herd.” If the market is in the latter stages of the Recession Phase, the stage is set to reap the absolute highest profits by buying at a time when prices are at their lowest. When the market is in the Recovery Phase, it’s still a great time to expand holdings and acquire properties while building long-term wealth.
We have all heard the phrase: “Buy low and sell high.” The best time to buy is when the cycle is in the Recession Phase or Recovery phases, when the lowest prices are available. Prices can be negotiated and many prime locations are available. The time to sell is during the Expansion Phase, when buyers can easily obtain financing and the market continues to expand. One way to think about is this: when everyone is talking about buying, you should be selling. When everyone is talking about the doom and gloom in real estate and selling, you should be buying.
The challenge with this strategy is that it goes against our basic instincts, even though logic and history dictate otherwise. Our “herd instinct” is affected by the people around us, the media and our resulting emotions. Although we understand that we should not follow the herd mentality, logic and emotion are in conflict. Unfortunately for most, emotion will usually rule over logic. This human tendency creates opportunities for the more logical and less emotional investors.
One thing that we can be certain of is that cycles will continue. History has proven that those with the emotional fortitude and the financial ability to take advantage of the cycles will reap tremendous rewards.
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