Many smart economists and financial advisers claim that the idea of "market timing" is a myth designed solely to pad investment brokers' pockets. But even the most cynical investors will admit that markets move in cycles and often give off strong signals before they shift direction.
By paying attention to these cycles and having some background knowledge on what constitutes a percolating (or overheated) market, you'll be poised to swoop in and take advantage of real estate investments others might let pass by.
Using Value Metrics to Predict Market Cycles
While owning multifamily units can accelerate your investment returns, the key to real estate success lies in not overpaying for assets. With this in mind, studying value metrics can help you predict market cycles—and know whether the acquisition price for a certain piece of real estate is a fair one.
Timing the market to ensure sufficient returns becomes even more important when you're utilizing bridge loans. These short-term loans can be a boon in hot markets, allowing you to snap up properties before you've secured more long-term financing—but in a down market, you may not have the time (or liquidity) to wait for values to improve before you need to take out additional funding. Savvy investors use bridge loans to boost returns in all markets, however.
For rental real estate, value metrics require the study of the market's physical cycle. The physical cycle drives your investment's rental income—and because it's entirely based on local markets, national figures and metrics aren't always relevant. Evaluating the physical cycle in your area requires a look at new construction (supply), occupancy and vacancy rates (demand), and other economic factors like unemployment, property tax rates, crime rates, and demographic trends.
Only by considering each of these factors as they apply to a specific piece of property can you determine whether this property is likely to have low-enough vacancy rates (and fetch high-enough rates) to make your financial investment a worthwhile one.
Recent Growth Trends in the Multifamily Market
Observing population and demographic shifts can often point you in the right direction when it comes to valuing multifamily housing units. Until the last couple of years, the need for multifamily units in urban areas continued to rise—but today, large metropolitan areas are registering the slowest growth in nearly three decades, while non-metropolitan and small metro areas are beginning to expand.
As discussed earlier, value metrics are highly location-specific—but this broader nationwide trend may require investors to more carefully scrutinize any potential acquisitions in metro areas. On the other side of the coin, potential opportunities may abound in previously untapped rural and suburban markets.
Signs of an Overheated Market
Some overheated markets can be identified only in retrospect. But in most cases, there are a few subtle indicators that should give savvy investors pause.
Prices (and Rental Rates) Outpacing Wages
When average wages aren't rising nearly as quickly as rental rates and property asking prices, the majority of consumers will at some point lose the ability to rent in certain areas. If you've noticed a substantial upward trajectory in asking prices over the last year or two without any precipitating factors (like a state or local income tax cut, an influx of new businesses, or an increase in the local population), this may be a strong sign of a bubble that's about to pop.
Although more common in the residential real estate market, bidding wars on commercial or multifamily properties can also be a sign that prices are beginning to climb not due to an increase in value, but as a result of non-economic factors. Brokers in Los Angeles often say if a property has an Offer Memorandum, then it’s overpriced.
An Air of Desperation
This factor can be tougher to quantify. But if you've noticed more than a few people with no real estate background jumping into the rental business, this may be another sign of an impending bubble. A strong real estate market grows slowly and steadily, and even seasoned investors may occasionally snap up "losers," so the perception of real estate investment as a sure path to riches for inexperienced investors can be a red flag.