real estate is too complex for simple folks. Again, this isn’t true. Remember when you started using some new software? You had no idea how to use it. It seemed too complicated, and it had entirely too many features. But there was a help section or YouTube tutorial to get you started. After that, through repetition and practice, what seemed much like a puzzle is now fully understood and appropriately used. Getting to know commercial real estate investing is the same concept. You have quite a few things to master, but it isn’t rocket science.
Timing the Commercial Real Estate Market
Wouldn’t it be great if you could time the commercial real estate market precisely? For instance, what if you could predict what the office building market would do five years from now in your town? Imagine if you had a process and procedure for knowing the perfect time to buy in a certain market. Well, here’s a secret: None of this exists. Sorry for bursting your bubble! But if we could predict such things, we’d be living on our own islands off of Tahiti.
But here’s the good news. Remember the old adage, “Buy low and sell high?” Believe it or not, this truly is how you get wealthy in real estate over time. It’s a tried-and-true method. And here’s another secret (and this time we’re serious): A tool exists that helps you buy low and sell high in any market anywhere in the United States. That tool is the real estate cycle. And when you pair this cycle with some knowledge of trends, you’re sure to be successful.
Knowing whether to buy, hold, or bottom-fish
Real estate cycles are like traffic lights. When you see a green light, you go. When you see a yellow light, you might go, but if so, you proceed with caution. When you see a red light, you stop. The trick, however, is knowing when you’re facing green, yellow, or red lights. Here are some examples:
A green light in commercial real estate investing may be spotted when you notice upcoming job growth due to a factory expansion. Or when the demand to build exceeds the supply of available properties. Most likely, you’ll also see a lot of undeveloped land sales activity.
A yellow light may be indicated by interest rates creeping up suddenly and causing you to examine your costs of new money to borrow. Or it could be when you see vacancies and “lease specials” increase. What if your newsfeed reveals many struggling businesses in an area? That has yellow light written all over it.
A red light may be revealed by a halt in new construction, which may be caused by overbuilding in the area. An increase in foreclosures and a decrease in property values is a sure red light.
Expansion phase: During this phase, population increases, incomes rise, employment is good, vacancies are decreasing, and rents are rising. New buildings are planned. The human emotion here is excitement.
Peak phase: This is the time to sell for maximum profit. This is a seller’s market, and in this phase, you see new building projects increasing and bidding wars between investors. Listings are on the market for only a short period of time. The human emotion here is sheer confidence.
Contraction phase: Most likely, you’ll see a bunch of new projects on the market now, and you may see evidence of overbuilding. Inflation is up, interest rates are increasing, vacancy rates begin to creep up, and prices begin to level. Foreclosures generally grow during this time. The human emotion here ranges from mere concern and denial to utter shock.
Recession phase: Real estate in this phase is becoming more difficult to sell, and so properties stay on the market for longer periods of time. Property values decrease, interest rates are high, and landlords are competing for tenants because of overbuilding. Foreclosures are usually rampant. The human emotion here is complete panic.
Bottom phase: This is the best time to buy. However, this is the scariest phase there is: Unemployment and inflation are high, and the demand for apartments is decreasing. This phase separates the men from the boys, the women from the girls, and the true investor from the stock market refugee. The human emotion here is plain old depression for most folks.
Recovery phase: This phase is the breath of fresh air. The local economy shows signs of life, vacancies decrease, rents level off and start to trickle upward, speculation starts again, and money begins to flow back into market. The human emotion here is pride, because you’ve waited out the storm.
FIGURE 2-1: The real estate cycle.
When is the best time to buy? The truthful answer is that it depends. If you’re a smart investor, you should buy in the bottom or middle of the expansion cycle. That way, you’re buying on trends and following the market and other investors. You’ll likely feel safe because you’re following what everyone else is doing.
When is it the best time to sell? The best time to sell is at the peak phase, right at the top of the market. And the biggest problem with selling here is knowing exactly where the top is. Here are two clues that have never failed us yet: Watch the rents and vacancy rates separately. After rents level off and become flat for three straight months or more, you’ve reached the top. Or for another indication you’ve reached the top: After vacancy rates are at a three- to five-year low, you’ve reached the top. It’s that simple.
When is it the best time to go bottom fishing? If you aren’t a bold risk taker, you may find this advice uncomfortable (so consider yourself forewarned!). Maverick investors buy at the bottom phase or at the front end of the recovery phase. This is called “bottom-fishing” for deals. This is where the big, big money is made. Maverick investors are brave and courageous trendsetters. They’re usually the first investors in the worst part of town, and they’re usually banking on the area to come back big time. If they play their cards right, they come out on top, and if they don’t, they simply walk away with an “aw, shucks.” Now that’s bravery!
Following Trends
True friends are always around when you call on them, and they won’t ever let you down. And economic and demographic trends are your true friends in commercial real estate investing. And best of all, these trends aren’t terribly complex or difficult to determine. Here are the three trends that
