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The commercial real estate cycle generally follows a pattern of recovery, expansion, hypersupply and recession. “But there’s no set duration for each phase,” Felsot said. “The length of each phase depends on economic conditions, government policies and other market factors, with expansion and recession being fairly short in duration.”
1. Recovery
The recovery phase is located at bottom of the trough, when excess construction from the previous cycle stops. It’s difficult to correctly time the market trough, as the recovery phase shares traits with the recessionary one. Recovery is characterized by lower occupancies with minimal leasing activity. New construction is usually limited, and rental growth may be flat or declining. If there’s rent growth, it may be below the inflation rate.
Recovery investment strategies: Investors may be able to find strong bargain opportunities in varying states of distress. “These properties are ripe for value-add via repositioning and/or capital improvement campaigns that could make the property more attractive as the economy improves,” Felsot said.
2. Expansion
During the expansion phase, the market is improving: Demand increases, prices rise and vacancy rates drop, plus there’s more construction activity. But it’s important to note that increased construction can lead to overbuilding and more speculation. Looking at the broader economy, GDP is likely up, job growth is strong and unemployment rates are down. Supply and demand are in equilibrium.
Expansion investment strategies: “The expansion phase is an ideal time to develop or redevelop properties because current demand for space helps properties stabilize more quickly,” Felsot said. “Rent levels are also on the upswing, helping make construction projects viable as demand picks up.” Likewise, expansion is a good time to refinance commercial properties.
3. Hypersupply
Overbuilding or reduced demand creates an oversupply of multifamily properties. Often, an economic shift is the culprit in this disruption in the supply-demand equilibrium. For example, reduced GDP could cause unemployment to tick up and consumers to limit their discretionary spending. In this phase, rent growth remains positive but may begin to slow.
Hypersupply investment strategies: Some investors may sell ahead of perceived market declines and more inventory hitting the market. Increased inventory could drive up cap rates, lower expected returns and decrease property values. To remain competitive and attract or retain renters, multifamily operators may offer concessions or lower rental rates.
4. Recession
In the final phase of the real estate cycle, supply outweighs demand, economic conditions are soft, vacancy rates are high and rent levels are down. Rent growth is either negative or below the inflation rate. In response, multifamily owners and managers may offer more favorable terms on renewed leases to retain renters.
Recession investment strategies: The recessionary phase is an ideal time for multifamily investors to purchase distressed assets from financial institutions, special servicers or private party sellers at a steep discount. In turn, investors can offer lower rents. “Assets purchased during this phase can be highly profitable with execution of the right value-add repositioning strategy,” Felsot said.
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This article was originally published by a www.jpmorgan.com . Read the Original article here. .