Understanding Real Estate Cycles & Finding Deals

Many readers have emailed me asking how I find my real estate deals. Often, readers share their struggles of how they cannot find good deals. Sometimes readers even say there are no deals. This is a limiting belief. Deals are always out there if you are willing to look. With that said, I also share in my readers’ frustration as finding a good deal is not always easy – If it was easy, everyone would do it. Though, nothing worth having ever came easy.

This post will cover the following:

• Understanding real estate cycles
• How long real estate cycles last
• Phases of real estate cycles
• My experience with real estate cycles

Part II, Selecting a Real Estate Strategy, covers:

• Real Estate Strategies
• Setting your real estate goals
• Making sure your strategy aligns with your goals
• Specializing in real estate investing

Part III, will cover Finding deals:

• My approach to finding deals
• Creating your criteria for deals
• How to look at deals differently than the competition
• Overcoming Analysis Paralysis

Understanding Real Estate Cycles

Being a successful real estate investor requires finding deals. You cannot be a real estate investor if you never buy a property. The real estate market ebbs and flows and will continue to do so. Depending on where we are in a real estate cycle, finding a good deal may be easy or very challenging.

Understanding real estate cycles is important if you want to play the real estate game. There are always good deals regardless of where we are in the real estate cycle. My mentor always reminded me that he bought his best deal at the height of the market. That’s right – he bought his best deal just before the market crashed in 2008.

Today, he laughs about this when he reminds me of this factoid. His success was a direct result of sticking to his fundamentals. My mentor invests for cash flow. He does not buy to speculate about appreciation – he buys for cash flow.

How long do real estate cycles last?

Research from the past 200 years suggests the average real estate cycle is 18 years. Some cycles may be longer while others may be shorter. However, on average, a real estate cycle lasts for 18 years. The table below summarizes the history of real estate cycles:

As you can see, most real estate cycles last about 18 years. There are two notable exceptions. First, the Post World War II expansion which was one of the greatest economic expansions in history. And second, the ‘bust’ in the 70s where the Federal Reserve doubled interest rates to tame inflation. Otherwise, 18 years is pretty much the standard.

Phases of real estate cycles

During a cycle, the real estate market will experience a boom and a bust. The ‘boom’ part of the real estate cycle consists of two concepts – recovery and expansion. The ‘boom’ times usually last for 15-16 years. This is where property values rise, confidence increases, and developers build which increases supply. The ‘bust’ times usually last 2-3 years. During bust times, property values are usually in free fall and it’s a buyers market.

My experience with real estate cycles

My love affair with real estate began in 2013 when I was searching for my first property. I checked out a few homes, found a place I liked and submitted an offer. My offer was accepted and I had the property under contract. After the home inspection, I decided to walk away. The inspector discovered a mold infestation in the attic. The roof and all the support beams were rotted out and needed to be replaced as well. I would’ve walked into a money pit.

The property I walked away from was inspected in November of 2013; I paused my search to enjoy the holidays with family.

After an enjoyable holiday season, I was revved up and ready to go. I bought my first property in early 2014. The home was located in a working-class neighborhood and had three bedrooms and two bathrooms. There was nothing fancy about the place and many would consider it a ‘starter home’.  I was house hacking to keep my cost of living low; this allowed me to save a ton of money.

The best deals occurred between 2009 and 2012. During this time frame, many short sales and foreclosures (bank owned properties) took place.

However, deals were still easy to find during 2013 and 2014. I was fortunate to enter the market at a good point in the real estate cycle. By this point, we were probably past ‘Phase I’ and in the early stages of “Phase II’. Property values were still below pre-recession highs. Banks were lending again and the rental market was strong.

After enjoying modest success at my first property, my doctor confirmed that I was infected with the real estate bug. Rental Property #1 was great and significantly reduced my housing expenses. I was paying ~$400/month to own a home in the Washington, D.C. area. The alternative was renting a 1 bedroom apartment for $1,500/month (likely more).

However, I lacked cash flow and was paying to own my property every month. I wanted to be paid. Cash flow, I discovered, is the most important factor in real estate investing.

In 2015, I began looking for another property to buy. The first and most important factor in my search criteria was cash flow. While my first property lowered my living expenses I wanted to get paid while house hacking. This would also allow me to live for free. Actually, I would get paid to live.

The real estate market was booming in 2015. Prices were increasing and in some instances skyrocketing. My search began by looking at duplexes, triplexes, and quadplexes. Locally, developers were having a field day converting these types of buildings into for-sale condos.

Properties were receiving a dozen or more offers and selling above asking price. In fact, many buyers were submitting all cash offers. My offers’ were contingent on FHA loan financing (low down payment) and would take about a month to close. As a result, my offers were not appealing and many sellers overlooked them.

Fortunately, I found an old, rundown rowhome in an up-and-coming neighborhood. The property was listed at an obscenely high price – mind you this was when I found the listing. The listing agent had already cut the asking price three times. My agent and I put our heads together and submitted a lowball offer.

To my surprise, I received a call from my real estate agent the following day. He informed me my lowball offer was accepted. I was shocked, fearful, and then excited. You see, the purchase price was on the high end of my comfort zone. The property needed a full renovation and I had limited funds. Between a 203K FHA Loan, and maxing out three no-interest credit cards I was able to pull off the renovation.

I moved into the new property, elected to live in the smallest room, and rented the remaining rooms. I was living for free. Better yet, I was actually getting paid about $1,500/month after all expenses and the mortgage to live in my own house. This allowed me to quickly pay back my credit card debt.

In 2016, my desire to own cash flowing real estate didn’t fade. The DC real estate market was hotter than ever. The city was still booming and property values continued to trend upward. Based on my experience, I would say we were nearing the peak of ‘Phase II’ in 2016.

I submitted several offers that year and lost several bidding wars. Heck, I even had the highest offer on one property. However, the seller selected a lower, all-cash offer. I was shut out in 2016 and unable to buy a property.

I opened up a HELOC (home equity line of credit) at the end of 2016 and had been saving aggressively for over a year. With a mountain of cash behind me, I was ready to make a deal. I still desired more cash flowing real estate. 2017 would be my year; I was determined to find a (good) deal.

Property values continued to rise. At this point, the more well-established neighborhoods no longer provided quality investment opportunities; the returns disappeared. Some of the ‘up-and-coming’ neighborhoods were becoming too expensive as well; returns in these neighborhoods were declining.

This led me to look in new areas. I wanted to be in the next hot market. I decided to explore on the fringe. I sought places that everyone would want to be in one, three or five years.

After educating myself on the upcoming development trends, I identified a few neighborhoods with potential. This served as a great strategy as I closed on rental property #3 in the first quarter of the year. The duplex was modestly improved and rented out a few months later.

Towards the end of the year, I got a notification on my phone which turned out to be a pleasant surprise. The notification informed me a property I saw earlier in the year was back on the market. This triplex was under contract for a long time but the buyer was unable to close. The seller was fed up and relisted the property.

This is where I stepped in and bought rental property #4. The property has been like a redheaded stepchild (no offense to my ginger friends). The renovation went well and the property was ready to go in less than 60 days. However, the property sat vacant for over 9 months as the city made me jump through unnecessary red tape.

You see, DC has shotty recordkeeping and had no documentation of the building. They claimed the property did not conform to the zoning ordinances. Long story short – they were wrong and I was right. The property is now humming along but it took most of 2018 to stabilize the property.

I was intentionally out of the market in 2018. I had bought two properties in less than six months the previous year. My cash reserves were depleted, I was focused on getting rental property #4 up and running, and I needed to repay my HELOC. The real estate market still moved forward in 2018 as prices climbed to record highs. There was less inventory to go around. Increased interest rates also sidelined some would-be buyers.

As we enter 2019, many people are concerned about a recession. Likewise, many are concerned about real estate prices and think we are due for a pullback. Candidly, we are a bit ‘long in the tooth’ as the United States’ economy has experienced one of the longest economic expansions in history. We are probably near the peak or in ‘Phase III’. However, the real estate market may not slip into ‘Phase IV’ for a few years.

I am still actively looking for new real estate deals and have submitted multiple offers this year. However, many deals do not provide appealing returns. Given that we are probably late in the current real estate cycle, it’s more important now than ever to stick to fundamentals. Do not forget that cash flow is king. Don’t do a thin deal or leave yourself little room for error.

The economic data suggests the economy is on stable footing. Don’t let the fear-mongering media convince you otherwise; their job is to drive ratings and attract eyeballs. Based on the 18-year cycle theory, we shouldn’t expect a real estate correction/pullback until 2024.

If you are struggling to find, its probably because of where we are in the cycle. Keep in mind that every market is different and that there is always a deal out there. A few years ago I might’ve looked at 8-10 places before finding a quality deal. Today, I scan dozens of deals before finding a quality investment opportunity.

Stay tuned for part II… where I will cover how I find my deals