The questions of whether real estate bubbles can be identified and prevented, and whether they have broader macroeconomic significance are answered differently by schools of economic thought, as there is not a single way to explain this phenomenon
BY KOSTA KIOLEOGLOU
Globally, one of the most lucrative and preferred modes of investment is real estate. People buy properties for different reasons, but what they all have in common is that they want to make a good purchase that will give positive returns on short, medium or long-term.
When you are looking to purchase or sell real estate, you will hear the terms sellers’ market and buyers’ market. It is vital to understand what these terms mean and how each market impacts you as a buyer or seller. In this article, I will try to provide a simple and brief explanation.
How can you identify the different markets?
When there are more buyers than properties for sale, a sellers’ market is in effect. As you might expect, the conditions in this market favor sellers over buyers. During a sellers’ market, you will generally find that home prices rise higher than they normally would and that homes tend to sell more quickly.
At other times buyers have more negotiating power. In a buyers’ market there is a surplus in housing inventory. In other words, there are more homes on the market than there are willing buyers. During this period, prices tend to rise more slowly and may even fall. Also, homes typically take longer to sell.
When conditions do not necessarily favor either buyers or sellers, you have a transitional market. This period occurs between moves toward either a buyers’ or sellers’ market. When the market cycles change, they don’t do so overnight. There is a transitional period in between when housing demand and supply are approximately equal and pricing typically stabilizes.
How are buyers and sellers affected?
Buying a property in a sellers’ market is a very fast and competitive process. Multiple offers on the same property are not uncommon. Some of these offers may even be above the asking price. To improve negotiating position as a buyer, one needs to be prepared to act quickly, and make a strong offer. Even so, during a sellers’ market, buyers often get squeezed out of the market by escalating prices and bidding wars.
If a property is for sale when conditions have created a sellers’ market, the timing is ideal for reaping the rewards of price appreciation. Generally speaking, sellers have more leverage in the negotiating process. However, regardless of this position, a buyer has to be wise to set realistic expectations and remain flexible in negotiations. It is unreasonable to think that a sellers’ market automatically means that buyers are ready to go for the full asking price, agree on all terms, sale within a few days, or sale regardless of property condition. Holding your ground beyond a reasonable point might cause unexpected results leaving a property unsold when the market swings in the other direction.
Selling when a buyers’ market is in effect can be a big challenge. Buyers tend to be more demanding with higher expectations for seller incentives and concessions. If an owner needs to sell, then he must be ready and willing to consider sensible compromises with respect to both price and terms. More aggressive marketing may be needed to attract buyers and extra attention to getting your property in the best possible condition will help improve your competitive edge in the marketplace.
Purchasing a property in a buyers’ market presents a great opportunity to find the right property at the right price. Along with this opportunity though comes a different set of potential challenges. With a greater number of properties on the market and bargaining power in buyers’ hands, availability of numerous choices and the ability to negotiate on just about everything is the trend. During this period buyers need to be wise in order to be efficient. Focus and narrow the property search based on needs, wants and affordability. When the right property is found, it is a must to focus on which concessions are really critical to meet goals and needs.
What stimulates market changes?
The housing market tends to cycle between shortage and surplus. Therefore factors that impact supply and demand influence housing market changes. Factors that have a widespread effect include interest rates, economic conditions, and consumer confidence levels. For example, low interest rates, good economic conditions and high levels of consumer confidence can increase the number of potential buyers. Since housing supply tends to lag behind demand, the result is movement toward a sellers’ market.
Reverse those factors and buyer demand will most likely slow. When the market reaches the point where there is an excess of properties, a swing toward a buyers’ market generally occurs.
In recent times however, the options for direct or indirect investments in real estate as well as the huge appetite for quick profits are defying the traditional rules of demand and supply creating what is known as Bubbles.
A real estate bubble or property bubble is a type of economic bubble that occurs periodically in local or global real estate markets, typically following a land boom. A land boom is the rapid increase in the market price of real property such as housing until they reach unsustainable levels and then decline. The questions of whether real estate bubbles can be identified and prevented, and whether they have broader macroeconomic significance, are answered differently by schools of economic thought, as there is not a single way to explain this phenomenon.
Bubbles in housing markets are more critical than stock market bubbles. Historically, equity price busts occur on average every 13 years, last for 2.5 years, and result in about 4% loss in GDP. Housing price busts are less frequent, but last nearly twice as long and lead to output losses that are twice as large (IMF World Economic Outlook, 2003). A recent laboratory experimental study  also shows that, compared to financial markets, real estate markets involve longer boom and bust periods. Prices decline slower because the real estate market is less liquid. The effects of real estate market bubbles have serious side effects to the economies and the daily lives of people.
It is important for everyone who is or wants to get involved in the property market to understand what a property cycle is, how long they last and how they can affect the property market. This is the first step to build up a shield that will protect your portfolio from expected or unexpected market changes as well as bubbles.
A property cycle is a logical sequence of recurrent events reflected in factors such as fluctuating prices, vacancies, rentals and demand in the property market. Business and economic cycles typically last over a decade and they influence property cycles in different sectors.
There are two different property cycles. The first is the physical cycle of demand and supply, which determines vacancy, which in turn drives rents. The second is the financial cycle where capital flows affects prices.
Property cycles are international and global forces. Economic conditions affect the real estate market. Globalization of real estate markets has increased the impact of economic conditions on the market. Property cycles are affected from the business and economic cycles.
Business or economic cycles are fluctuations in economic activity which historical analysis will show proceed with upward spurts followed by pauses and relapses. They are based on four key economic principles: depression, recovery, boom and recession (also frequently referred to as boom, downturn, upturn and stabilization).
All markets have their own cycle. There has never been a market so far without at least one cycle. It is important to understand that it is not about if it will happen; it is simply when it will happen and how long it will last.
Measured by peaks and troughs in performance, property cycles have durations ranging from four to 12 years, with an average of eight years, although there are some authorities that refer to 18-year property cycles.
Property cycles are usually used as a measure for commercial property, but in several countries, where the volatility of the housing market plays important factor in the economy, the peaks and troughs of the residential market are commonly referred to as boom and bust. Looking back in the last fifty years, there have been examples of boom and bust in the 1970s, 1980s and 1990s. Following the economic downturn from 2008 onward, there are signs of economic recovery and growth in the global real estate market, illustrating how the market fluctuates in a relatively short period of time.
Property markets and investments are exposed in risks. The underlying principle of portfolio theory is that investors seek to maximize the terminal value of their portfolio wealth. In order to achieve this goal both systematic and non-systematic risks have to be considered and if possible removed. But in reality, it is not possible to diversify away market risk (systematic risk) because this risk relates to the economic and financial factors that affect the performance of all assets and asset classes.
The systematic risk of a portfolio within a single country is linked to the country’s specific factors. These factors include national monetary policies that affect interest rates, inflation, and the cost of capital, the political situation, the business cycle and institutional, social and demographic factors.
Therefore, one must understand that there is no such a thing as a guaranteed market, investment or returns. No one can predict or control a property market and no one can predict how long is a given market cycle going to last. It can last for months, or several years. Much is dependent on the driving forces behind the change. Forecasting the duration and timing of changes is difficult at best.
What is certain, however, is that sooner or later the housing market will change. Neither buyers nor sellers have the upper hand all the time. For any buyer or seller, knowing that market change is inevitable will make an informed decision about buying and selling real estate minimizing the risk and maximizing the expected returns.
Everyone involved with the property market needs to stay updated, informed and ready to make decisions that will enable them face the market cycles.
MD AVAKON GROUP
source : Nairobi Business Monthly