Getting in Front of the Inevitable: Cyclical Change
Are you a change leader? Read on to find out how to recognize the four types of change.
The ability to anticipate and manage change is a critical leader-ship skill. The first step in being a change leader is recognizing the four types of change: Cyclical; Structural; Exponential and Incremental. In this article, we’ll focus on cyclical change and how to predict and benefit from market cycles.
We are in a cyclical industry. Knowing where we are in the market cycle is a critical skill. Real estate market cycles tend to be long, slow and predictable (when we watch the fundamentals). I teach market cycles in the College of Business at Colorado State University. Here are four fundamentals you can use to predict market cycles:
- Jobs Employment is a leading indicator of a real estate market cycle by 12 to 18 months. This is your earliest warning signal of a change. Contact your state employment office and join the mailing list to receive the monthly employment numbers for your county. Watch for a change in employment (either up or down). This is your best crystal ball, giving you a 12- to 18-month head start.
- FHFA.Gov Go to this government website and download their quarterly “House Price Index” report. This is a long report (usually 75 pages) so scroll down to the charts that give you “House Price Appreciation by State” and 300 individual metropolitan markets. These charts show the house price appreciation for the last year, the last quarter, the last five years and since 1991. Want to see if the market is speeding up or slowing down? Take the quarterly change in prices for the market and annualize it (multiply x 4). Then, compare this number to the annual price change. Here’s an example using the June 30, 2014 report:
Nevada led the nation with a 14.80 percent price increase for the last year. However, their increase in the last quarter was only 0.87 percent. Annualize this last quarter (multiply x 4) and we get 3.48 percent, indicating that this market is slowing down. On the other hand, Massachusetts with a 4.95 percent, one-year appreciation and a 2.5 percent quarterly appreciation (10 percent annualized) is a market that is speeding up. Some markets are seasonal, so be careful about jumping to conclusions based on just one quarter. Start tracking each quarter, and you will spot the trends.
- Affordability The three components of affordability are house price, household income and interest rates. Because of the low interest rates, most markets are more affordable today than they were 10 years ago—even with rising home prices. Ultimately, home prices and real estate activity is a function of people’s ability to pay. The funny money, subprime lending was an aberration that was not sustainable and contributed to the housing bubble.
- Investment Ratios Tracking supply, demand, rents and the relationship of rents to prices will also give you a clue as to whether a market is overheated, and a bubble is building. Markets tend to seek equilibrium over time and develop historic ratios. If a market gets out of sync with these historic ratios, watch out. Unless there has been a structural change, (which we will discuss next month)
a change is on the horizon.
Tracking these four fundamentals will help you get in front of the inevitable. Unfortunately, some real estate leaders ignore these fundamentals when they succumb to media hype or the euphoria of a hot market. Fearless and disciplined leadership is required in order to assess and exploit the change.
Right before the bubble burst, leading to the great recession, two of my wealthy real estate friends (who are masters of using these four fundamentals to predict market cycles) put all of their real estate on the market for sale. One of them owned over one million square feet of commercial property, and it was all free and clear. They had spent years building these portfolios. They were “real estate people.” So, I asked them what they were going to do once they sold all of their real estate. “We’ll wait and buy it all back from the banks at 50 cents on the dollar,” they said. And they did! They got in front of the inevitable.