It can be helpful to think of the market as a giant pendulum, constantly fluctuating above and below a set threshold that shows normalized long-term economic growth. These fluctuations are prompted by the collective decisions of market players that dictate supply and demand, and any number of other variables.
The aforementioned threshold line is always pulling the pendulum back towards equilibrium—a principle often referred to by economists as mean reversion. It indicates that, despite temporary vacillations up and down, the market (i.e. the “pendulum”) will inevitably trend back towards the threshold line.
The speed and amplitude of the pendulum’s swing from the threshold line is relative to the momentum with which it moved away from that line. In other words, the greater the pendulum increases above the threshold, the greater it will decrease. The subsequent outcome can range from a modest correction to a catastrophic plummet like the one experienced in the 2008 market crisis.
Overall, the market cycle can be explained in uncomplicated terms. As the pendulum travels upward, prices are pushed higher. The elevated price points inevitably relent to higher risk, prompting the pendulum to reach its apex. Asset values and activity level reach an unsustainable point—resulting in a subsequent downswing as the pendulum plummets below the threshold line and into the negative. This downward trend continues until the momentum generated by the quick rise is countered by corrective actions.
Developing an idea of the pendulum’s current location in its cycle can provide insight as to whether your investment strategy should be aggressive or reserved.
Still, it is risky to attempt to ‘time’ the real estate marketplace. Be wary of making snap investment decisions because you predict a quick rise or fall of the pendulum — that kind of reactionary approach is all too common, and can lead to immense excess and devastating corrections.
The way forward is to rely on approximations of where we are in the present cycle—including the momentum of the upward or downward trend—and premise your investment strategies based on that. Lucrative opportunities can be leveraged even in the most negative market conditions.
Practically, the best method to weather the economic trends is to be an aggressive buyer when the pendulum seems to be nearing its bottom, then take a more reserved approach when the pendulum approaches its peak. It sounds simple; however, those low and high apexes are challenging to predict regardless of the experience level of the investor.
Now it’s time to address the elephant in the room: what impact has the coronavirus pandemic had on the market cycle? Before the crisis took the world by storm, the private lending industry was anticipating a competitive market with high demand and low inventory and mortgage rates going into the spring season. Now, the situation has completely changed.
With nationwide shelter-in-place policies continuing to wreak havoc on many industries (especially the service and entertainment industries) with no clear, definitive end in sight, it is uniquely difficult to predict a timeline for the pendulum’s next upward swing. Real estate buyers and sellers have been reigned in, and demand for loans is down. The capital markets have slowed to a crawl. Fear and uncertainty have led many investors to play it safe for the time being, and private lenders are raising interest rates and lowering LTVs in response.
But it’s not all doom and gloom; the consequences of these developments have been offset somewhat as conventional lending has slowed down. There is some evidence based on studies of past pandemics that the economic effects of COVID-19 will be relatively short-lived, particularly in regards to the mortgage industry. Technology has lessened some of the economic impact of the virus as well; the remote work phenomenon has empowered more businesses to remain functional, and the internet gives potential borrowers the freedom to engage with the real estate markets without ever stepping outside.
Continue monitoring the current downward trend via easily-identifiable market indicators—particularly those in your local sector. Factor in days on the market and negative fluctuations in sales price compared to the listed price. Remember to keep close tabs on the mean reversion. That established base line has a magnetic effect on the swinging pendulum of the economy—sooner or later the variations will reach equilibrium. That’s the very reason why investing in real estate pays dividends when the correct strategy is implemented. Don’t be dissuaded from making moves in the event of an economic downturn, even the one we’re experiencing right now—investment opportunities are there at any point in the cycle for the confident investor.
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What Real Estate Investors Should Know About Economic Cycles and Coronavirus | Gauntlet Funding – Melville, NY