Keys to Understanding Emerging Markets

When my team and I consider where to make our multifamily investments, we look for emerging markets.

I talk about this often in my blogs as well as my presentations to potential investors. So just what does that mean?

The basis of that is an understanding of the emerging market “cycles.”

It is like a loop. It starts from Buyer’s Market 1, then goes to Buyer’s Market 2 (which I call the “Millionaire Market”), then to Seller’s Market 1 and Seller’s Market 2, before returning to the Buyer’s Market 1 stage and repeating.

Let’s first take a look at the characteristics of each stage:

Buyer’s Market 1

• Oversupply of inventory
• Prices and rents are falling
• Time on market is increasing
• New construction is stagnant
• Unemployment is at its height
• Foreclosures are rising sharply

Buyer’s Market 2

• The market is absorbing the oversupply
• Time on the market is decreasing
• Job growth is increasing
• Existing properties are being rehabbed
• Prices and rents are slowly beginning to increase

Seller’s Market 1

• Supply is dwindling
• Properties are selling fast
• Time on market is at its lowest point
• Property prices and rents are rising
• Demand is at its highest point

Seller’s Market 2

• Time on market is increasing
• Supply is increasing
• Sellers are waiting but still get inflated prices
• Construction is excessive
• Business and job growth are slowing

The optimal point at which to pick up the property is at the Buyer’s Market 2 stage.

This is where there is an oversupply, so the prices are coming down for office buildings, apartments, and other properties. Rents also are falling. The net operating income (NOI) falls. And when the NOI falls, the prices of the properties fall. The time on the market increases. New construction is stagnant. Not many people want to build in that market phase because there is always oversupply and unemployment reaches high levels. When unemployment is high, many people are not able to rent out or spend money at the grocery stores. It is just a downward cycle in the market.

Foreclosures rise sharply. We have seen that in the U.S. and all over the world. We have seen that happen within 2007-2009.

In Buyer’s Market 2 at the lowest point, that is when the market absorbs oversupply. The time on the market decreases and job growth is starting to take hold. Offers are coming into that area. Existing properties are being rehabbed. The prices and the rents begin to increase slowly. The reason we call this the “Millionaire Market” is because that is the best time to buy.

What happens in Seller’s Marker 1 is that supply dwindles. Because many people are buying commercial real estate, the supply goes down. With fewer properties on the market, they sell faster — whether it is multifamily, industrial companies, offices, hotels or others. Time on the market is at the lowest point and property prices and rents rise. Demand is at its highest point.

That is where the seller’s market is. Sellers are unable to determine how much they want to sell their properties for. There are some bids coming in from different buyers and that drives the price higher.

In Seller’s Market 2, time on the market increases. Supply increases. The seller is waiting but still gets inflated prices. Construction pipeline is excessive. Business and job growth are also slow.

The best time to buy is in the buyer’s market. Then 3-5 years later you try to sell the properties at Seller’s Market 2 before things go into a downward trend and over the cliff.

I want to tell you about a really nice service we use: Integra Realty Resources, Inc. This company does considerable work looking at the fundamentals that determine phases within cycles, including vacancy rates trends, new product supply, delivery, and expectations. They design charts like the ones here (which are several years old, by the way), which show where different markets are in the cycle.

Each phase lasts about 3-5 years. It is about 6-8 years between the bottom and the top. The best time to buy is in the recovery phase when Buyer’s Market 2 has just happened and the vacancy rate is decreasing. There is low new construction and moderate absorption, low/moderate employment, negative/low rental rate growth. And then it moves higher into the expansion stage, where there is a decrease in the vacancy rate, the rents are getting higher, and moderate or high employment growth is there. You do not want to hit the hyper-supply.

When to buy is in the recovery phase and where to sell is in the expansion phase. The key also is not to be greedy by keeping the property for a longer time. You have to leave “some meat on the bone” so the other people who buy the property can also realize some good appreciation when they are purchasing.

The worst part is to buy properties in the hyper-supply and the recession phase. That is a period to watch and then you pick up in the recovery phase a little before or right after Buyer’s Market 2. You never know where the bottom is until you have gone to the bottom. Then you can look back and say, “That was where it was.”

How do you identify emerging markets?

Do your own market research, using:

• Job growth reports
• Population growth reports
• Path of progress reports
• Local economy reports and trends
• Chamber of Commerce reports

Look for the following factors in your market:

• Where are the largest businesses locating?
• How many new jobs are being created?
• Is the lifestyle appealing?
• What is the rental potential?
• Does the community include universities or a state capital?
• Are there big-box retail centers, shopping hubs, health hubs?
• Does the market have an airport?
• What is the infrastructure like?
• Is the population in the preferred area of 50,000 to 100,000?

When approaching the emerging market in the U.S. and all around the world, you have to do market research. That includes reviewing job growth reports, population growth reports, and path-of-progress reports. Also look at local economic reports and trends. Chambers of Commerce are good places to start. Try to understand where you are going. And there are numerous websites on the internet from which you can get information, including www.globest.com, www.irr.com, and www.cbre.com.

Then you can look for the emerging markets where the stable, larger and service industries are coming in with more new jobs and an appealing lifestyle — where there is good rental potential, and especially around state capitals and universities. You want to look for a market where big-box retail, shopping, and health hubs are moving in. Because these big-box retail and shopping hubs do a lot of extensive marketing to determine which markets are adding jobs (and therefore population). Those are the markets they choose. In addition, they look for nearby airports, infrastructure, roads, transportation, utilities and 50,000-100,000 population.

Good luck to you in making the right decision in buying commercial property in the right cycle.