The Real Estate Cycle

It is difficult to protect an investment that is made at too high of a price.

The real estate cycle is similar to other cycles:

1. Positive events and increased profitability lead to greater enthusiasm and optimism.
2. Improved psychology encourages increased activity, that includes doing more of “something” on the basis of rosy assumptions and paying higher prices and/or lowering standards. Taking on greater risk.
3. The combination of positive psychology and the increase in activity causes asset prices to rise, which encourages more activity, further price increases and greater risk bearing.
4. News turns less positive, the resulting price correction causes psychology to become less positive, which causes disinvestment, which puts further downward pressure on prices.

The real estate cycle can have a longer lead time due to the time it takes for construction.

Initiating projects in boom times can be a source of risk, buying them in weak times can be very profitable. People’s decisions often fail to take into account what others are doing. A lot of people make the mistake of believing in extrapolation instead of cyclicality. Meaning if prices are going up, they will continue going up for ever, instead of coming back through the cycle. The author urges readers to have a conscientious belief in the inevitability of cycles. The reasons behind successful decisions invariably are obvious in hindsight. When people use terms such as “ever increasing” it should be a red flag for the investor.