As you probably know, modern day real estate economies are cyclical and goes through cycles of suppressed market conditions, where property prices are relatively low, to expansionary conditions of unsustainable high levels. Holding an investment through an economic cycle and buying or selling at the appropriate time is the aim of most investors. However, apart from the general real estate economic cycles, there is also the property investment cycle or building life cycle. The two are not exactly the same but they are very close.
The property investment cycle looks something like the graph below. Please note, this is an investment life cycle, not a speculating or flipping cycle.
At the introduction or acquisition phase, the investor will need two sets of information to make an investment decision, namely property specific and market specific information.
Property specific information relates to the property you are planning on investing in and includes among other the extent, type and number of accommodation, quality and condition of finishes, and location to name a few.
Market specific information relates to the nature of the market the property is organised and falls into and the associated drivers of value. This is where the building life cycle becomes important. Depending on where the property is in terms of the building life cycle, it will have an influence on the value of the property and your decision to invest, wait, renovate or sell.
The building life cycle sits within the larger real estate economic cycle and interacts with it as it works its way toward expressing a value for a specific property at a specific point in time. For instance, it is not only the age of the building that matters, but comparatively the state of renewal in the area. If most of the properties in the area offer buildings of a similar age, then the value would not be that affected. However, if your property is new, or property owners in the area (including you) are renovating, or the general economic cycle is expansionary, this will positively influence the value.
The growth and maturity phase of the investment is when the property is in high demand and the area is sought after. Directly after this phase comes the decline and exit points for the investor. Optimistically, an investor should invest prior to the exponential growth phase and sell at the entering of the maturity phase; this is based purely on the income being derived from the investment. This period is not necessarily a short period. For example, the building life cycle generally in South Africa is taken at 50 years. This assumes regular maintenance intervals and the investor should forecast expenses and the replacement of functional items (lifts and air-conditioning for example) and other demands made by tenants. There is also the movement towards the greening of buildings that will need to be considered.
The motivation behind selling during the growth phase is the increased possibility of finding an investor and since the property is performing well, this positively influences your bargaining position. It does not mean necessarily that the next investor will not make a profit from the investment, it depends on his or her strategy. For instance, they might be waiting for the decline phase and invest directly into renovating and improving the property with the aim of securing a stable tenant.
The assumption is that over time, property generally increase in value, however, if you invest in a property at the peak of its maturity, you will need to wait a considerable time to justify that investment i.e. 15-20+ years. It depends on your investment strategy, this is not a fixed rule, but for the part-time investor it is perhaps more convenient to invest during the introduction phase.
Therefore, from an investment point of view, the investor will need to consider three layers of information:
- The general state of the economy, specifically the real estate economy i.e. suppressed, recovery, growing/expansionary;
- The property specific information being the technical information of the property such extent, finishes, age of the building, etc.;
- The market specific information being the building-area life cycle, new development causing shifts in demand and supply, etc.