Similar to the broader economy, commercial real estate is cyclical in nature. There are four main phases to the real estate cycle:

  1. Recovery
  2. Expansion
  3. Hyper Supply
  4. Recession


Image by Glenn R. Miller, PhD.

Depicted above is a single cycle. The end of the recession phase connects to the beginning of the recovery phase to form the continuous wave pattern. The general consensus is that it takes ~18 years to move through the entire cycle.

One of the unique aspects of commercial real estate is that investors can invest successfully across all four phases of the cycle. However, understanding whether a cycle is approaching  a market peak or starting down the slippery slope towards a market low can affect a variety of factors, such as:

  • Pairing investment strategy to the market phase
  • Holding periods and exit strategies
  • Return expectations
  • Performance as it relates to income and appreciation
  • Timing of capital improvements

Understanding the progression of each phase within the cycle is critical to identify the unique investment opportunities of the moment, as well as the risks that can arise, particularly when phases are on the verge of transitioning. For instance, COVID-19 drove much of the global economy into a recession, but the mass distribution of vaccines could stimulate economic recovery. Investors must remember, however, that different aspects of the economy recover at different times.

Phase 1: Recovery

The early phase of recovery is usually near the bottom of the trough. Occupancies are likely at or near their low point with tepid demand for space and minimal leasing velocity in the early recovery stage. There is usually no new construction underway and rental rate growth is either still negative to flat or, later in the phase, possibly occurring, but at levels that are below the rate of inflation. Identifying the beginning of the recovery phase is difficult as the market still feels like it is in recession. 

Investing strategies:

  • Opportunistic: Provided you act early in the phase, there are usually opportunities to buy bargain-priced properties in varying states of distress and begin to reposition those assets as the recovery phase takes hold. Holding periods are often targeted at two to four years with a business plan that contemplates transitioning the subject acquisition out of its current state of distress and liquidating during the expansion phase once the property achieves a core-plus to value-add profile.
  • Value-add: Value-add strategies during a recovery phase require careful thought and patience. For example, while pricing may provide for a great basis in a value-add asset during the early to mid portion of a recovery phase, many real estate professionals include contingencies for execution since strong lease up may not occur until the early part of the expansion phase.
  • Core: Investing in core properties during the recovery phase can be an advantageous strategy, particularly if the targeted asset has a significant amount of lease rollover for the ensuing two to four years. A typical strategy for a core asset in a recovery phase will be to acquire a trophy asset in a “main and main” location and then capitalize on the strong rental growth of the next cycle through a combination of lease renewals and lease-up of any residual vacancy from the previous recession phase. The asset is then primely positioned to be refinanced or sold during the expansion phase.

Phase 2: Expansion

During the expansion phase, the market is on the upswing marked by the growing demand for space. From a macroeconomic perspective, GDP growth is back to normal levels and quarterly job growth is strong. Occupancy rates are improving and rents are on the rise, approaching levels that can justify new construction, and, in very tight markets, rent might surge ahead at breakneck speeds. Development activity also begins to return more readily during the expansion phase. There also is a high point during the expansion phase–the crest of the wave–where supply and demand are in equilibrium.

Investing strategies:

  • Development: Many real estate professionals consider this the opportune time to develop or redevelop properties because the demand for space often increases leasing momentum, thereby increasing occupancy and facilitating property stabilization, often at rental rates that set new market highs.
  • Core-Plus: Investors who seek lower levels of risk can consider acquiring  Core-Plus properties, which frequently enjoy high rates of tenant retention with continued rent growth.
  • Value-add: The expansion phase is generally considered to be an optimal time for value-add investing. Investors may be able to acquire properties with current deficiencies, including outdated interior finishes and common area amenities or aging mechanical (HVAC) systems and elevators, at substantial discounts to their stabilized value, invest into capital expenditures, and hopefully reposition assets, benefitting from the typical increased absorption rate characteristic of the expansion phase. 
  • Opportunistic: While most opportunistic opportunities have disappeared by the expansion phase, it may still be possible to find the exception where a capital-starved asset remains in a state of distress. In that event, an opportunistic strategy during an expansion phase can be fruitful 

Phase 3: Hypersupply

The equilibrium between supply and demand in the expansion wave often tips over into excess. Oversupply can be caused by overbuilding or a pullback in demand caused by a shift in the economy. Hypersupply is marked by rising vacancies. Rent growth may remain positive but at declining levels.

Investing Strategies:

  • Core: Some investors may decide to sell assets ahead of what they perceive as an impending decline in property values and a more challenging leasing market. At the same time, other investors may concur on the macro perspective but, instead of liquidity, seek opportunities to take shelter from the coming storm. A core property with high occupancy and credit tenants with average remaining lease terms in excess of five years is a prime example of a core property that will likely perform well through the downturn with lease roll that is optimally timed to occur during the next expansion phase.
  • Opportunistic: In the hypersupply phase, an opportunistic strategy may be more of a pricing strategy that can apply to any asset class rather than a typical distressed asset scenario. For example, once the hypersupply phase has set in, owners who are ill-equipped to operate through the impending recession, may hit the panic button and liquidate assets at recession-level prices. In this scenario, the buyer leverages their cash reserve to acquire a solid asset that he/she is confident will ultimately perform well in the next cycle with a recession phase already priced into the deal.

Phase 4: Recession

In a recession, supply outweighs demand, which produces higher vacancies. Rent growth during a recession is either negative or at levels that are below the rate of inflation. In addition, operators often resort to offering more concessions and rent reductions to entice and retain tenants.

Investing strategies:

  • Opportunistic: This is an ideal time to buy distressed assets at steep discounts to replacement costs. Generally,  recession-phase buyers have the highest probability of acquiring assets in distressed scenarios such as those owned or managed by special services or subject to lender foreclosure. This strategy relies on a patient and well-capitalized business plan that, when the recovery phase emerges and the sun begins to shine again, the buyer will be able to reposition the asset with hopes of disposing of it during the end of the recovery phase or early expansion phase.

It’s also important to understand the phases do not necessarily occur in equal periods. The recovery phase may be brief and quickly transition to the expansion phase, or it may drag on for years. It’s also difficult to project the duration of expansion phases. 

Cycles can also vary depending on geography and asset class. Certain markets, like growing secondary markets, may lead the transition from recession to recovery while other markets lag. Furthermore, different asset classes recover, expand, oversupply, and decline at different rates. For example, the office asset class may be in a hypersupply phase in a given market, suburban office assets may recover as companies move out of a city’s core in search of more space at lower costs. Therefore, when thinking through the four phases of the real estate cycle, real estate investors typically want to pair a specific asset with its geographic location and the overall health of the asset class to truly gain a sense of where it sits inside the cycle wave.