How to time the market

Everyone wants to know the best time to buy, sell or hold real estate. These charts will help you anticipate the market to maximize profit.

Chart 1


Chart updated 12/7/2012

October 2012 September 2012 October 2011
Yield spread 1.65
Home sales volume

Chart 2


Chart updated 12/7/2012

September 2012 August 2012 September 2011
Home sales volume
Average home price movement

Data courtesy of Standard & Poor’s and DataQuickThere is a 1-2 month reporting delay for all data.

These market charts are your investment planner. They tell you when a business cycle will enter a buy, sell or hold phase.

First, we review the basic factors that influence the buy, sell and hold phases. Then, we put these factors to work with examples from the Millennium Boom and recent recession. Last, these factors and the charts are narrated for a deeper understanding.

Buy, sell or wait out the market

The economy moves in cycles. The length of a cycle is determined by the extent and duration of economic excesses and recesses during the cycle.

Collectively, a recession and a financial crisis combined with zero-bound interest rates will draw out the present recovery cycle for several years beyond the norm. The current cycle from which we are emerging — 2001-2009 — had unprecedented levels of excess and recess. Further, we have less monetary and financial ability to recover quickly than at any time since the Great Depression

Each real estate market cycle can be neatly divided into three phases:

  • The Buy Phase: the ideal moment for buying property is the start of the recovery. This phase is characterized by:
    • cyclically low prices;
    • low interest rates; and
    • few willing buyers;
  • The Hold Phase: the phase following a purchase during the buy phase or a sale in the sell phase, can be the longest time period in the cycle. Prudent investors patiently bide their time, awaiting the boom or bust to play out before reentering to buy or sell; and
  • The Sell Phase: this phase commences with a peak in sales volume. It is characterized by:
    • rising prices;
    • a drastic fall in the yield spread; and
    • monthly reductions in sales volume.

The buy and sell phases each occur just once during a real estate cycle. The hold phase appears twice: once after the buy phase, and once after the sell phase.

The investor’s goal

The key to successful real estate investing is to look beyond the property’s annual operating income to the end goal: a sale. Whether on a quick flip or after a long-term buy-to-let period, the goal is to profit on a resale. That is, to sell at a price appreciated beyond the price paid and consumer inflation.

For investors to sell for a profit, they need to buy at the most opportune time — the buy phase. This is when property prices are closest to their historic mean price. [SeeChart 2]

It is rarely, if ever, possible to identify the top or bottom of a market cycle until after it has already passed. However, studied effort makes it more likely.

Anticipating prices

How can prices be anticipated? Fortunately, prices are a lagging indicator of real estate activity. Several early signs indicate an approaching price increase and the buy phase.

The yield spread is the first domino in a series of movements influencing the housing market. The yield spread, a margin of sorts, is the difference between the long-term (10-year) and short-term (3-month) Treasury rates. [See Chart 1]

The yield spread directly affects home sales volume 12 months forward. Thus, if you observe movement in the yield spread, you can successfully predict the direction of future home sales volume. Six months of consistent yield spread movement is long enough to create a trend.

Sales volume will follow in the same direction 12 months after the yield spread trend began. Until it reverses course to run with the yield spread, sales volume will continue on its previous downward or upward path.

In turn, home sales volume sets the level of prices another 12 months forward. [SeeFigure 1]

Figure 1: Phases of the real estate cycle

 Yield spread increases for 6 months (prepare for buy phase)
12 months pass from the start of the yield spread movement Home sales volume begins to increase (buy phase begins)
Sales volume increases (buy phase continues)
12 months pass from the start of the sales volume movement
Home pricing increases (buy phase continues)
Yield spread decreases for 6 months (prepare for sell phase)
12 months pass from the start of the yield spread movement
Home sales volume begins to decrease (sell phase begins)
Sales volume decreases (sell phase continues)
12 months pass from the start of the sales volume movement
Home pricing decreases (sell phase ends, hold phase begins)

The best way to demonstrate is with an example from our recent history.

1999-2002: hold phase

From 1999-2002, home sales volume declined annually even as home pricing continued its decade-long rise. The yield spread stood at an historic low, averaging 0.95 from 1999-2001. More importantly, it went negative (with short-term rates valued lower than long-term rates) for several months in early 2001. These conditions signaled an imminent recession.

When the Federal Reserve (the Fed) raises interest rates, their aim is to slow the market down. Fewer loans are made and sales volume slows within 12 months. However, the 2001 recession failed to fully materialize. It was unable to work its magic to cool the economy (and real estate prices) since the Fed prematurely bolstered the economy after September 11, 2001.

When the economy is deliberately slowed and delivers mixed signals, prudent investors hold onto their cash and their property. They neither buy nor sell.

2002-2004: buy phase

Once the yield spread initially increases for a period of roughly six months after a recession investors are to prepare for the beginning of a buy phase. This preparation includes researching location – where and what type of property will the investor buy – and price – how much they will pay.

The actual time to buy? Once the yield spread begins to waver at its peak, as in late 2001/early 2002. As can be seen in Chart 2, 2002 demonstrated upward price movement above the 2001 trough, increasing to its peak in 2005. After that, prices slipped, then plunged.

The buy phase continued from 2002 through 2004. Preferably, an investor would have bought early in 2002 and waited until 2005 to sell. This waiting game is strategic — wait too long and you may lose money. Or, sell too soon and you may receive less than the maximum return on investment (ROI).

2005-2006: sell phase

If prices have risen sufficiently for you to meet your profit goals and the economy is delivering signals that the buy period will soon end, sell. Sell periods are the shortest, quickest phases of the cycle. If you miss the window, you will have to wait several years before your goals can be met.

The briefness of the sell phase is due to public pessimism. The general public is slow to trust the market (causing slowly rising prices) and quick to get out at the slightest hint of falling prices (causing a sharp price drop). Therefore, one ignores the signs of a sell phase at one’s peril: it will be over just as soon as it began.

Real estate prices increase about 12 months after sales volume starts to drop. Prices rise beyond sustainable demand. Thus, sales volume begins to decline.

In 2005, both the peaks and low points for monthly home sales volume were lower than the previous year’s, the presage of a price drop 12 months forward. This slip in home sales volume is the clearest indicator the sell phase is ending.

Later, as in 2006-2007, the price dropped abruptly, further accelerating within a matter of months. The time for selling preceding a drop is marked by general optimism about ever-increasing prices. New buyers arrive every day, but in fewer numbers, still expecting unlimited profits on a resale. These optimists are unaware of the quicksand beneath their feet.

A savvy investor can see the dramatic fall in home prices even before sales volume decreases. As soon as the Fed increases short-term interest rates for 6 months continuously, investors must prepare to sell.

The Fed began raising rates in August of 2004. The yield spread began its precipitous fall just ten months later. It then dipped below the 1.21 spread which portends a recession some 12 month on. On schedule, home sales volume fell in mid-2005. 12 months later in 2006, again on schedule, home prices peaked and began their nosedive.

Another indicator of the time to sell is a slip in sales volume that persists for 12 months, followed by a slip in prices. This observation of reduced sales volume typically takes place while jobs and prices remain high and are rising.The rise decelerates to level out and eventually turns into a decline.

When sales volume begins to flag, sellers must be ready to list if selling is the short-term goal. Investigating price levels for comparable properties determines an appropriate listing price, and the acceptable sale price. Equally as important, an investor can use this time to locate a broker or agent who will aggressively market the property, locate a buyer and close escrow.

Real estate is local

There are, of course, variations on these themes. Real estate demand is highly localized. Thus, a thorough knowledge of local economics is necessary to accurately pinpoint the real estate phases.

Even if the yield spread is continuously increasing, pockets of high loan-to-value ratio (LTV) mortgage debt and low-income buyers may blunt any future price increases. There just isn’t sufficient buyer-occupant demand. This situation is currently observed in Riverside, San Bernardino and much of the Central Valley.

Likewise, regional employment levels can either escalate or kill the profit-making aspects of a buy phase. After all, employment is the basis for a buyer’s ability to take out a mortgage and create demand for real estate. Thus, suburban locations have their own demand issues separate from coastal areas, where job opportunities are most abundant.

If employment is rising but prices are still low, it is time to prepare for a buy phase.

This is the time to:

  • canvass your region and categorize local inventory.
  • select where to buy, whom to work with and what type of properties to purchase (size, valuation-rent);
  • investigate the local lenders and their rates, including getting pre-approved by multiple lenders; and
  • consider short- and long-term ownership objectives, including what type of property (multi-family, SFR, vacation home, etc.) will meet your goals.

To buy or sell in 2013?

Now that you understand the basics, let’s apply them to today’s housing market.

The situation:

In mid- to late-2012, the California real estate economy can best be characterized as abumpy plateau. This washboard condition has existed since early 2008 and will continue on an upward-tilting trend well into 2016. California’s real estate market is not in a state of free-fall, but neither is it evincing signs of full recovery.

As depicted in Chart 2, home sales volume has shown dramatic change from quarter to quarter, but little long-term change since 2009. Total sales in 2011 were 1.6% lower than 2010 and 12.2% below 2009. Home sales were elevated temporarily in 2009 due to effects of the government stimulus, as intended. Speculator interference in 2012 has distorted price movement, causing an unsustainable price bump.

Price bumps are often misconstrued as cycles in and of themselves. However, they are merely the result of frenzied speculator attitudes to buy low and sell high within a matter of months. These short bursts in rising prices are unpredictable. You are better off not attempting to apply the factors influencing buy and sell phases to these short periods.

How can you tell the difference between a price bump and a buy phase? Price bumps are characterized by:

  • no long-term rise in the yield spread;
  • no corresponding, long-term increase in sales volume; and
  •  unusual market factors, such as an increased speculator presence.

Home pricing remains low (though it rose in the last half of 2012), after falling from 2007-2008 and wavering from year to year. Still, prices remain above the historical mean price for this cycle.

This suggests prices must fall further, or remain level for several years. When home prices match up with mean pricing, prices will rise at the rate of consumer inflation for the next 10 years. Prices never follow the mean price trendline precisely. However, they are magnetically drawn to the mean price point, oscillating above and below. Prices will likely slip just below the trendline in 2014, bouncing to a mini-peak in 2016-2017.

Finally, the yield spread was 1.65 in October 2012, down from 2.13 one year earlier. This suggests the economy will certainly remain in recovery mode through 2013. This recovery has been and will continue to be weak, and at times even imperceptible. Still, a return to recession is now improbable.

Why? The yield spread peaked in mid-2010. It has since declined intermittently over two years under the zero-interest rate regime. The continuous decline indicates a stalled economy.

The Fed’s September 2012 announcement of further quantitative easing (QE3) came on the heels of weak jobs reports and minimal housing starts. They are related issues, with jobs coming first in priorities.

The Fed, seeing a weakening economy going forward, assured the public it would not raise short-term interest rates until at least 2015. Even then, it will not increase short-term rates unless the jobs market has greatly improved.

Many investors will properly choose to buy real estate before 2015 with the intent to flipand pull in a quick profit. These short-term investors must be watchful of the first sign of rising interest rates. Once rates rise consistently for six months, it is time to consider selling. Prices, whatever they are, will be at their cyclical highs within 12 to 18 months.

However, long-term investors will hold onto their property until a future sell phase, when home values have had more time to appreciate. Little asset appreciation will occur between now and 2015 as property prices hit their bottoms.

The continuing buy phase

Many flippers will likely sell when they see the rising price regime prior to the 2015-2016 phase of rising mortgage rates. However, conditions will most likely continue to be good for buying. Those holding out for greater profits should buy when prices slip due to the rise in rates.

This elongated buy phase will likely pick up momentum in 2016–2017. By that time, the Fed will have backed off on interest rates since sales volume will have slowed and prices will have slipped.

More significantly, the Boomer generation will begin to retire in earnest by 2018 and members of Generation Y will enter the housing market in ever greater numbers. This period will be a mini-boom, as property changes hands between Baby Boomers and the next generation of first-time homebuyers. Also, the displaced homeowners of today in some part will buy again when optimism returns.

For those who have real estate they would like to sell, all these signs suggest 2013 (and most likely 2014-2016) is a hold period. Current owners should hold their properties until increased employment creates demand (and higher prices).

Those who wish to buy may have already missed their most recent best opportunity. The buy window is not yet closed, but current speculator interference continues to disrupt the market. This speculator-driven price rise is not permanent. Still, prices will not begin to rise consistently until after they fall below their mean price level, as seen on Chart 2. Flat line home pricing for a few years would also allow the mean price to catch up.

Risk of opportunities lost

It must be emphasized, of course, that it is ultimately impossible to determine the absolute best moment to take advantage of an economic boom or crisis. Those moments only become apparent in hindsight. In this article, we have identified historical moments of opportunity. However, our forecasted ideal times to sell and buy are only informed opinions, sometimes jokingly referred to as educated guesses. Facts and data can only be derived from the past.

The actual decision of whether to buy or not depends not only on the economy — which is highly localized — but also on the specific homebuyer, and the seller’s willingness to carry paper.

The years following 2012 will not be times of untrammeled get-rich-quick investment opportunities. Nonetheless, if you have an eye for long-term market stability in real estate prices, you will be rewarded.

This is due primarily to the present zero level interest rates. With this comes the certainty mortgage rates will rise for the next couple of decades or more. Those who mean to use their home for its intended purpose—as a residence, rather than an investment —will also benefit.

Advanced forecasting: applying the charts

Chart 2 tracks three economic factors of importance to real estate investors:

  1. The average low-tier property price movement in San Francisco, San Diego, and Los Angeles. Pricing moves in response to both demand (driven by employment) and supply (known as inventory). Other influences include construction starts, loan delinquencies, lending standards and interest rates.
  2. The mean price trendline, which is the historical mean price of property at any point in time, based on the California Consumer Price Index figures published by the State Board of Equalization (SBOE). This is the underlying dollar value of property, divorced from the market’s pricing bubbles and subsequent busts, to which prices must eventually return.
  3. Home sales volume, the total number of homes sold in California from month to month. Trends in home sales set the direction for price movements approximately 12 months forward.

Chart 1 looks at the direction of real estate prices (and the economy) from a monetary perspective, through the yield spread.

The yield spread is the difference between long-term (10-year) and short-term (3-month) Treasury rates, as set by the Fed. The lower the yield spread, the greater the likelihood of a recession one year forward. Historically, when the yield spread dips below 1.21%, a recession is imminent.

The yield spread’s predictive power comes from two sources. On one hand, most recessions are created and controlled by the Fed raising short-term interest rates. On the other hand, bond market investors collectively set bond rates based on their perception of the economy’s likely future strength or weakness. Thoughtful long-term real estate investors will consider the friction created by the Fed’s short-term rate and the bond market’s long term rate to get a clearer idea of the economy’s anticipated forward performance.

Of course, everything is different when confronted with a zero-bound interest rate regime. Unlike during the past 30 years, the current yield spread decline is not due to the Fed raising short-term interest rates. Rather, the decline is a result of long-term investors’ negative perception of the economy’s performance. These investors shift investments from stocks into bonds as production of goods and services slows. (Production is slowing globally. The U.S. is the exception. Our production still grows, powered by the continually growing tech industry, improving exports and a most trusted reserve currency).

If investors believe nothing is worth investing in, the 10-year note quickly gains popularity due to its risk free value. In turn the 10-year rate falls, decreasing the yield spread between it and the 3-month rate. All this movement portends an economic slowdown. In turn, bond market confidence in the economy’s future causes the 10-year to increase, which can cause the yield spread to rise.


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