The Garrison Cycle of Real Estate Economics

Are there any good deals left anymore?

What would you give to buy properties right now between $15,000 to $35,000 per unit that have a stronger positive cash flow than if you paid between $60,000 to $100,000 per unit? The traditional dilemma in residential investment grade real estate has always been - should I buy for appreciation or cash flow? At NAREI we refuse to buy a property that doesn’t have both.

During Graduate school my discovery of the Fifth Migration led me to a new way of looking at all real estate markets. After developing my theory of the Fifth Migration I chose ten real estate markets that represented everything in the spectrum from the highest job growth statistics to the highest job loss areas. I was looking for an actual model that I could use to identify the economic health of each unique market. Also, I was looking for a definition and an explanation of how I could make money in any market. In addition, I was trying to identify the most profitable time to buy in a region of opportunity and when to sell before that market became a region of obsolescence.

Over a period of almost a year of study I found that all real estate markets are without exception in one of four market cycle stages. I defined those stages as -

- Expansion
- Equilibrium
- Decline
- Absorption

I saw this circular economic cycle as the answer to and the explanation of why my real estate investing profits had hit a brick wall in the mid 1980’s. I had been investing successfully in an appreciation expansionary market that had quickly transitioned straight through equilibrium and was now in a free-fall decline due to the job cuts and the local governmental anti-business policies and practices.

All of this research more than made sense theoretically - but did it work in actual real estate markets?

To solve that question I had defined each of the four economic stages as noted above. I then proceeded to make a plan to perfect my initial research. During the next year I would leave academia and focus on perfecting the analysis of an investment area and timing signals to maximize real estate investing profits. I used different markets that represented my interpretation of one of the four cycle stages for real estate. I chose one expansion market, one equilibrium market, one decline market and one absorption market to work in.

Little did I know then that the understanding of this circular cycle of real estate economics would essentially reduce my risk in real estate investing and guarantee me profits on every transaction.

No longer would I be subject to the whims of my local real estate investment market, job cuts, rent control, or governmental policies and practices. Of course I would as with any real estate acquisition protect my investments with proper property insurance. Also, I would make sure that my investments were placed in an asset that wasn’t paper such as the stock market. The bottom line is that I knew that people would always need a place to live. I set out with confidence. If you can master these economic realities you can have that same confidence to proceed in your real estate investments. Your profits can be predictable again. You can be in control.

Areas of the country were and are booming and through your understanding of the Fifth Migration and the Garrison Cycle you will be able to continue to make a real estate investing financially profitable.

The cycle stages are as follows. First of all, every market begins in Expansion.

Phase 1 - Expansion

As I entered into the expansion market I noticed that demand structures due to the new job growth forced the absorption of all available housing. A market at the beginning of absorption could typically have as mach as a 25% vacancy rate. However, new professional job growth and the accompanying ripple effect in the service sector would quickly absorb all of the vacant rental property.

This certainly made sense. For example, if you add 129,000 new professional jobs into a market like Dallas , Texas there would instantly be an incredible demand in the service sector. More workers would be needed in fast food, banks, gas station employees, UPS drivers, hospitals, even local governmental agencies. In real estate economics that ripple effect is approximately 4.2 new service sector jobs for every new professional job. So in reality you were not just looking at 129,000 new jobs for that area but you were actually looking at about 600,000 total jobs.

I also learned that as a market absorbed the residential rental rates soared. As I continued my research I saw markets in where the rents had risen as much as 200% in two years. I have even seen rental rates go even higher in some markets over the years. The Landlords aren’t stupid but sometimes they are slow to react. Often information transfers very slowly in the real estate investment community.

I noticed that in each expansionary market the property owners had lived through some very dark days - typically during the previous decade. During that time there were not a lot of buyers for their real estate. As well, tenants (good ones) were is short supply.

I also realized that unbeknownst to the typical landlord the new professional job growth and the ancillary ripple effect in the service sector would completely change the picture for their local market.

I definitely saw incredible opportunity for investors.

A great example would be Salt Lake City , Utah , in 1988. Property prices had been stagnant for years. The good Landlords had been lucky just to keep their units filled. When we first started investing in Salt Lake City it was just starting to absorb. Absorption is the most profitable economic cycle stage for the real estate investor.

At that time in SLC there was a minimum new job forecast in excess of 85,000. Remember this number is actually combined with the ripple effect in the service sector and that employment forecast would be approximately 400,000 new jobs.

I had completed the market analysis research. When NAREI first started buying in SLC the rental market was about 18% vacant. When NAREI started investing in SLC the local real estate investors and real estate professionals thought that we were completely crazy. We were but crazy like a fox.

Before we started investing NAREI knew about the companies that were relocating to SLC from the more expensive areas of the country. It really was like fishing in a stocked pond. We were able to made rock bottom offers and were able to get many of them accepted without any additional negotiation. The sellers actually felt they were lucky to just dump their real estate that had been lagging for years. I remember on one particular rental property a NAREI investor bought the previous owner was getting only $185.00 rent per month for a two bedroom apartment. Within 18 months of buying that residential income property the investor was getting $650 for the same unit. This was just simply a function of supply and demand. The housing market actually became so tight that a city ordinance was passed that you could convert your garage into a rental unit! Consider the great demand on rental property from the service sector arriving into an area and in great need of basic housing.

In addition, for a developer to secure construction financing they have to prove to a lender the financial viability of a project. That means that if you build a residential income property you are going to have to have a positive cash flow. Rents had to go up almost 300% in SLC before any new construction would be feasible via traditional financing.

Crazy?

Rents at the time were so low that bankers did not feel confident about giving a new construction loan on a piece of residential income property. Also, as the demand for rental properties increased the landlords could put an ad in the paper and would get 75 phone calls from potential tenants. Soon, the landlords began to figure things out economically. At this point the rental rates in SLC began to skyrocket.

Let me tell you about Steve and Eric, two brothers from Southern California who were NAREI students and went on a BuyingTour to Salt Lake City . We taught them about the Fifth Migration, the Garrison Cycle and all of the essential tools for investing wisely in real estate today.

Their first real estate investment was a small residential income property. In less than two years that small rental property not only produced a positive cash flow every month but it also appreciated to the point where they sold it for a $170,000 profit. The SLC market had transitioned from the absorption stage into the expansion stage.

In these expansion markets there is an incredible job growth transition.

The expansion stage of the Garrison Cycle of real estate economics is depicted by new construction. In simplistic terms, supply catches up to and (in most cases) exceeds the original demand. Because of the growth that places heavy demand on materials and labor, this stage is also depicted as an inflationary phase. We found that it is a great time to be a seller early on in this stage of the cycle. The bottom line definition for an expansion market is that rents have risen high enough to justify to a banker a new construction loan to a developer of residential income properties.

Phase 2 - Equilibrium

As the demand pushes new construction in the expansion stage the cost of housing dramatically rises. Note that the value of any property is a function (product) of its ability to earn income, replacement cost, and comparison of recent sales of comparable properties. However, when you buy a property in the absorption stage the replacement costs and comparable sales are thrown out the window. During this time your focus is almost entirely on the ability of a specific property and the potential income produced from it. Remember that the beginning rental rates in absorption markets do not justify replacement cost. There also are typically no comparable sales.

It is your understanding of job growth trends that will allow you to purchase with confidence. Understanding that a property boom is just beginning to happen is like the frosting on a cake. Remember you do not purchase based on speculation. You want to buy only at prices below the market value with payments structured to give you an instant positive cash flow after all operating expenses.

Through economic application real estate investing can make you a fortune.

The new job growth that is the catalyst for the demand continues until the cost of housing reduces the incentive that a company has to relocate to a given market. In economic terms, the market imperfection or “low housing price” incentive disappears because of the very same demand that it attracted in the first place. At NAREI we have watched this happen in market after market after market.

Buying properties at the cycle stage before the expansion (absorption) becomes apparent as the only viable approach today for earning explosive real estate profits. Being able to evaluate market timing is really everything for today’s successful real estate investor. At NAREI we will teach you how to identify market stages so you can sell when you will get the best return on your investment. NAREI BuyingTour students stay on top of market changes to assist them in their own investment plan.

An equilibrium market is a perfected market where new job growth and residential income property appreciation have slowed to national averages. In an equilibrium market buyers are looking for deep discounts on the purchase of real estate investments because they realize that the current property price appreciation will barely beat what they could do on their own with investing their money in a normal passbook savings account.

Phase 3 - Decline

The previous market phase is characterized as a period of high prices and as a natural consequence the market becomes less attractive to businesses looking to relocate or even expand. As well, during the equilibrium stage typically local and state governments become increasingly anti-business. Confidant in their economic base they make serious mistakes as far as corporations are concerned. This “lack of humility” is easily apparent in California and most other traditional major market areas. During the latter stages of equilibrium many jobs are lost to other domestic and foreign markets who are aggressively seeking businesses to relocate there due to the high cost of living in the equilibrium markets. With the jobs moving and the predictable over building the atmosphere in equilibrium market changes from serene to the beginning of decline. This change occurs as there is far more supply available than the demand. This reality results in declining occupancy levels, rents and overall property values, and as well all of the new construction of residential income properties.

This negative attitude or group based “psychological hysteria” of a down market feeds upon itself. To the owner of a residential income property in a decline market there seems to be no hope or way out of what at one point looked like a great investment. Owners tend to feel if only they had sold years before while their market was filled with buyers. Little did the owners know that their market at the time was in the expansionary stage of the Garrison Cycle of real estate economics. Hindsight certainly is 20/20.

Phase 4 - Absorption

The previous phase of the Garrison cycle was characterized by declining property values after over building from new construction - this stage of the economic cycle offers a lower cost of housing than the national averages with an extremely pro-business climate. The low cost of living and with lower costs for operating businesses is the foundation of an absorption market. Combine this formula with new local or regional governmental incentives offered to businesses looking to expand and / or relocate is like throwing gasoline on dry wood. When struck with a match it simply explodes! This same principle applies in absorption markets as the economy starts adding jobs - which will then translate to increased property demand – which will increase occupancy levels – finally rental rates soar and property values skyrocket. Investing early on in this stage of the Garrison Cycle is like real estate insider trading. You are investing in an area with the knowledge of an economic boom in the near future.

Brad came with NAREI on a BuyingTour when Kansas City , Missouri had just started to recover from its decline. The minimum new professional job growth estimates were well above 50,000 translating into approximately a quarter million new jobs when you factor in the ripple effect from the service sector. Brad invested into several properties using our nothing down and low down payment techniques for absorption markets. On just one of his buildings he made enough money to completely pay off his family farm in Nebraska

John from New York State also came with us into Kansas City , Missouri . John is still investing in Kansas City as we write this. He e-mailed us today that he had just bought a duplex for $26,500 with nothing down. He estimates that he will put $9,000 into it for rehab. When the repairs are completed his market analysis (and we will teach you how to do the same) projects that he will have two rental units that will generate a $750 per month positive cash flow. He will also have a property that he can sell in that market for in excess of a $30,000 profit. John is a young man. He is a born again real estate investor since we rescued him from wage slavery. He has invested with us in several absorption markets now.

As you get more and more involved in real estate investing you will come to realize how incredibly nice and friendly most real estate investors are. They are down to earth real people who are not looking for handouts. They are willing to learn. Successful real estate investors are humble and teachable. They don’t know it all. However, they will listen, learn, and then dig in and work hard.

If you are that kind of person we would love to get to know you. Make sure and fill out the free membership form and start learning the incredible methods NAREI InnerCircle members use. Feel free to call NAREI’s office at (480) 813-6043 if you have any questions or would like to become a member of NAREI’s InnerCircle.

At NAREI, we welcome your comments and would love to have you join our InnerCircle and have access to NAREI mentors who have extensive experience and are available to speak directly with you. They know how to make money in today’s absorption markets. If you are a beginning investor you really need to learn to walk before you can run. We would encourage you to first determine the exact stage of the Garrison Cycle that your backyard investing area is in.

Once you have mastered some of the basics of real estate investing you should begin your research of absorption markets. These markets are where the truly incredible real estate profits are to be made because of the job growth that fuels the population increases which support increased occupancy and rental rates.

NAREI, since 1986 has worked in absorption markets with our BuyingTour students.