How to Use Real Estate Trends to Predict the Next Housing Bubble

Faculty Insight

Teo Nicolais

President, Nicolais, LLC

Nicolais is a real estate entrepreneur who teaches courses on real estate principles, markets, and finance at Harvard Extension School. He helped design the Real Estate Investment Certificate.

The next major bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war.” 
— Fred E. Foldvary (1997)

The destructive wave that swept across the US economy in 2008 seemed to catch the world completely by surprise. The phrase so often used to describe it, a “financial tsunami,” reinforces the popular belief that the disaster arose suddenly.

In reality the build up to the Great Recession could be clearly tracked and its timing predicted with a stunning degree of accuracy long before the phrase “collateralized debt obligation” entered the popular lexicon.

The real cause of the crisis is far older, far more interesting, and far more profitable to understand for those interested in what lies ahead.

As early as 1876, Henry George observed the curious cycle through which real estate markets inexorably move. His findings can be summarized (with the help of Glenn R. Mueller’s refinements) as follows.

A graph from Mueller's book shows the market quadrants

Phase I: Recovery

We know the characteristics of a recession: high unemployment; decreased consumption; and decreased company investment in buildings, factories, and machines. The price of land, essential for economic activity, is at its lowest point in the cycle.

As population increases so does the demand for goods and services. This expansion is typically hastened by government intervention in the form of lowered interest rates (the key ingredient for investment).

With increasing demand and lower investment costs, companies expand their businesses. They hire more people, build new factories, and buy more machines. This expansion adds to the demand for land (buildings) on which the economic activity can take place.

Vacancy across all real estate asset classes (office, retail, residential, etc.) decreases as companies use previously empty buildings and individuals move into previously vacant homes.

Phase II: Expansion

The transition from recovery to expansion occurs when companies and individuals have bought up or rented most of the available buildings. Occupancy begins to exceed the long-term average. As unoccupied buildings become scarce, landowners raise rents.

This graph shows the phases of recovery and expansion

Since most real estate expenses are fixed, increased revenues translate almost dollar-for-dollar into increased profits. Increased profits attract new development of vacant land or redevelopment of existing properties.

Basic economics tells us that new supply will satisfy demand and eliminate the upward pressure on rents and land prices accordingly. But here’s the twist: it takes a long time to add new inventory to the real estate market once it’s needed.

Market studies must be undertaken. Land sales must be negotiated. Zoning and permitting must be obtained. Financing for the project must be found (no easy feat coming out of a recession). Only then does new construction begin. And the construction itself takes a long time (two to five years for the average development).

By the time meaningful amounts of inventory start to come online, the overall economic expansion has been under way—without the benefit of new supply—for five to seven years. During all of that time, occupancy rates and rents have been increasing.

In fact, the cycle reaches a point at which rents are not simply going up—they are going up faster and faster (rent growth is accelerating). Investors build this trend into their forecasts. And we reach that critical point in the real estate cycle where, as William Newman documented as far back as 1935, the price of land begins to reflect not the existing market conditions but rather the anticipated rent growth to come.

Investors, believing the price is justified by the future growth, overpay for the land relative to the current market, and start building for a future market. The boom is officially on.

Phase III: Hyper Supply

As long as the current occupancy rate exceeds the long-term average, there will be upward pressure on rents. As long as there is upward pressure on rents, new construction is financially feasible. This is the case for both the expansion and hyper-supply phases.

The First Indicator of Trouble

The delineation point between expansion and market hyper supply is marked by the first indicator of trouble in the real estate cycle: an increase in unsold inventory/vacancy.

A line graph showing the characteristics of the expansion to hyper supply phases

This occurs as new completions from the mid-expansion phase begin to quench the market’s thirst for product. With occupancy rates above the long-term average, rents are still rising but the rate at which they are rising now changes: rent growth is no longer accelerating, but rather decelerating.

This is a precarious time in the real estate cycle. And what happens next will determine how severe the upcoming recession will be.

Wise developers, noting the change in direction of rent growth and factoring in the likely consequence of units currently under construction being completed, should choose to stop building. If you find such a developer, please let me know.

Phase 4: Recession

The Second Indicator of Trouble

The transition from hyper supply to recession is marked by the second indicator of trouble in the cycle: occupancy falls below the long-term average.

New construction stops, but projects started in the hyper-supply phase continue to be delivered. The addition of surplus inventory leads to lower occupancy and lower rents, which significantly reduces revenue for landowners.

A line chart that shows the transition from hyper supply to recession

The Third Indicator of Trouble

Finally, investors must watch for the third indicator of trouble: an increase in interest rates.

The increases in prices throughout the broader economy that accompanied the expansion and hyper-supply phase will, sooner or later, force the Federal Reserve to fight inflation by increasing interest rates.

The good news is that this halts any developers still forging ahead in hyper-supply mode because the increase in borrowing costs makes new developments financially unfeasible.

The bad news is that it’s too late for the projects started in the midst of the boom. The music stopped, but there are still people rushing toward the dance floor.

The combination of lower occupancy, lower rent received on those occupied units, and increased interest expenses (a large fixed cost) quickly erodes landowners’ profits.

There are broader issues from the shutdown of the economy’s largest growth engine (new construction), but that is for another discussion. Suffice it to say, the downturn in the Real Estate market has a huge impact on the economy as a whole which, in turn, pushes the Real Estate market down further.

Vacancy stalks landowners and, as revenues fall below landowners’ fixed costs, foreclosures follow. The real estate cycle comes full circle and, as Foldvary (2007) notes, “shrewd investors pick up real estate bargains.”

The Duration and Frequency of the Real Estate Cycle

Perhaps the most stunning aspect of the real estate cycle is not its inevitability but rather its regularity. Economist Homer Hoyt, through a detailed study of the Chicago and broader US real estate markets, found that the real estate cycle has run its course according to a steady 18-year rhythm since 1800.

Table that shows the cycle of peaks in land values, construction, and business from 1818 to 2008.

With just two exceptions (World War II and the mid-cycle peak created by the Federal Reserve’s doubling of interest rates in 1979), the cycle has maintained its remarkable regularity even in the decades after Hoyt’s observation.

Where are we now?

It’s important to remember that the Great Recession was not caused by an unexpected event. To those who study the real estate cycle, the crash happened precisely on schedule. It was painful, but it inaugurated the next iteration of the real estate cycle.

Today, most real estate markets are well into the expansion phase. Many, as indicated by skylines filled with cranes and slowing rent growth, have already entered the hyper supply phase. 

Those who study the financial crisis of 2008 will (we hope) always be weary of the next major crash. If George, Harrison, and Foldvary are right, however, that won’t happen until after the next peak around 2024.  

Between now and then, aside from the occasional slow down and inevitable market hiccups, the real estate industry is likely to enjoy a long period of expansion.

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Barry Kainth (not verified) replied:

Excellent Article.

October 20, 201611:15am

Jimmy Clark (not verified) replied:

I believe that the 2024 prediction is quickly becoming inaccurate for the next real estate peak. Just three years after this article was written we are seeing the very economies such as oil and gas that brought us out of the 2008 recession affecting other industries. I believe that we have moved to number 10 on your Real Estate Cycle chart and that a peak will be much close to 2017-2018.

October 22, 20161:17pm

Cristie Connors (not verified) replied:

We are now 1/2 way through 2017 and still in hyper growth mode. In the major metropolitan areas buying a home is nearly impossible unless you over bid and homes are selling in a few hours or days.

May 14, 20176:31pm

King Vid (not verified) replied:

Since when does the end of a real estate cycle enable the collapse of the financial markets? Your ego aside, the result of the financial collapse was clearly brought on by excessive risk in the real estate markets. You can argue the risk was brought on because banks figured the real estate cycle was ending anyway, so why not make a bundle on it. But the resulting "Great Recession", was mainly a function of the horrific CDO and CMO inputs.

October 22, 20165:22pm

hogwild (not verified) replied:

now that the economy is rigged more than ever you can cut that in half...

October 28, 201612:50am

Tampa Commercia... (not verified) replied:

I enjoyed very much reading your blog. I think it's very informative. People interested in real estate should read this. Anyway, we also have a blog and I am the blogger at and I will include your blog as well in our archived blogs. Thank you for your consideration to approved my comment and we will link back to you as well

November 15, 201610:48am

Buruxa (not verified) replied:

This is a very interesting article. Thank you for sharing your findings.

November 20, 20162:44am

Mo (not verified) replied:

Or we could be at the peak of the largest, world wide debt bubble in human history (WINTER 2016). LOOK OUT BELOW!

December 13, 20169:36am

Terry Bogart (not verified) replied:

Although this is true there is also another cycle equally as important. Which is replacement cost, if you buy way under replacement cost you can typically stay in front of the game. Just remember the important things the direction of growth, location location location. Buy where people want to be not where they go just because it's affordable.

December 21, 20161:16pm

Zody (not verified) replied:

I have been watching the phases of real estate for the last 7 years and the predictions were right. May be I need to be ready to sell my properties by 2022, if they increased by 30% or more.

December 27, 20169:59pm

Nazrul (not verified) replied:

This has made the most amount of sense of all the articles I have read recently. Thanks Harvard!

January 5, 20177:22pm

David Teitelman (not verified) replied:

Prediction of 2024 realestate bubble is a long way off. But if we're still in an expansion phase, the 2017 markets should roar: Especially the lagging small caps. Defence stocks are immuned to market crysis.

January 14, 20173:05pm

Michael Brooks (not verified) replied:

Very good insight to identify sliding scale trends.

January 27, 20171:25pm

Tough Patrick (not verified) replied:

HOWEVER; If the average individual is saving for a home and taking this info as some sort of guideline where deals will be swept up when the "bubble" bursts, they are going to be screwed. When RE continues to "appreciate" at 3-5%, it would be much cheaper to buy a 400k home NOW then to wait when the bubble bursts in 2024 when that same house is 900k then drops to 575K at a 6% fixed rate. Kinda useless info.

February 11, 20172:02pm

Christophe (not verified) replied:

So, where are we now? 2017 coming to an end, sales have nationally flattened due to lack of inventory, pricing exceeding incomes, NAR press saying adjustment to "roaring 2017" will actually show less than 2016. Love the article, extremely helpful.

November 5, 201711:54am

KearyD (not verified) replied:

The regularity of the cycle is before the end of sound money and the finacialization of the housing market with mortgage backed securities (MBS).

December 28, 20175:51am

SPcommercial (not verified) replied:

Informative blog . Thank you for sharing with us........

January 3, 201811:43pm

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