Pyhrr 1999

Journal of Real Estate Research
ISSN: 0896-5803 (Print) 2691-1175 (Online) Journal homepage: https://www.tandfonline.com/loi/rjer20
Real Estate Cycles and Their Strategic Implications

for Investors and Portfolio Managers in the Global
Economy
Stephen Pyhrr, Stephen Roulac & Waldo Born
To cite this article: Stephen Pyhrr, Stephen Roulac & Waldo Born (1999) Real Estate Cycles and
Their Strategic Implications for Investors and Portfolio Managers in the Global Economy, Journal of
Real Estate Research, 18:1, 7-68, DOI: 10.1080/10835547.1999.12090986
To link to this article: https://doi.org/10.1080/10835547.1999.12090986
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JOURNAL OF REAL ESTATE RESEARCH
Real Estate Cycles and Stephen A. Pyhrr*

Stephen E. Roulac**
Their Strategic Waldo L. Born***
Implications for Investors
and Portfolio Managers
in the Global Economy
Abstract. This study synthesizes relevant research and commentary on real estate cycles
in a micro-decision-making context and discusses their strategic implications for investors
and portfolio managers. It begins with an extensive review of the macro-economic, micro-
economic and practitioner literature on cycles, with special emphasis given to the
emerging topic of global real estate cycles.
The second major section of the study presents the basic theory of cycles, examines
the nature and dynamics of real estate cycles, identifies the many different types of
interdependent cycles that affect real estate performance and presents strategies for
dealing with multiple interrelated cycles. Understanding the complex and dynamic
macro-to-micro cycle relationships is believed to be the foundation for understanding real
property performance in a specific market, submarket and site-specific location.
Successful cycle strategies that achieve above-market returns over the long run are
dependent on this understanding, good market timing and a degree of contrarianism.
Eight cycle models are presented in the third major section of the study. Each presents
an analytical definition of cycles, seeks to measure cyclical impacts on key investment
variables in an ex ante framework and provides insight into some aspect of investment
timing or other property / portfolio decisions. The final major topics addressed are the
key strategic and decision implications for investors and portfolio managers, and a
proposed cycles research agenda for the future.
Introduction
Real estate cycles have been a significant underlying reason for the financial successes
and failures of real estate investments throughout history. Cycles are a major
determinant of success or failure because of their pervasive and dynamic impacts on
real estate returns, risks and investment values over time—impacts that should not be
ignored or over-simplified. Because of this recognition, as well as a growing industry
focus on real estate as a distinct asset class that deserves increased portfolio
allocations, investors and portfolio managers are placing increased emphasis on the
*SynerMark Investments, Inc., Austin, Texas 78731 or spyhrr@synermark.com.

**The Roulac Group, San Rafael, CA 94901-3202 or sroulac@roulac.com.
***Eastern Illinois University, Charleston, IL 61920 or cfwlb@eiu.edu.
7
8 JOURNAL OF REAL ESTATE RESEARCH
strategic and decision-making implications of real estate cycle theory and analysis
(Roulac, 1996).
The concept and importance of real estate cycles was central to the early land
economics work of Homer Hoyt in the 1930s (Hoyt, 1933), which represents the
foundation for the urban land economics discipline, and which later evolved into the
real estate finance and then real estate investment disciplines. Even prior to Hoyt’s
work, Wesley Mitchell established the theoretical foundation for and empirical
evidence of cyclical economic activity in the United States (Mitchell, 1927), and a
strong body of knowledge developed on the subject of business cycles over the next
fifty years. However, despite its early importance in the general business and land
economics literature, real estate cycles have been largely ignored or discounted by
real estate academics and practitioners until recent years.
In recent years, an intense interest in the subject of market and property cycles has
developed among real estate academics and industry researchers and decision makers,
as evidenced by the rapidly expanding academic body of knowledge on the subject
and the inclusion of cycle references and analysis in a wide variety of proprietary
industry publications. This growing body of knowledge can be measured by the
number of articles appearing in the real estate literature, as well as paper and panel
sessions at annual meetings of organizations such as the American Real Estate Society
(ARES), the International Real Estate Society (IRES), the European Real Estate
Society (ERES), the Asian Real Estate Society (AsRES) and the Pacific Rim Real
Estate Society (PRRES). One example of the growing recognition of the important
role of real estate cycles is the observation by the recently merged Equitable Real
Estate and Yarmouth pension fund advisory groups (representing assets worldwide in
excess of $40 billion) from their publication Emerging Trends in Real Estate 1998:
‘‘Today’s real estate investors have literally emerged from the Dark Ages. They’re
better positioned to gauge cycles, and can move more rapidly to take advantage. Real
estate has always been a cyclical business, but you were always looking through a
rear-view mirror trying to figure out what was going on. That’s not true today.’’1
Purpose of Study
The purpose of this study is to synthesize relevant research and commentary on real
estate cycles in a micro-decision-making context, including a review of cycle
literature, theory and financial modeling, and to discuss their strategic implications
for investors and portfolio managers. While limited research studies are currently
available on real estate cycles in a global decision-making context, researchers are
focusing more attention on global cycle considerations because of increasing
commitments by investors to real estate in other countries. Also, researchers and
investors recognize that investment and portfolio returns and risks are increasingly
being influenced by international economic events and flows of investment funds.
Special emphasis is therefore given to the emerging topic of global real estate cycles.
We devote a substantial early section of the study to a fairly exhaustive review of the
macro, micro and practitioner literature on real estate cycles.2 We offer this review
VOLUME 18, NUMBER 1, 1999

REAL ESTATE CYCLES AND THEIR STRATEGIC IMPLICATIONS 9
for three reasons: (1) it has not been done previously; (2) it reveals the growing but
fragmented body of knowledge on cycles and suggests an opportunity for researchers
to develop a cohesive theoretical and analytical framework for evaluation of cycles;
and (3) it provides academics and practitioners with a basic body of knowledge
summary and reference list for future research on the subject, whether that research
is macro or micro, theoretical or empirical, or analytical or anecdotal in nature.
The Relevancy of Cycles

To provide a context for consideration of real estate cycles it is helpful to recognize
that cycles in nature are everywhere and interdependent. Among the dynamic cyclic
patterns that have repeating and predictable behavior are a quartz watch crystal
vibrating 10 billion times a second, an Ice Age every 100,000 years, the Milky Way
spinning on its axis every 200 million years, as well as the sunrise, sunset, the new
moon, the full moon, high tide, low tide, heartbeat and seasons. Other cycles that
occur in the same place, and occur again and again, but do not recur in any set time
period include earthquakes, floods and forest fires (Miller, 1997).
Comprehension of cycles, specifically understanding, planning for and exploiting

predictable cycles concerning the food supply, was central to the emergence of hunting
and gathering societies and their location decisions. Basic, then, is to understand that
‘‘a cycle is a sequence of events that repeat,’’ (Miller, 1997). Consequently, the
capacity to perceive events as susceptible to repetition as opposed to being isolated,
random and non-recurring is crucial to coping with nature, political economy, business
and investing.
With growing contemporary interest in both history and futurism, reflected by an

interest to learn lessons of the past and comprehend the implications of change, cycles
are central to effective functioning in a contemporary world. Indeed, cycles are basic
to such diverse involvement as surfing—the tide cycle; dairy farmer—weather,
seasonal milk production and daily milking; and music—coherence, rhythm, the tonal
system cycle from rest to complexity to return to rest (Kaufman, 1997).
Cycle impacts from space (the solar system), the Earth’s atmosphere and the Earth
itself are manifested as forces that affect the physical environment in which we live.
Changes in the physical environment, in turn, affect human behavior and economic
activity. Human behavior and economic activity affect supply and demand forces in
the real estate markets, which in turn affect the financial performance of properties
through changes in rents, vacancy rates, operating and capital expenses and
capitalization rates. Changes in financial performance, which are caused by these
external forces, are measured through rate of return and risk analysis, which are the
key parameters that determine rational investment decisions. Now, if most or all of
the physical forces from the solar system to Earth to our immediate physical
environment are cyclical, then it is logical that property performance is also cyclical.
It is our belief that understanding the complex macro-to-micro cycle relationships and
‘‘linkages’’ described above is the foundation for understanding real estate property
performance in a specific market, submarket and location. Thus, cycles at every level
should be studied and modeled, and the resulting information used for making better
investment decisions. These beliefs, however, are not universally held by our real
estate and finance contemporaries.
Not surprisingly, there are two schools of thought on the question ‘‘Are real estate
cycles relevant?’’ The ‘‘first school’’ argues that real estate cycles are not relevant and
therefore can be ignored; the ‘‘second school’’ argues that real estate cycles are very
relevant and should be carefully studied by analysts and investors. By relevant, we
mean that an investor or portfolio manager can use the theory and knowledge of cycles
to make better decisions that result in greater wealth over the long run.
The Case for Ignoring Cycles

Over the past twenty-five years of research on the subject, authors have recounted
numerous reasons for and arguments on the irrelevancy of cycles. As recent as the
late 1980s, it was not uncommon to hear a finance professor dismiss the concept of
real estate cycles as a research topic and decision variable, and suggest that research
on the subject was misguided. Support for these assertions is based on fundamental
concepts embodied in the efficient market hypothesis.3 Also, valuation theorists and
appraisers have historically ignored cycles in their valuation frameworks and models
(Born and Pyhrr, 1994; and Pyhrr, Born, Robinson and Lucas, 1996). Sixteen reasons
and arguments that real estate cycles are not relevant, or can be ignored, are
summarized in Exhibit 1.
While these arguments continue to be prevalent among ‘‘first school’’ advocates, the
thought leadership of the real estate discipline has steadily shifted its allegiance to
the ‘‘second school’’ of thought: the belief that real estate cycles are relevant, have
significant and measurable impacts on investment returns and risks, and therefore have
important strategic implications for investors. The ‘‘preponderance of evidence’’ cited
by these ‘‘second school’’ cycle advocates can be placed into three categories:
macroeconomic, microeconomic and practitioner.
Distinction between Macroeconomic and Microeconomic Literature

A wide variety of ‘‘macro’’ and ‘‘micro’’ real estate cycle topics are addressed in the
literature presented in this article. Macroeconomic cycle studies are defined here as
those whose primary cycle focus or emphasis is at the national, international or
regional levels. The general business cycle, inflation cycles, currency cycles,
population and employment cycles, and technology cycles are examples of cycles that
are generally classified under the macroeconomic category. Demand (absorption)
cycles, supply (construction) cycles, occupancy cycles, long cycles and short cycles,
when studied at the regional or national levels, are also considered macroeconomic
for classification purposes.
In contrast, microeconomic cycle studies are defined as those whose primary cycle
focus or emphasis is at the metropolitan area market, submarket or property location

Exhibit 1
Reasons Why Real Estate Cycles Are Not Relevant or Can Be Ignored
1. Little academic interest in cycles: Not many academics are interested in conducting research
on real estate cycles; therefore, cycles must not be very relevant.
2. Financial theory does not address cycles: Modern financial and portfolio theory does not ex-
plicitly address cycles; therefore, cycles must not be very important.
3. Cycles cannot be measured: If there is such a thing as a cycle, one cannot measure it, or
determine where one is in the cycle, or forecast where the cycle is going. Statistical research
cannot validate the presence of cycles.
4. Economic forces are random: The economic forces that are perceived to create or represent
cycles are random in nature, thus cannot be forecast or modeled.
5. Real estate markets are efficient: Therefore, knowledge about cycles cannot be used to increase
the returns of a portfolio (or reduce risk), if the portfolio is properly diversified to begin with.
6. Diversification eliminates cycle effects: With a large portfolio, a manager can diversify away
the effects of cycles through good property type and geographic diversification; therefore a
portfolio manager can largely ignore them.
7. Long-hold approach eliminates cycle effects: Many investors, especially institutions such as
pension funds and Life Insurance companies, are patient investors that ignore short-term mar-
ket cycles.
8. Cycle strategy gains are offset by costs: If there are increased returns from ‘‘playing the cycle,’’
any potential extra gains will be eliminated because of the additional information and trans-
action costs and risks associated with turning over properties in the portfolio.
9. Lack of evidence about economic cycle impacts: Little is known about the effects of economic
cycles on cash flow variables—rents, vacancy rates, operating and capital expenses, capitali-
zation rates.
10. Cycle model specification is difficult: Accurate specification of analytical models that explicitly
consider cycles and their impact on investment returns / risks is difficult or impossible.
11. Inadequate data: Adequate and accurate market and financial data needed for inputs into a
cycle model are not available.
12. Lack of investor interest in cycles: There is no evidence that investors use cycle forecasts in
their investment decision making or strategies.
13. Simplicity and lower cost of trend analysis: Traditional DCF models that input constant rent
and expense increases over the analysis period are easy to use, inexpensive and have become
the market standard among individuals and institutions.
14. Tradition: Since cycles have not been considered a relevant decision variable in the past, they
can be ignored in the future; traditional investors are slow to change their perception of the
investment environment and cling to traditional investment evaluation techniques.
15. Vested employment interests result in conventional wisdom strategies: Most portfolio man-
agers have vested employment interests and justify their positions by employing the safe,
acceptable ‘‘prudent-man’’ strategy. They do what their peers in the industry do or they ‘‘go
with the flow’’ and ‘‘conventional wisdom,’’ which largely ignores cycles strategies. Mavericks
and contrarians are not generally acceptable in bureaucratic institutional environments.
16. No crystal ball: Most portfolio models are based on historical data inputs. In contrast, cycle
decision models require the analyst to input forecast data. This is difficult since the real estate
industry has not developed good forecasting and prediction models. Further, as one manager
has observed, ‘‘If you live by the crystal ball, you will die by eating a lot of broken glass.’’
Forecasting is a high-risk business. Most investors and portfolio managers are risk adverse
and seek to minimize the probability of being wrong.
levels. This classification also includes comparative analyses to identify investment

opportunities among specific metropolitan areas (or submarkets) located within a
region or nationally. Examples of cycles that are generally classified under the
microeconomic category are urban cycles, neighborhood cycles, physical life cycles,
ownership life cycles, rent rate cycles, occupancy cycles, capitalization rate cycles
and portfolio mix cycles. Generally, studies that focus on project level or portfolio
level decision making are classified as microeconomic studies.
Whenever a study includes elements of both a macro and micro nature, often with
the purpose of linking together or integrating cycles at both levels, the primary purpose
and conclusions of a study are used as a guide to subjectively determine its proper
classification. Clearly, the process is subjective and we apologize to our colleagues
for any resulting mis-classification of their research work.
Cycle Relevance: Macroeconomic Literature

Cycles in the national economy. The cyclical nature of the national economy is well
documented in the literature beginning in the 1920s. A radical Russian economist at
that time, Nikolai Kondratieff, noticed that since the start of the industrial revolution
capitalist economies experienced long waves of growth and contraction (Stoken,
1993). These long waves, which became known as the ‘‘Kondratieff Wave,’’ consist
of twenty-five to thirty-five-year waves of increasing prosperity and living standards
and are followed by a decade or more of depression and falling living standards and
employment. As Kondratieff (1928) explained it, these severe economic depressions
come at fairly regular forty-five to sixty-year intervals, and are followed by another
long surge of business activity that results in a new peak of economic output and
prosperity. Kondratieff also identifies temporary setbacks, known as recessions, that
occur during the twenty-five to thirty-five-year up cycle period. The Soviet
government did not like the capitalist implications of his theory for their socialist
economy, so Kondratieff was quickly relocated to Siberia where his publications
ceased, but not before certain notable U.S. capitalist economists (e.g., Schumpeter,
Forrester and Rostow) embraced his work and cycle theories.
Another early pioneer of long real estate cycle research was an American by the name
of Roy Wenzlick, who published one of the first real estate periodicals, The Real
Estate Analyst (Rabinowitz, 1980). Wenzlick charted long cycles of housing
transactions from 1795 through 1973 at the national level, and concluded that the
average length of the long cycle was eighteen and one-third years.
Much of the early economic cycle research in the U.S. was concerned with moderating
fluctuations in the national economy and promoting growth in the macroeconomy.
Mitchell’s (1927) work for the National Bureau of Economic Research established the
theoretical foundation for and empirical evidence of cyclical economic activity in the
U.S. This was complemented by Burns and Mitchell’s NBER report (1946). Dauten
and Valentine (1974) expanded on Mitchell’s theoretical base and included
macroeconomic theory to help explain economic cycles. Klein and Wolman (1975)
then showed that economic cycle instability during post-World War II periods was

greater than during pre-World War II. Moore (1983) updated Mitchell’s work and
included an extensive theoretical and empirical treatise on business cycles and inflation
in the national economy. Fabozzi and Greenfield (1984) built on the theory and
empirical evidence specifying linkages between economic factors and capital
spending, construction activity, interest rates and inflation.
Recent thought regarding the implementation of counter cyclical monetary policies to

dampen business cycles through financial market controls was reviewed by Chatterjee
(1999). His review included examination of works studying pre-WWII and post-WWII
business cycles to evaluate the effectiveness of counter cyclical policies in damping
the variability in business sector productivity that is judged to be the underlying cause
of cyclical economic activity in the nation. Real business cycle theory is the
foundation for this research, and Chatterjee suggests that policy initiatives to buffer
the effects of business cycles may not be necessary. He notes the possibility that post-
WWII programs such as FDIC insurance, superior control of the money supply and
income-maintenance programs may have contributed to reducing the instability that
characterized pre-WWII business cycles. Consequently, monetary and financial
disturbances have not been the main issues of concern. Business-sector productivity,
instead, has surfaced as the main source of business cycles. Macroeconomists have
not developed reliable techniques for damping the cycles of business-sector
productivity without causing a reduction in long-term economic benefits to
individuals.
National economy linked to real property. Economic cycles impact a major portion of
the national wealth. In 1997, total fixed reproducible tangible wealth (real estate) in
the U.S. was about three times greater than the annual gross domestic product
(Statistical Abstract of the United States, 1998). Consequently, the connection between
this large percentage of national wealth and economic cycle activity is important.
Burns (1935) compiled the first authoritative summary and analysis using the mass
of economic data collected by government agencies and private parties concerning
the long construction cycles. The work was linked to macroeconomic research by
Mitchell and Burns. Grebler and Burns (1982) analyzed total construction, public
construction, private construction and residential property construction over the period
from 1950 to 1978 and found six cycles in residential construction and four cycles in
nonresidential construction in the U.S.. They also found that peaks in GNP lead the
peak in the construction cycle by about eleven months. Brown (1984) evaluated
existing single-family home sales during the period from 1968 to 1983. His purpose
was to validate that there were cycles in real estate after removing seasonality and
trend factors. He also found a high correlation between economic cycles and real
estate performance during the period studied.
Pritchett (1984) analyzed the impact of the national economy on cycles in investment
grade real estate during the period from 1967 to 1982 to understand which key real
estate cash flow variables indicated the change in cycle phase. He concluded that: (1)
demand leads supply as the construction cycle rises to a peak but lags supply as the
cycle falls to a trough; and (2) the best indicator of the cycle phase is vacancy rate.
Usually, vacancy rates reach high levels during the recession phase of the cycle,
declining during the expansion phase, then reaching a low point as the peak of the
construction cycle is approached. Hekman (1985) evaluated aggregated office market
data from fourteen cities over the 1979 to 1983 period. He developed and tested two
models: the first regressed class ‘‘A’’ office building rents on vacancy rate, constant
dollar gross national product (GNP), total metropolitan area employment and the
metropolitan area unemployment rate; and the second regressed value of office permits
on the ratio of employment in 1980 to that in 1970 for three industrial sectors—
finance/insurance/real estate, service and government. He found that office market
rents adjusted in response to local as well as national economic conditions,
construction of office space was highly correlated with inflation-adjusted office rents
and rents showed a strong response to current vacancy rates. Furthermore, in his study
of the office sector, he concluded that office construction was highly cyclical at the
national level.
Kling and McCue (1987) considered the influences that the macroeconomic factors
have on office construction. They employed vector autoregression models evaluating
monthly office construction, money supply, nominal interest rates, output (GNP) using
personal income as a proxy and aggregate prices (CPI). They concluded that office
overbuilding and market cycles resulted from a decline in nominal interest rates that
raised developers’ projections of GNP and future demand for space on a
macroeconomic level. They also substantiated the effect of the 1981 tax act on
stimulating office construction.
In a study of publicly traded real estate investments trusts (REITs) and real estate
companies during the 1973–1987 period (14.5 years), covering several business
cycles, Sagalyn (1990) showed risk and return relationships between these two classes
of firms to be quite different, and more pertinent to this study, also showed the effect
of the business cycle on the cycle of real estate asset performance.
Downs’ (1993) work concluded that differences in equilibrium vacancy rates in

different markets are due to fundamental differences in market supply and demand
conditions in those markets. He argues that, because some markets contain a higher
proportion of rapidly growing firms, or are experiencing more rapid population
growth, dynamic markets will have higher vacancy rates than static markets. He also
validated the linkage between real estate cycles and general economic cycles.
Janssen, Kruijt and Needham (1994) used the economic theoretical approach of the
honeycomb cycle in a study of Netherlands housing over a fourteen-year period
(1976–1989). They demonstrated a cyclical manifestation in the national market as
well as cycles at the metropolitan level that were different from each other and
different from the national market aggregate.
Two works completed by Roulac are further examples of national economic cycles
linked to real property. First, the Roulac and Sobolik (1985) study evaluated the ex
post impact of tax reforms on real estate performance. Second, Roulac’s (1993)
perspective view of twenty-five years of real estate business provided a general
philosophical examination of important cyclical relationships that existed and might

be expected to be important in the future. He evaluated real estate markets influenced

by the economy, office demand, office construction, property values, volume of
transactions, capital for real estate, investor interest and tax climate factors. The
vitality of capital flows to commercial real estate were categorized for pension funds,
financial institutions, foreign investments, securities and corporate investments.
Finally, the implications of the market changes were time-period segmented for space
users, real estate services providers, developers and the public sector.
Macro real estate cycles. There is extensive evidence of real estate market cyclicality.
In this section, we review the literature on macro real estate cycle characteristics and
cyclical indicators that can be measured.
Early real estate cycles research evaluated market behavior based on a homogenous
national market. More recent analyses explore inter-market distinctions and linkages
between macroeconomic variables and real estate market variables. Wheaton (1987)
evaluated post-World War II national office building construction activity and vacancy
rates and found a recurring twelve-year cycle. He found a direct linkage between
office employment changes and both supply and demand variables and noted that
supply responded more quickly than demand.
A number of studies have examined the cyclic movement of the commercial property
market in the U.S. Kling and McCue (1987), Wheaton (1987) and Grenadier (1995)
have all documented long-run cyclic movements in office rents, construction and
vacancy that do not match the more frequent macro-economy fluctuations. By contrast,
the Grebler and Burns (1982) and DiPasquale and Wheaton (1994) studies of the U.S.
housing market show that both single- and multi-family housing movements tended
to be much more closely aligned with macroeconomic movements.
Vacancy rates are identified by numerous researchers as a key variable linked to rent
cycles and building cycles. In their analysis of the national office data for the period
between 1968 and 1986, Wheaton and Torto (1988) found a clear indication that office
vacancy rates and real rents were cyclical. The peaks and troughs of the real rent
cycle lagged the trough and peak, respectively, of the vacancy rate cycle by about one
year. Both tenants and office managers apparently recognized the need for real rent
adjustments in response to vacancies above and below the structural (natural) vacancy
rate. In 1968, the natural vacancy rate in the U.S. was about 7.5%, but by 1988 it
had increased to nearly 12%. Wheaton and Torto broadly documented evidence of
real estate cycles, but cited the failure of existing explanations to provide a satisfactory
answer for the boom-and-bust behavior in real estate markets. The severity of the
boom-and-bust cycle has been attributed to developers lagging optimum timing,
building too late in the boom, and continuing to build into the bust.
Grenadier’s (1995) work on the persistence of real estate cycles provides further
insight into the causes of the mismatch between supply and demand that result in
prolonged periods of abnormally high vacancy rates, which are followed by periods
of abnormally low vacancy rates. The combination of demand uncertainty, adjustment
costs and construction lags leads to two phenomena that offer explanations of market
persistency. First, the reluctance of owners to adjust occupancy and rent levels, even
when they face large shifts in renter demand. And second, the phenomenon of periods
of sustained overbuilding even in the face of already high vacancy rates. Grenadier
develops a theoretical option-pricing model that helps explain that such behavior on
the part of owners and developers is not myopic (lacking knowledge and foresight),
nor is a result of leasing hysteresis (the failure of owners to reverse their behavior
even when the underlying causes are fully reversed). Rather, such behavior is said to
be a logical result of optimal planning and development strategies in an environment
of demand uncertainty, high costs (tenant improvements and leasing costs) of adjusting
to demand shifts and long planning and construction periods for real estate assets.
His model further explains why the office market (as compared to the industrial and
apartment markets), is most prone to periods of over-building due to longer planning
and construction times.
Chinloy (1996) linked both production and absorption of apartment units to prices
and rents of both existing units and new construction in a theoretical construct. The
model showed that when builders under-forecast rent increases, unexpected excess
returns trigger construction. Apartment market rents depend on the behavior of the
vacancy rate cycle, which affects new supply. He found that rent adjustments were
sluggish to return to equilibrium after a macroeconomic shock.
Clayton (1996a) studied the determinants of commercial property prices over the
Canadian property cycle and the implications for real estate investment strategies. He
developed a time series vector autoregressive (VAR) model to study the linkages
between economic or business cycles (measured by cycles in GDP growth) and real
estate cycles (measured by cycles in aggregated total real estate returns for all property
types), the effects of market cycles on pricing and property income and the
implications for buy-and-sell decisions. The study results suggest that commercial
property prices may be ‘‘forecastable’’ and that major market movements (cycles)
may be detectable in advance. The VAR forecasting model developed yielded sensible
buy-sell decisions over the fifteen-year study period (1979–1994) and hence appears
to be a potentially valuable tool for investors managing a widely diversified multi-
city portfolio (all property types, all metropolitan areas). Within this framework,
Clayton makes a strong case for attempting to time real property acquisitions and
dispositions. Another significant finding was that the relative importance of capital
market forces and real estate supply and demand changes over the real estate cycle.
Capital market forces become relatively more important than real estate supply and
demand fundamentals in real estate pricing during periods of volatile market cycles
and during market upswings. Hence, it is important for market participants to become
aware of which factor is the primary driving force behind property price changes at
different points in the real estate cycle when making investment and valuation
decisions.
Kaiser’s (1997) study on long cycles in real estate examines seventy-eight years of
real estate aggregated performance data comparing institutional real estate returns;
data characterizing construction, office employment, inflation, interest rates and stock

indexes; and property type performance measures to obtain a sense of the cyclic
relationships among these macro-variables. Kaiser discusses the presence of three
types of long cycles (thirty-year, fifty-to-sixty year and several hundred year), which
he believes better explain the behavior of the real estate markets than shorter-term
cycles.4 The study of short cycles, in contrast, are highly useful in the management
of real estate portfolios—in the timing of purchases and sales—but of very limited
use in deciding how much to allocate to the real estate asset class.
Wheaton and Rossoff (1998) developed a structural model of the lodging industry,
examining the 1969–1994 period, and found that occupancy and room rental rates
followed the cyclical movement in supply. Hotel demand, however, seemed to move
closely with the macroeconomic cycle. The model results indicated long lags between
occupancy and room rental rate changes as well as long lags between room rental
rates and new supply changes.
The most recent study on macro real estate cycles, as of the time of this writing, is
one commissioned by The Royal Institution of Chartered Surveyors (RICS, 1999) and
undertaken by the Investment Property Databank, and published in January 1999. The
study is an analysis of property cycles in the United Kingdom from 1921 to 1997
and is an extension of a basic treatise on understanding the property cycle, which
RICS published in May 1994 (RICS, 1994). The study’s primary measure of the
property cycle is the rate of all-property total return, although other indicators of
property activity (rental values, yields, building rates) are also used to describe cycles,
but have varying leads and lags against the all-property cycle. The study concludes
that property cycles have durations ranging from four to twelve years, with an average
of eight years. The upswings run from two to seven years, and downswings from two
to nine years. Also identified by the statistical tests are the possibility of two
underlying cycles, of roughly five years and nine years in duration. Comparisons
between the scale and timing of the property cycle and the national economic growth
cycle show that there are strong correlations between the two for many cycles, but
not all, and that these relationships have changed over time. Unfortunately, because
of the empirical model used, which limits data inputs to highly aggregated all-property
total returns, the model has limited usefulness for understanding individual property
markets or forecasting purposes.
Conclusion
The economic and real estate literature demonstrates that economic factors are
cyclical, cash flow variables (rents, vacancies, capitalization rates) are cyclical and
real estate performance (rates of return) is cyclical at the national and regional levels.
While modeling at the national and regional levels is useful for understanding the
relationships between economic and real estate market cycle variables in a general
sense, its power as a tool for forecasting and decision making at the property and
portfolio levels is limited. As will be seen, the usefulness of cycle modeling increases
as we move from macro-to more micro-level analysis at the metropolitan area and
property location levels.
Cycle Relevance: Microeconomic Literature

In recent years, several researchers have analyzed the effects of cyclical economic
factors on real estate investment performance at the metropolitan area, submarket and
property levels. These analyses were structured to reflect more realistic cycle (versus
trend) relationships between economic factors and cash flow variables. In addition,
valuation frameworks and models have been extended to include cycle analyses and
linkages, and investment strategies that take advantage of cycle forecasts and
projections.
Relatively few articles, papers and chapters on micro real estate cycles appeared in
the literature in the 1980s, with notable exceptions including those by Pyhrr and
Cooper (1982), Peiser (1983), Brown (1984), Pritchett (1984), Wheaton (1987), Witten
(1987), Voith and Crone (1988), Wheaton and Torto (1988) and Pyhrr, Cooper,
Wofford, Kapplin and Lapides, (1989). Beginning in 1990, there has been a
proliferation of micro real estate cycle research, including articles and papers by Pyhrr,
Born and Webb (1990), Roulac (1993, 1996), Born and Pyhrr (1994), Mueller and
Laposa (1994), Mueller (1995), Shilton (1995), Clayton (1996, 1997), Gordon,
Mosbaugh and Canter (1996), Hendershott (1996), Mueller, Laposa and Wincott
(1996), Pyhrr, Born, Robinson and Lucas (1996), Mueller and Pevnev (1997),
Wheaton, Torto and Evans (1997) and Kaiser (1997).
Born (1984) developed cycle theory, models and applications that considered cyclical
inflation in a real estate investment analysis framework. He also demonstrated that
cyclical inflation can produce performance results that are significantly different from
results using a constant inflation rate. In subsequent research, Pyhrr, et al. (1989),
used this analytical framework and expanded it by incorporating other economic and
property specific cycles. In addition, several authors have found that inflation has a
significant impact on real estate returns (e.g., Lusht, 1978; and Hartzell, Heckman and
Miles, 1987).
A number of authors have addressed the strategic importance of measuring the

dynamic impacts of cyclical economic factors on real estate investment performance.
In a classic prescriptive article, Roulac (1982) recited a litany of change during the
1960–1980 period including volatile inflation and markets, increasing complexity of
financing mechanisms, shifting national markets and the internationalization of
markets combining to produce increased economic uncertainty. His prescription for
including real estate cycle considerations in the analysis of real estate investments is
clear: ‘‘Investment analysis and valuation techniques must be compatible with the
dynamic market they seek to measure... Explicit economic approaches that forecast
every relevant item in the investment analysis and employ reasonable real return
numbers are preferable to static models that have long dominated the United States
markets’’ (p. 573).
Peiser (1983) studied inflation linkages to the capitalization rate. Using the accepted
linkage between inflation and the discount rate (discount rate equals real return plus
inflation plus business risk) in a DCF framework, Peiser showed the overall

capitalization rate (ratio of current NOI to sales price) to be negatively correlated with
inflation induced expectations for growth in property value. This linkage was the
underlying cause for capitalization rate decline with an expectation for increasing
inflation rate.
Lusht and Fisher (1984), while reviewing the predictive capability of standard
valuation models, observed that an anticipated decline in economic growth rates may
be an important determinant in underwriting decisions as lenders attempt to minimize
the probability of loan default. Pritchett (1984) evaluated the construction dollar
volume of investment grade real estate (office, industrial and retail) in New York City
during 1967 to 1982. His results show about one and one-half cycles, with cycle
magnitude (from trough to peak) varying between 50% (industrial) and 160% (office)
of the average value. Office activity was the most volatile and industrial the least
volatile, with volatility of retail and residential activity falling in between the two.
Hekman (1985) studied the office sector in fourteen cities over the 1979–1983 period
and found that construction was highly cyclical when the areas studied were
aggregated. Apgar (1986), although implicitly recognizing cyclicality of economic
variables, suggested the use of a strategic framework to avoid missing important
economic factors. The suggested strategy included key factors related to property type,
entrepreneurial involvement, investment strategy, investment structure, target market
and, ultimately, target properties.
Corgel and Gay (1987) evaluated the potential for regional investment diversification
and found significant differences in the economic vitality of the thirty largest
metropolitan areas in the U.S. Corcoran (1987) refined the economic relationships
between office rents, vacancy rates, asset prices, user costs and reproduction costs.
The linkages between the rental market (tenants) and the asset market (investors) are
through opportunity cost (user cost) of competing investments and replacement cost
of real property. He explained that rising vacancy rates in the face of strong growth
in demand in the asset market for rental properties in the 1980s, was due to extra
incentives in the asset market. Specifically, office building acquisition prices rose more
rapidly than reproduction costs, and encouraged new construction that led to
overbuilding and high vacancy rates.
Witten (1987) applied basic regional and metropolitan area analysis to understand the
effects of economic cycles on the timing of real estate investment acquisitions and
dispositions. Rodino (1987) connected Apgar’s (1986) strategic framework with
market data and stressed that market research is the key to satisfactory analytical
results. He suggested that supply, demand, economic base and investor factors should
be considered. He carried this structure through market analysis, and concentrated on
acquisition and resale capitalization rates, vacancies, rental income and expense
escalations. The framework was anchored on the metropolitan statistical area (MSA)
economic data linked to supply/demand variables for each property type. The
suggested process emphasized the consideration of the impact of market cycles on
each variable, and developed linkages between exogenous factors and cash flow
variables. He suggested that the analyst can use the conclusions drawn from market
research (i.e., through an objective evaluation of current and projected market

conditions for each property including cyclicality of cash flow variables in a pro forma
context) to time acquisitions when the market is soft and dispositions when the market
is tight.
Voith and Crone (1988) evaluated office market vacancy rates in seventeen large
metropolitan areas in the U.S. for the period June 1980 through June 1987. There
were clear indications of cyclic vacancy rates and market differences between
metropolitan areas both in cycle frequency and amplitude. Furthermore, the natural
(structural) vacancy rate was upward sloping in thirteen metropolitan areas, almost
constant in two metropolitan areas and slightly downward sloping in two metropolitan
areas during this period, which included two recessions (January–July 1980, and July
1981–November 1982). They asserted that inter-market variations were significant and
suggested that additional research was needed to validate the relationships between
the natural vacancy rate and market conditions.
Pyhrr, Born and Webb (1990) developed an empirically-based discounted cash flow
model to measure the relationships between key economic variables and real estate
performance. They develop a decision framework and operational model for projecting
investment returns for different inflation cycle scenarios and demonstrate their
application for developing dynamic real estate investment strategies. Pyhrr, Webb and
Born (1990), and Born and Pyhrr (1994) later expanded the inflation cycle model to
include supply and demand cycles, property life cycles, and urban area economic
cycles, and their impact on real estate valuation analysis, optimal holding period,
solvency, mortgage debt structure and asset diversification. Three important concepts
introduced were market equilibrium (and equilibrium property rents), new construction
market rents and the rent catch-up cycle. These models and their decision-making
implications are discussed in greater depth later.
Pollakowski, Wachter and Lynford (1992) suggested that it was inappropriate to

assume a single structure for demand and supply relationships in all markets. They
tested for structural differences among metropolitan areas by office market size. Based
on rental data from the REIS reports for twenty-one metropolitan areas over the time
period 1981 to 1990, they concluded that real estate cycles are clearly not uniform
across markets. Their results suggest that market outcomes vary by city size, larger
markets are better modeled using ‘‘standard procedures,’’ and Manhattan behaves quite
differently from the other markets.5
Clapp (1993) evaluated office markets nationally. In a case study, Clapp quantitatively
validated the relationships between cyclical economic factors, including employment,
location factors of supply and demand, and office market performance variables of
absorption and vacancy rates. Initially, he explored measurement of the natural
vacancy rate in office market cycles. The case study included analysis of four
metropolitan areas in the northeastern U.S. compared with the nation. The results
indicated that in the 1990s, the four MSA markets studied were highly correlated with
the national office market which suggests that, in the long-run, investment grade office
properties in metropolitan areas held in institutional portfolios tend to perform about

like the national office market during periods of national economic prosperity. Also,
he concluded that estimates of office supply growth are necessary to forecast office
space supply, rent rates, expenses and vacancies, and that such market forecasts should
establish a range of possible outcomes, not just a single possible outcome, for decision
making.
Mueller and Laposa (1994) investigated the cyclical movements of fifty-two office
markets around the U.S. By examining average vacancy and deviations from this
average as an indication of market risk or volatility, they classified and captured the
nature of cyclical risk inherent in these markets. They found that there were cycle
differences between markets and that by examining the duration, amplitude and timing
of the market cycle, one could better understand the market forces that affect real
estate investment risk. Also in 1994, Laposa and Mueller (1994) developed a
submarket cycle model to study the cyclical behavior of submarkets within SMAs
relative to the SMAs as a whole. Then in 1996 and 1997, Mueller, Laposa and Pevnev
developed models for analyzing rent distributions under alternative market cycles
(Mueller and Laposa, 1996) and rent growth rates during different points in the real
estate cycle (Mueller and Pevnev, 1997). These models, the study conclusions and
decision-making implications are discussed in depth in the cycle modeling section of
this study.
Shilton (1995) also examined office market cycles in a framework designed to promote
an understanding of the cyclic characteristics of office employment demand. He found
that the economic base of a city influenced the rate of overall growth in office
employment. He also showed the link between cyclic office employment and market
volatility and concluded that markets experiencing higher volatility in office
employment are more likely to experience higher levels of office vacancy.
Gordon, Mosbaugh and Canter (1996) studied office market volatility, showing that
different metro areas behave differently over time and that some markets have longer
cycles or less volatility than others. The study utilizes the C.B. Commercial/Torto-
Wheaton database for thirty-one metropolitan areas over the time period 1978 through
1995, and the change in vacancy rate over time as its measure of the real estate cycle.
Their study focused on identifying economic factors to determine the underlying
causes of office market cyclicality and risk. The analysis suggests that movements in
vacancy rates are likely to be affected by different factors at different stages of the
cycle. In the long run, the analysis shows that capital flows have the strongest effect
on the volatility of vacancy rates, while employment growth and market conditions
(e.g., size and economic diversification) were also major contributing factors. In
contrast, during the recovery phase of the cycle (following periods of excess
construction), demand-side factors such as employment growth and economic
diversification appear to be the dominant influence on market behavior.
Wheaton, Torto and Evans (1997) studied the London Office market covering the
1970–1995 period and found ‘‘generally inelastic supply and demand relationships
that yielded a dynamically stable system.’’ They determined that the 1980s building
boom was a delayed response to the one-time huge growth in service employment
that occurred during this period. In his study of the Sidney office market, Hendershott
(1996) noted that investors grossly overestimated property value at the peak of the
cycle and undervalued it at the trough. This investor behavior profile provides
additional insights into the explanation of developer response to supply/demand
imbalance studied at the national level by Grenadier (1995), as previously discussed
in the macroeconomic literature section.
Although not as volatile as other property types, residential real estate cycles research
provides important information regarding economic factor relationships. Clayton
(1996b) evaluated the quarterly time series of prices of single-family detached housing
over the 1979:1 to 1991:4 period in the Vancouver, B.C. metropolitan area, using
immigration and new unoccupied single-family housing (new supply) as the
explanatory variables. The structure used was a simple asset-based forward-looking
model of housing price determination to explain the dramatic cyclical movement in
Vancouver housing prices over the twelve-year period. The extensive econometric
evaluation and test results reject rational expectations, suggesting that housing markets
are characterized by irrational expectations that, at times, deviate from fundamental
values. These deviations suggest that irrational expectations may aggravate cyclical
movements in housing markets.
In a follow-up study, Clayton (1997) evaluated condominium housing price cycles

during the 1982–1994 period in eight submarkets in Vancouver, B.C. using a time-
series framework. The data are housing prices, rents and property assessed valuations,
and represent a cross section of housing submarkets. Clayton’s model tested the
efficiency of housing markets at a more micro level than did his 1996 study.
Nevertheless, the 1997 study had similar conclusions—significant evidence against
rational expectations in condominium housing prices since prices deviated
significantly from fundamental values over the real estate price cycle. House price
changes moved in the opposite direction from rational expectations in the test of an
efficient asset market model. Such inefficient markets can provide cycle investors with
excellent arbitrage profit opportunities.
Gallagher and Wood (1999) recently studied the risk and predictability of overbuilding
in the office sector and examined three techniques that can be used to examine the
probability of overbuilding. Using quarterly data on thirty-four MSAs from 1977–
1997, their research concluded that both economic base employment (McNulty, 1995)
and the Space Market Index (Miles, 1997) provide the most practical methods for
assessing the risk of overbuilding. There was considerable variation across MSAs in
terms of risk of overbuilding, which has important implications for investors from a
tactical asset allocation viewpoint.
In an extension of his 1997 long cycles study, Kaiser’s (1999) study examined ex post
data over a forty-six-year period to evaluate the benefits of including real estate in
a mixed-asset portfolio, and concluded that ‘‘a model that takes into account
fundamental value (as measured by real estate cap rates, stock market earnings yields
and ten-year bond yields) offers superior return/risk ratios to any single asset
comparisons.’’ In general, two complete cycles of activity were evident in Kaiser’s

data. Kaiser’s ‘‘fundamental value’’ model allocates portfolios between stocks and real
estate, and between bonds and real estate, based on relative yield comparisons between
the assets, then reallocates these portfolios as relative yields change over the real
estate and capital market cycles. His results illustrate how a portfolio can be
periodically rebalanced using ‘‘switching strategies’’ to take advantage of real estate
and capital market cycles and thereby raise returns while simultaneously lowering risk
(bond and real estate portfolio), or lower risk with the same return level (stock and
real estate portfolio).
Other researchers have also become interested in the impact of real estate cycles on
the return and risk characteristics of mixed-asset portfolios. Knowing how assets co-
move over different market phases or market conditions is important for portfolio
management, asset allocation, weightings and understanding future inter-asset
correlation dynamics (Newell and Acheampong, 1999). Such research can be expected
to proliferate in the future as more reliable databases are developed and made available
to researchers.
At the micro as well as macro level, the real estate literature supports the theory that
real estate markets are cyclical, cash flow variables (e.g., rents, vacancies,
capitalization rates) are cyclical, and real estate values and returns/risks are cyclical.
Further, as we move across the continuum from macro to micro to practitioner
categories, the research focus becomes more decision-making oriented and applied,
as contrasted with theoretical and empirical in nature. In the following section we
turn our attention to the cycles literature that has evolved rapidly in the real estate
industry, primarily from institutional real estate investment organizations who have
significant research and publication capabilities in-house.
Cycle Relevance: The Practitioner Literature

The increased popularity and perceived importance of market cycles among
practitioners is evidenced in recent research. For example, Leinberger (1993) has
stated that the real estate cycle is the most important determinant of strategy of real
estate participants. Roulac (1996) adds, ‘‘Perhaps second in influence only to the
location, location, location real estate investment selection criteria, the concept of
market cycles dominates the concerns of, and is employed as a rationalization by, real
estate investment professionals. Perceptions of real estate cycles influence market
participants’ strategies and transactions decisions.’’
A recent study of 685 real estate plan sponsors by Ziering and Worzala (1997) indicate
that real estate cycles has become a very hot research topic among portfolio managers
as a result of the dismal performance of institutional real estate portfolios in the late
1980s and early 1990s. Nearly 40% of respondents rated Real Estate Cycles and Their
Predictability as the most important research topic and 80% rated it among the top
three.
Roulac (1996) notes that the concept of real estate cycles has been more used in
professional practice than has been addressed in the academic literature, and has
received only very limited attention in real estate education. As a result of recent
experience with volatility in real estate performance, decision makers have become
ever more concerned about when the Adownturn might turn up or the current
expansion might top off that downturn.@ If location, location, location, is used as
the vehicle to justify a specific investment opportunity, market cycles is increasingly
becoming the vehicle for justifying the timing of various real estate strategies with
regard to portfolio allocations, property types and geographical market selection.
Often ignored in the past, the concept of real estate cycles is now in the forefront of
consciousness of virtually every practitioner involved in the real estate markets.
Reflective of this cycle consciousness is the highlighted, boxed introductory statement
to the feature story in the July 1997 Real Estate Forum on ‘‘Real Estate Services
2000,’’ as follows: ‘‘Like a wheel of fortune, the real estate cycle presents varied
changes and opportunities. Can you bet with confidence in your response?’’ (Dobrian,
1997). Then, the cover story profile on Barney Skanska Construction Company
describes the CEO’s intention ‘‘to build a cycle-proof CM firm,’’ (Salustri, 1997). The
extent to which interest in real estate cycles has extended is reflected in a recently
advertised NYU Stern School of Business one–day conference (1999) on the impact
of real estate cycles on the real estate industry.
Numerous pension fund advisors and investment banking companies have developed
cycle research capabilities to enhance their investment advisory services and company
publications. The focus of these cycle research activities is very diverse, including
everything from macroeconomic presentations on portfolio property-type
recommendations or the status of hotel markets in Europe, to analyzing an office and
industrial REIT’s target property markets, to specific investment strategies for
identifying hot markets for acquisitions and weak markets for dispositions. A few
examples are presented to illustrate these applications.
Macroeconomic/portfolio strategy cycle recommendations. LaSalle Advisors (and more
recently their merged entity, the global real estate conglomerate Jones Lang LaSalle)
has been one of the leaders in applying macroeconomic cycle concepts to the analysis
of real estate markets and portfolios. In the company’s quarterly publication Market
Watch and its Investment Strategy Annual, cycle analyses are presented as a basis for
developing strategic recommendations. For example, Exhibit 2 illustrates how model
portfolio strategies for various investors seeking specific types of risk-return
combinations (income, balanced, high yield, growth, opportunistic) can be matched
with different property types that appear at different risk-return points on the property
cycle. LaSalle makes portfolio recommendations for a three-year investment horizon
based on matching client objectives with property cycle characteristics as shown here.
For example, in 1998, a diversified mix, which avoids malls and hotels, was
recommended for a balanced portfolio; CBD office and full-service hotels were
recommended for growth investors. In making global investment and portfolio
allocation recommendations, LaSalle analyzes the position of each country for each
property type on the real estate cycle, as shown in Exhibit 3 for European hotel
markets.

Exhibit 2
Real Estate Cycle Analysis: Determining Portfolio Strategies
Security of Income Growth-Oriented
Opportunistic
Growth
Return
High Yield
Growth Portfolio
Balanced Typical Investment: Building
with High Tenant Rollover
Income Target Total Return: 12-17%
Target Cash Return: 4-7%
Balanced Portfolio Moderate Leverage (30-60%)
Riskless Typical Investment: Leased
Rate Building in Improving Market
Target Total Return: 9-12%
Target Cash Return: 6-8%
Low Leverage (Under 30%)
Risk
Opportunistic Growth Balanced Income

New Construction
Industrial - Warehouse
R&D/Flex Hotel (Limited Service)
Apartments Power Center
Office Suburban
Neighborhood & Community Centers
1st Tier - Regional Mall
Parking
Hotel (Full Service)

Over Supply
Office Downtown
Factory Outlet Centers
2nd Tier - Regional Mall
Source: 1998 Investment Strategy Annual, page 27. LaSalle Investment Management Research,
Chicago.
Exhibit 3
Real Estate Cycle Analysis: Status of European Hotel Markets
Status of European Hotel Markets
Second Quarter 1998
New Construction
United Kingdom
Sweden
The
Netherlands
Belgium
Italy
Over Supply
France
Spain
Germany
Source: Second quarter 1998, Market Research, page 7. LaSalle Investment Management Research.
Analyzing REIT portfolios. The real estate research group of a major east coast
investment banking firm, Legg Mason Wood Walker, uses various types of cycle
analysis to evaluate real estate opportunities by property type in over sixty metro-
politan areas in the U.S., and publishes a quarterly report called Real Estate Market
Cycle Monitor. A most interesting use of cycle analysis is its application to the
evaluation of new REIT offerings and existing company stock evaluations. Exhibit 4
shows the market cycle analysis for the office and industrial markets that make up
the portfolio of Duke Realty Investments (as of 1996:4). Duke’s portfolio was
concentrated in steady but slower-growth Midwestern office and industrial markets,
which were in the up-cycle phase of their market cycles where rents would slowly be
trending upward over the next five years.
Identifying hot markets for acquisition. The strategic planning and research group of a
large pension fund advisor, The O’Connor Group, publishes a report called Horizon,
which describes various cycle investment strategies. The September 1997 report states
that O’Connor’s approach to cycle investing ‘‘provides investors—public or private—
with a way to find opportunities and to time markets with more analytical discipline
and rigor.’’ Most importantly, our approach identifies ‘‘hot markets’’ that the herd has
stampeded right by.’’ O’Connor’s cycle model is actually a ‘‘tri-cycle’’ model because
it takes into consideration: (1) economic cycles; (2) property cycles; and (3) capital

Exhibit 4
Real Estate Cycle Analysis: REIT Stock Analysis
Office & Industrial Market Cycle Analysis

Duke Markets
4th Quarter, 1996
St.Louis-Industrial
Columbus -Office
Indianapolis - Industrial
St Louis - Office
Long Term Occupancy Average NATIONAL - Industrial Equilibrium
Cincinnati - Office
Indianapolis - Office
NATIONAL - Office
Cleveland - Industrial
Columbus - Industrial
Cleveland -Office
Source: Equity Research Company Analysis, February 18, 1997, page 4. Company Reports and Legg
Mason Research, Baltimore.
flow cycles. The basic cycle-investing construct used in its analysis is shown in Exhibit
5 and applied to the Boston metropolitan area for the years 1977–1996. Using this
model, O’Connor analyzes 700 submarkets across fifty-four U.S. markets.
Cycle Relevance Conclusion

The overwhelming academic and practitioner interest in real estate cycles, as
evidenced by the growing body of knowledge on the subject, leads to the clear
conclusion that real estate cycles are relevant and will become a more important
decision variable for investors and portfolio managers in the future. While in the past,
the concept of market cycles has been oversimplified and used more to support self-
serving assertions about probable market recovery than as a guide to investment
decisions, the situation appears to be changing rapidly. Increasing numbers of
investors and portfolio managers appear to understand the dynamics and complexity
of real estate cycles and their implications for investment and portfolio strategies and
decisions.
Basic Theory of Cycles

Cycle Definitions
‘‘Before a phenomenon can be measured, it must be carefully defined.’’6
Unfortunately, the published literature on real estate cycles uses the term to describe
Exhibit 5
A Cycle-Investing Construct For Analyzing Markets and Submarkets
Source: Horizon, Strategic Planning & Research, Volume II, Issue I, September 1997, pages 4 and
7, respectively. O’Connor Group, New York.

many things—such as rental growth, absorption, vacancy and construction activity—

but never develops a standard definition of a cycle as economists have done in the
business cycle literature. One of the few concise definitions of the real estate
(property) cycle is offered by The Royal Institution of Chartered Surveyors in its 1994
publication on Understanding the Property Cycle: ‘‘Property cycles are recurrent but
irregular fluctuations in the rate of all-property total return, which are also apparent
in many other indicators of property activity, but with varying leads and lags against
the all-property cycle.’’
While we might argue about the above definition, and proclaim that real estate cycles
are elusive and hard to define with precision, we should also recognize that at least
one precise definition has now been offered for consideration, pending more rigorous
definitions that may evolve as further theoretical and empirical research is completed.
The Basic Mathematical Construct

The basic language and definitions of cycles were established in physics and
engineering three quarters of a century ago, as illustrated in Exhibit 6.7 The cycle is
depicted as a sine wave with its important characteristics being the cycle period,
frequency, peak, trough, amplitude, phase and inflection point. We would encourage
all cycle researchers to adopt these basic time-tested definitions and not reinvent them
for personal or professional reasons.
Exhibit 6
Sine Wave Plot of a Cycle and Its Basic Characteristics
Cycle Phase Nomenclature and Economic Characteristics

A further distinction and expansion of the sine wave construct, adapted to real estate,
is shown in Exhibit 7 (Mueller and Laposa, 1994). The four phases of a real estate
cycle are defined as: (1) recession; (2) recovery; (3) expansion; and (4) contraction
(oversupply). Phases 2 and 3 (recovery and expansion) are characterized by falling
vacancy rates, while phases 4 and 1 (contraction and recession) by rising vacancy
rates. The equilibrium vacancy rate line is the ‘‘inflection point’’ that differentiates
positioning and direction for markets. When investors refer to the ‘‘cycle upside’’ or
‘‘upcycle,’’ they are describing the recovery and expansion phases of the cycle, while
the use of the term ‘‘cycle downside’’ or ‘‘downcycle’’ refers to the contraction and
recession phases of the cycle. Another approach to the conceptualization of cycle
phases is offered in Exhibit 8 (Pyhrr, Webb and Born, 1990). This approach
distinguishes between supply and demand cycles and their key economic
characteristics. Cycle phases are defined according to the interaction of supply and
demand forces over time and the resulting vacancy rate.
Fundamental Cycle Concepts

As previously emphasized, real estate cycles have dynamic and complex impacts on
the investment variables that determine a project’s or portfolio’s returns and risks.
Cycle impacts should be considered at virtually every step of the investment decision
making process, as illustrated in Exhibit 9. The challenge for the investor or analyst
is to understand how market and property specific cycles should be considered at each
stage of this process and how they impact each investment variable at each stage.
For example, an investor’s strategy (Step 1) will define cycle-determined investment

objectives and criteria, and plans and policies that direct acquisition efforts in specific
cities, submarkets and property types that are positioned correctly to take advantage
of a forecasted market recovery, expansion, contraction or recession period. Properties
will be identified that meet the basic market cycle and other screening criteria
benchmarks (Step 2), and each property will be analyzed using basic financial
feasibility models (Step 3) that input cycle-determined financial information (e.g., a
lower NOI capitalization rate might be appropriate in a market that is in the early
recovery stage of the cycle that is characterized by relatively low, but rapidly
increasing occupancy and rent rates). As illustrated by several models presented later,
the detailed feasibility and due diligence research (Step 5) is the key cycle analysis
stage that produces forecasts of occupancy rates, rent rates and operating/capital
expenses over alternative economic and market cycle scenarios. This data is then used
in Step 7 to perform DCF analysis and evaluate a property’s rate of return, risk and
portfolio impact characteristics. If acquired, the property is managed and leased (Step
9) using a strategy that takes advantage of the cycle DCF forecasts (e.g., lease
structures that capture rapidly rising market rents over a forecasted recovery phase
through rent step-up or short-term lease renewal provisions). The property is sold
(Step 10) at an appropriate point in the market cycle, and the net proceeds are
reinvested in other properties or assets that meet the then-current cycle-based

Exhibit 7
Real Estate Cycle Phase Nomenclature
Source: Mueller and Laposa (1994).
investment objectives and criteria of the investor. (Step 1 is repeated.) At this stage,
a full investment life cycle has been completed and the investor’s portfolio mix has
been revised.
As previously concluded, virtually every phenomenon in social affairs, political

economy, business and real estate is cyclical in nature. However, most investors and
analysts incorrectly view such phenomena as ‘‘trends,’’ not cycles. Because of this
perception, most investors capitalize the present economic situation into perpetuity
when forecasting the future, acting as if the current trends (whatever they are) will
continue forever. As a result, most investors do the wrong thing at the wrong time
over the cycle, buying high (during the boom) and selling low (a foreclosure sale
during the bust), following the ‘‘herd instinct’’ and doing what the crowd is doing.
The divergence between investor assumptions and property performance reality over
the cycle is illustrated by Roulac (1996) in Exhibit 10, where he compares economic
forces and property performance in the 1980s and 1990s. As further explained by
Stoken (1993) in his book on The Great Cycle, the majority of investors are victims
of their own experience. ‘‘They see things in light of what has happened in the past
and commit themselves to one phase of a cycle. Like most politicians and generals,
Exhibit 8
Phases of the Real Estate Supply/Demand Cycle
Economic Characteristics of the Real Estate Cycle (Pritchett, 1984; Wheaton,

1987; and Witten, 1987).
n In a growing economy, the rising and peak phases of the cycle dominate
(in years) the declining and bottom phases of the cycle. On average, there
are more years of ‘‘good times’’ than ‘‘bad times’’ for investors.
n In a growing economy, the long-term trend line for both change in demand
and supply is upward sloping. At the peak of each new cycle (point B), the
additions to supply and demand reach new peaks as compared to the pre-
vious cycle. The opposite occurs in a declining economy.
n Change in supply is somewhat more volatile than change in demand.
Develop/lender enthusiasm causes supply to rise above demand during the
peak phase, and developer/lender pessimism causes supply to fall below
demand during the trough phase of the cycle.
n The demand cycle leads the supply cycle by a period of time. The lengthy
process of planning and financing a new project makes it difficult for de-
velopment to begin as soon as the market demonstrates a need, or to stop
as quickly as demand begins to decline.
n The best indicator of the phase of the cycle is the occupancy rate. Occu-
pancy rates reach a low point during the trough phase of the cycle (point
A), increases gradually during the rising phase, reach a high point at the
peak of the cycle (point B), then gradually decrease during the declining
phase.
Source: Pyhrr, Webb and Born (1994:476).

Exhibit 9
Cycle Considerations in Each of the Ten-Step Investment Analysis and
Financial Structuring Process
Source: Pyhrr, Cooper, Wofford, Kapplin and Lapides (1989:90).

34
Exhibit 10
Economic Forces and Property Performance: 1980s Trend Assumptions and 1990s Cyclical Reality
1 9 8 0 S A S S U M P T I O N S 1 9 9 0 S R E A L I T Y
ECONOMIC MARKETS MARKETS ECONOMIC

FORCES FORCES
PROPERTY PERFORMANCE
GRAVITY AND

PERFORMANCE PERFORMANCE
PREMISE OF ATTRIBUTES DISCONTINUITY
CONTINUITY REALITY PREVAIL
PROPERTY PROPERTY
Uninterrupted Supply Economy sags in
economic High Rent Low 1990 and downturn
Strong surplus
expansion sustained relative to persists through
space demand demand 1993
Continued office relative to ASSUMPTION
employment growth supply High Occupancy Low
Declining office
employment
Incremental new
construction is con- New construction
sistent with demand High Cash Flow Low
outpaced demand
Investors continue CAPITAL Return CAPITAL Investors perceive

to favor property High on Low property has
investments Investment Market investors adverse return-risk
Strong
sustained disinterested: characteristics
investor capital
Tax law provides demand flows down Tax law treats real
incentives and sub- estate activities in
sidies to real estate punitive manner
investing
Source: Roulac 1996, page 10.

they find themselves continually fighting the last war. So, perhaps we learn the lessons,
or at least some of the lessons, of history too well.’’
The Nature and Dynamics of Real Estate Cycles

Real estate cycles have been proven to be volatile, complex and persistent. Perhaps
most importantly, they have pervasive effects on people’s livelihoods, wealth and
health. What causes real estate cycles? One behavioral economist explains that the
culprit is crowd behavior and mass psychology (Stoken, 1993). Stoken argues that we
are not economic individuals who act in our own rational self-interest. Rather, we are
psychological beings, conditioned by our experiences, especially those experiences
that serve as important lessons of pain and/or pleasure. Because of this, cycles are
created:
‘‘Following an extended period of prosperity, men and women adopt the

psychology of affluence and its byproduct, economic optimism, wherein
they enjoy life, have fun, and become economic risk takers. This mass
psychology of optimism, once set off, takes on a life of its own and
continues until people become excessively optimistic... They rationalize that
what has happened will continue to happen, and thus come to see less risk
than actually exists. Consequently, too many people become risk takers,
which in turn creates the conditions for a big bust. This bust, or depression,
then sets off a psychology of pessimism which continues until people see
more risk than really exists. At that point too many people become risk
averters, and this lays the foundation for a long period of economic
expansion,’’ (Stoken, 1993: 83–84).
A traditional real estate economist might alternatively explain that real estate cycles
are caused by structural and behavioral supply and demand forces in the economy
that can be studied, measured and forecasted with some degree of accuracy. The
strategic implication for investors is that it is possible to anticipate cycles and respond
proactively to increase investment returns and reduce risks—thereby increasing wealth
at a significantly greater rate than typical investors who make decisions based on
trends and anecdotal evidence that has not been validated.
A composite real estate cycle of all property types in Austin, Texas for the 1972–
2000 period is depicted in Exhibit 11. This graphic illustration provides an interesting
story of two decades of cycle impacts on profits and losses in Austin real estate. Real
estate values (on the vertical axis) are the benchmark for determining the stage of the
cycle being experienced.8 The long-term growth trend-line slopes upward the entire
time and represents the ‘‘average’’ nominal dollar increase of real estate values over
time, assuming cycles are ignored. The ‘‘actual cycle’’ solid line shows actual changes
in the value of property based on transaction prices during the boom and bust periods.
This cycle is contrasted with the ‘‘normal cycle’’ that would have been experienced
if excessive optimism, greed and irrationality had not overtaken the behavior of
investors, developers and the federal government beginning in 1982. This period
Exhibit 11
The Dynamics of a Real Estate Cycle: From Boom to Busto to Robust 36

Source: Pyhrr, Synermark Investments, Inc.

marked the implementation of: (1) the Garn–St. Germain Act (financial deregulation)
which provided thrift institutions with broad-based power for real estate investment;
and (2) the Tax Reform Act of 1981, which provided liberal shelter benefits for real
estate investors. This illustration of the Austin real estate cycle over two decades can
be augmented by three important observations.
Observation 1: Many real estate professionals ignore cycles during the expansion phase
(boom period), because they are making extraordinary income from commissions,
fees, points and profits. They act as if the boom will never end, because it is in their
economic self-interest to do so by promoting the idea that prices and rents will
continue to rise in the future, thus maximizing expected commissions, fees, points
and profits. These same individuals often preach the cycle recovery concept during
the recession phase (bust period), because again, it is in their economic self-interest
to do so. One might hear such statements as, ‘‘Don’t be pessimistic...occupancy will
improve...Rents will bottom out and rise as employment growth continues...The
market has hit the bottom...Prices are a fraction of replacement costs...Now is the
time to invest!’’
Observation 2: On the upside (recovery and expansion phases), the cycle usually goes
up faster and higher than is anticipated by market participants. The market produces
‘‘overpriced’’ real estate. For example, values in Texas cities in the mid–1980s rose
25% to 50% higher than were expected; unfortunately, market participants acted as if
the trend would continue forever. On the downside (contraction and recession phases),
the cycle usually goes down faster and lower than is expected. This results in
‘‘underpriced’’ real estate. During the downcycle in Texas (1987-1991) it was common
to see values of commercial real estate values drop by 60 to 80 percent from previous
highs. Office properties that sold for $100 to $120 per square foot in 1985 were sold
for $25 to $35 per square foot in 1992. Apartment buildings that sold for $25,000 to
$30,000 per unit in 1985 were sold for $7,000 to $10,000 per unit in 1991. Zoned
office land that sold in 1985 for $25 to $30 per building square foot (with approved
site development permits) sold for only $4 to $5 per square foot in 1992–1993. Again
on the upside of the Texas real estate cycle, beginning in 1992, values increased
rapidly through 1998 and were approaching their mid–1980s values in some growing
cities and submarkets.
Observation 3: Timing is the key element to successful investing. Investors must be
willing to make significant changes in their portfolios to take advantage of constantly
changing property and market conditions. Different assets will perform differently
during the various phases of a real estate cycle. For example, there is a property-type
lead-lag sequence over the composite real estate cycle. In the Austin real estate cycle
experience (Exhibit 11), the recovery was led by apartments and single family
subdivisions (1989–1990), followed by suburban office and industrial properties
(1991–1992), then by retail properties (1992–1993), raw land (zoned and platted) for
new apartments and office developments (1993–1994), and finally CBD office
buildings (1995–1996). There was a six-year time period during which different
property types passed through the trough (bottom) of the cycle and started up the
recovery phase of the cycle. One lesson learned is that, although there is no real estate
asset for all seasons, there is a season for all real estate assets.
Different Types of Real Estate Cycles

Although real estate investors often refer to ‘‘THE’’ real estate or market cycle, there
are actually many different types of interdependent cycles that affect real estate
performance and the success of a cycle strategy. The authors of one advanced real
estate investment textbook identify some fourteen different cycles that affect real estate
investors (Pyhrr et al. 1989). More recently, Pyhrr and Born (1999) have developed
a subject classification system for real estate cycles that identifies a wide variety of
cycles organized into eight general categories, as shown in Exhibit 12.
Tracking, comprehending and acting upon these multiple interrelated cycles is a

daunting undertaking. To respond to this challenge, a few basic principles are
recommended by one group of authors:9
1. Identify the critical cycles. Focus on those that will have the greatest
impact on rents, vacancies, capitalization rates and property values.
2. Research their effects on investment variables. Analyze the relationship
between these key cycles and cash flow variables that affect rates of
return and risk parameters, paying careful attention to the leads and lags
that characterize these relationships.
3. Develop an investment strategy to take advantage of cycles. Measure their
impact on cash flows, IRRs, and risk parameters under different
acquisition/disposition and market/economic scenarios, then act
accordingly to maximize long term wealth in a portfolio context.
It should be recognized that, over the real estate cycle, most average investors guess
wrong a large percentage of the time because they ‘‘gallop with the herd’’ and follow
‘‘conventional crowd wisdom.’’ In contrast, successful investors that consistently
outperform the market average are willing to follow a path contrary to that of the
masses. Thus, good timing and a degree of contrarianism are key ingredients to
successful investing that achieve above-market returns over a long period of time.
Investments must be bought and sold before cyclical trends are fully reflected in real
estate prices and activity. An investor must forecast cycles and act ahead of popular
opinion—buying when popular opinion is still negative and most investors are trying
to sell; and selling when popular opinion says the boom is on and speculative investor
buying causes asset prices to increase beyond economic reason.
Modeling Real Estate Cycles

Most of the existing cycle literature at the micro decision-making level focuses on
descriptive models of cycles, analysis of historical cycles, and general formulas and
strategies for buying low and selling high. Few studies have sought to model cycles
on an ex ante basis and measure their resultant impact on cash flows, rates of return
and risk, not to mention their financial implications for property and portfolio
decisions. In this section, we review eight models that have been developed in the
1990s. Each presents an analytical definition of cycles, seeks to measure cyclical

Exhibit 12
Types of Real Estate and Related Cycles
I. Economic and Business Cycles: National / Regional Levels
A. General business cycles
B. Inflation cycles
C. Population and employment cycles
D. Inter-industry cycles
E. Intra-industry cycles
F. Business focus cycle
G. Weather cycles
H. Technology cycles
II. Economic and Business Cycles: MSA / Submarket Levels
A. Urban area / city cycles
B. Urban / rural cycles
C. Neighborhood cycles
D. Planning theory cycles
III. Political / Social / Cultural / Behavioral Cycles
A. Political change cycles
B. Government subsidy / incentive cycles
C. Regulation cycles
D. Household formation cycles
E. Social change cycles
F. Popularity cycles
G. Residential regional preference cycles
H. Fashion design cycles
IV. Physical Market Cycles
A. Demand cycles (absorption cycles)
B. Supply cycles (construction / building cycles)
C. Occupancy cycles
D. Seasonal cycles
E. Property-specific cycles
F. Long real estate cycles
G. Short real estate cycles
V. Financial Market Cycles
A. Capital flow cycles
B. Mortgage term (interest rate / amortization) cycles
C. Debt / equity cycles
D. Mortgage underwriting stringency cycles
E. Securitization / direct investing cycles
VI. Specific Investment Variables: Project / Portfolio
A. Property physical life cycles
B. Property ownership life cycles
C. Rent rate cycles
D. Occupancy cycles
E. Operating expense cycles
F. Capital expenditure cycles
G. Capitalization rate cycles
H. Portfolio mix cycles (timing)
VII. International Real Estate cycles
A. Macro real estate cycles
B. Property specific cycles
C. Currency cycles
D. Trade cycles
impacts on key investment variables in an ex ante framework and provides insight

into some aspect of investment timing or other property/portfolio decisions.
Pyhrr/Born/Webb Inflation Cycle Model

In an inflation cycles study, Pyhrr, Born and Webb (1990) presented a decision
framework and operational model for projecting investment returns for alternative
inflation cycle scenarios and demonstrate their application for developing a dynamic
real estate investment strategy. The strategy developed provides insight into portfolio
revisions during different stages of the inflation cycle. A probabilistic DCF model is
designed and used to inflation-adjust each cash flow variable affected. Mathematical
relationships are developed for specifying unique cash flow variable linkages and
sensitivities, including lead and lag periods, that are consistent with the empirical
evidence of inflation impacts on these variables. The authors engaged in several
empirical studies of two MSA markets, using regression analysis to identify the lead/
lag periods and sensitivity coefficients between inflation and various cash flow
variables such as rents, operating expenses, capitalization rates, reinvestment rates and
required equity IRRs.
The Pyhrr, Born and Webb (PBW) model was based on the earlier work of Klein and
Wolman (1975) and their generalized model of an inflation cycle strategy that
illustrates how an investor should shift a portfolio between real and financial assets
over the inflation cycle in order to maximize wealth over the long run. An adaptation
of the Klein/Wolman (K/W) model (not originally designed to include real estate)
and the general criteria and buy/sell rules for investments, both real and financial
assets, over a hypothetical inflation cycle, is presented in Exhibit 13. Born (1984)
builds on the K/W generalized inflation cycle model and develops the mathematical
framework and algorithms for the later publications discussed here.
An inflation cycle model must be complex and dynamic to be compatible with the
‘‘real world’’ markets they seek to measure. The key inflation linkages that are in the
PBW model, each of which allows for a lead/lag period and inflation sensitivity
relationship to each effected cash flow variable and investor return requirement, are
summarized in Exhibit 14. The key output criteria in the model is the ‘‘real IRR,’’
not the ‘‘nominal IRR,’’ which is posited as the proper measure of return for evaluating
acquisition strategy and timing, optimal holding period and portfolio revision
strategies.
PBW concluded that inflation cycles have very pronounced effects on returns and
risks, but there are some conclusion (e.g., optimal holding period) surprises along the
way due to the dynamic interaction between the inflation and cash flow variables,
which results are neither intuitive or predictable a priori.10 The authors further observe
that there are different optimal portfolio, project acquisition and holding period
strategies that depend on several factors: (1) the slope of the long-term inflation trend-
line; (2) the acquisition period, which defines the position on the trend-line that a
project is acquired; (3) which short-term cycle is forecasted (positive vs. negative sine

Exhibit 13
Generalized Model of Inflation Strategy
General Criteria
n Rising inflation rates: real assets, like commodities, gold and real estate,
perform best.
n Falling inflation rates: financial assets like stocks, bonds, and mortgages
perform best.
General Rules
n Concentrate on investments, the prices of which are out of line with the
expected long-term inflation trend (expected IRR higher than or lower than
comparable investments).
n Point A: inflation rate well above long-term trend and before peak; sell real
assets and buy short-term money market instruments (lock in high interest
rates if possible).
n Point B: inflation rate above long-term trend but decreasing; real assets
liquidated, selling shot-term money market instruments and investing in
stocks and bonds.
n Point C: inflation rate below trend but before trough; sell stocks and bonds
and invest in liquid assets.
n Point D: inflation rate at initial stage of acceleration; liquidated all stocks
and bonds, convert liquid assets to real assets.
*The cycle is idealized for demonstration purposes.
Source: Pyhrr, Born, Webb (1990), page 180.
wave); and (4) the type of portfolio being managed and the ability of the investor to
reposition or shift its portfolio assets quickly to take advantage of short-term (four to
six year) cycles. This type of analysis establishes upper and lower bounds of expected
asset/portfolio performance and the level of investment risk attributable to inflation.
Exhibit 14
Model of Key Inflation Linkages
*Analyst selects one of three options available for reversion calculation.

†Minimum rate may be specified to avoid Keynesian liquidity trap.
Source: Pyhrr, Born and Webb (1990), p. 182.
The authors also conclude that, because of inflation’s fundamental importance as a

determinant of investment returns and risks, cash flow modeling should begin with
an analysis of alternative inflation cycle scenarios, which should be included as
explicit variables in a cash flow model. The investor’s ‘‘assumption base analysis’’
should include an analysis of inflation linkages to each of the critical cash flow
variables, and final output measures of return and risk should always be converted
from ‘‘nominal’’ to ‘‘real’’ terms. Additional research needs to be undertaken to better
theoretically define and empirically test these inflation scenarios and linkages in the
ex ante framework developed, and their impact on investment strategies.
PWB Market Disequilibrium Cycle Model

A year after the PBW inflation cycle study was completed, Pyhrr, Webb and Born
(1990) completed the development of an expanded cash flow model (PWB) that
explicitly incorporates and integrates four types of cycles: (1) property demand and
supply cycles (macro- and micro-market cycles); (2) inflation rate cycles; (3) property
life cycles; and (4) ownership life cycles. In this article, Analyzing Real Estate Asset
Performance During Periods of Market Disequilibrium Under Cyclical Economic
Conditions: A Framework For Analysis, the authors also broaden the types of strategic
decisions addressed by the model, which are categorized into five decision areas:
alternative measures of wealth for evaluating acquisitions, optimal holding period,
solvency and other risk factors, mortgage debt structure, and asset diversification.
The development of this expanded model incorporating four interrelated cycles

presented a unique communication problem. The cycle interrelationships and their
multidimensional impacts on a property’s NOI and value over time could not be
explained with existing terminology. New explanations and cycle terminology had to
be developed, including the following six terms:
1. Equilibrium price cycle. Assuming aggregate supply and demand are in
balance, the average market rent that can be achieved on new
construction over time.
2. New construction market rents. The required market rent rate necessary
to justify new construction and provide a competitive cash flow return to
investors.
3. Property ‘‘relative rents.’’ When the market is in equilibrium, the ratio
of the rent rate that an existing property can achieve relative to a new
property. This ratio declines over time as a property ages (property life
cycle).
4. Equilibrium property rents. Forecast of actual rent rates an existing
property will achieve over time assuming market equilibrium and aging
impacts.
5. Market and property relative occupancy rates. Forecast of occupancy
rates for a specific property being analyzed relative to market occupancy
rates. This factor adjusts the subject property’s competitive position in
the market.
6. Rent rate catch-up cycle. The period of time over which actual rent rates
achieved by a specific property increase to equilibrium property rents,
assuming a market recovery cycle. This cycle is controlled by changing

market demand and introduction of competing new construction.
One unique attribute of every cycle model is the presence of an ‘‘equilibrium’’

concept. It is a dynamic and elusive concept that is conveniently ignored, at least
explicitly, by most DCF models. But it becomes a critical benchmark in every cycle
model, against which an investor or analyst must measure a project’s position and
direction in a cycle. As a practical matter, in a cyclical world the market is never in
equilibrium—it is below it, above it, or just passing through it for a fleeting moment.
In essence, the market tends to be in perpetual disequilibrium. This presents a dynamic
modeling challenge for the analyst who seeks to capture ‘‘reality’’ in a decision model.
In two articles (see Born and Pyhrr, 1994; and Pyhrr, Born, Robinson and Lucas,
1996), the PBW and PWB cycle models are further refined and integrated for use in
a valuation context, as shown in Exhibit 15. The cycle model valuation results are
compared to those produced from traditional borrower and lender ‘‘trend-driven’’
valuation models. These studies conclude that market cycle effects are significant and
can dramatically alter valuation conclusions, especially at the peak or trough of the
market supply/demand cycle. Further, the entire market research process must be
redefined and reorganized to produce information and data for use in cycle models.
Witten Market Cycle Models

Witten (1987) first presented a generalized model of the real estate cycle and identified
characteristics and appropriate strategies to take advantage of the four distinct phases
of the real estate cycle: (1) development; (2) overbuilding; (3) adjustment; and (4)
acquisition. He illustrates that every city has its own cycles, which are unique in
length of time (cycle period) and degree of change (cycle amplitude). Also, local real
estate market conditions do not necessarily reflect national or even regional trends,
but rather are usually unique to the local market. Thus, the soundest indicators of
what the future holds for a given market are the internal dynamics of supply and
demand in the local market. Finally, Witten notes that cycles within different sections
and neighborhoods of a city will vary from the city’s overall cycles, as well as be
different for different property types.
The Witten model measures the supply cycle using local building permit and
construction data, and the demand cycle with employment growth and absorption data.
By indexing each city’s supply side data according to relative degree of overbuilding/
underbuilding (Opportunity Index), and its demand side data according to the relative
degree of weak growth/strong growth (Economic Growth Index), each potential city
that is being considered for investment or development can be graded, ranked and
compared for each property type (apartment, office, retail, industrial). In 1994, he
illustrated the application of his model for grading multifamily opportunities in major-
and mid-markets in the U.S. in 1993/1994, as shown in Exhibit 16 for major markets
(Witten, 1994).

Exhibit 15
Cycle Model Framework and Linkages
Source: Born and Pyhrr (1994), PA.

Exhibit 16
Multifamily Opportunity Grades
Source: Witten, 1994, MPF Research, Dallas, with permission.

In contrast with the PBW and PWB models that focus on project decisions with
portfolio level implications, the Witten model focuses on portfolio decisions with
project level implications. The Witten model focuses on macro supply and demand
cycles in each city, without explicit consideration of project specific variables such as
rent rates, operating expenses and capitalization rates, which together affect project
performance. The model is used to rank cities according to what might be considered
a macro return/risk profile, which then can be used by investors and portfolio
managers as a screening device for determining which cities should be targeted for
implementing acquisition, disposition, or development strategies.
Mueller/Laposa Market and Submarket Vacancy Cycle Models

Mueller and Laposa (1994) developed models for analyzing cyclical vacancy rate
movements in major metropolitan markets and submarkets in the U.S. The Torto
Wheaton database, compiled from the historical records of CB Commercial brokers
in fifty-two markets around the country, is used to track cyclical movements from
1967 to 1993 for thirty-one office markets that make up a majority of the markets of
interest to institutional investors. These data include semi-annual estimates of new
office completions, absorption, total stock, non-farm employment growth, office
employment, vacancy, rent and rent inflation.
The model is based on an equilibrium concept that defines a vacancy rate average
(equilibrium rate) that differentiates positioning and direction for markets (as
previously described and illustrated in Exhibit 7), and a set of decision rules that
become the benchmark for the mathematical model developed. Areas of investment
risk and opportunity, based on the cycle patterns in the twenty-nine of the thirty-one
cities studied, are analyzed using cluster analysis in conjunction with a multiple
discriminate analysis procedure.
The study results show that a majority of the twenty-nine markets experienced a
similar cycle pattern—an upcycle in the late 1960s and early 1970s, a downcycle in
the mid 1970s, and an upcycle in the late 1970s and early 1980s followed by a
prolonged downcycle in the late 1980s and early 1990s with some minor amount of
recovery in 1993–1994. However, many cities do not experience the general pattern
and some are counter cyclical to the general pattern. Also, the timing and amplitude
of each cycle varies from city to city, and successive cycles do not necessarily follow
the pattern of previous cycles. Some cities are clearly more risky than others (higher
peaks and deeper troughs, or greater amplitude). The authors conclude that timing
acquisitions and dispositions, and setting leasing strategy should be easier after a city’s
cyclical pattern is identified. Since market cycles are not similar to previous cycles in
either period (length) or amplitude (magnitude), however, investors and portfolio
managers should look for underlying factors that cause variations in cyclical period
and amplitude as an aid to predicting future cycles. From a strategic portfolio
viewpoint, markets should be targeted that will be at the most advantageous part of
their cycles for the holding period projected.
The Laposa and Mueller (1994) submarket cycle model, an adaptation of the MSA
market model described earlier, was developed to study the cyclical behavior of
submarkets relative to the overall market as a whole. Office markets and submarkets
in Philadelphia, Seattle and Salt Lake City were compared by investigating the
correlation of rental rate, completions, absorption and vacancy rate movements, using
multiple discriminate analysis on the correlation matrices of these variables. Exhibit
17 shows the positioning of markets from 1989 to 1993 relative to market equilibrium.
Only Salt Lake City achieved a position above the market equilibrium line during this
period, and led both Seattle and Philadelphia out of the recession phase of the cycle.
The study concludes that different cities and submarkets exhibit different behavior,
and to the extent that cycle phases, amplitudes and periods are different or counter
cyclical, the returns and risks are also different. Thus, the timing of acquisitions and
dispositions, and the portfolio mix of different market/submarket areas can be
optimized to enhance investment performance over time. Although this analysis is
based on historical data (ex post rather than ex ante) and is limited to office properties,
the strategy implications of utilizing this type of analysis in an expectations (ex ante)
framework are significant.
Mueller/Laposa Rent Growth Rate and Rent Distribution Models

In 1996 and 1997, Mueller and Laposa built on their earlier vacancy cycle modeling
work by adding a rent growth rate and rent distribution variable. The Mueller and
Laposa (1996), and Mueller and Pevnev (1997) studies test the relationship between
different market cycle phases (as measured by the vacancy rate) and their impact on
rent growth rates and the distribution of rent growth rates for fifty-four office and
industrial markets in the U.S. (from 1967 through 1995). The model results confirm
that rental growth rates are quite different during different physical market cycle
positions—increasing during an upcycle and declining during a downcycle. Further,
the distribution of rent growth rates varies by cycle position, with distributions
narrowing during an upcycle and widening during a downcycle.
Exhibit 18 illustrates the model results for office rent growth distributions and average
rent growth rates for sixteen different positions on the occupancy cycle. The
methodology used to arrive at these results involved three steps that were completed
for each market studied. First, an equilibrium vacancy rate was calculated according
to the Mueller/Laposa methodology (1994); actual vacancy rates for the market were
then compared to the equilibrium vacancy rate in order to identify specific points
along the cycle for each time period. Second, the market cycle was segmented into
sixteen points and each year for each market was assigned to a market cycle point
one through sixteen. Third, market cycle points were connected to the growth rates
for each year and for each market; then the aggregate growth rate for each cycle
position was calculated and the distributions examined. The same procedure was
followed for fifty-four industrial markets.
The Mueller and Laposa model and results are valuable to investment decision makers
because it provides them with a new empirical tool for estimating more accurate rental
growth rates over a forecasted market cycle, which are needed for inputs into the
discounted cash flow programs used by real estate investors. As noted in the PBW

Exhibit 17
Positioning of Three Markets and Their Submarkets From 1989 to 1993
Source: Laposa and Mueller (1994).
and PWB cycle models, the relationship between occupancy rates and rent growth
rates over time must be specified and forecasted correctly if accurate return and risk
measures are to be estimated by the cycle model.
Roulac/Sobolik Tax Policy Model

In 1985, there was considerable debate about tax reform proposals. This debate was
ultimately consummated in the 1986 tax reform act that had extremely adverse
implications on the historic favored tax treatment of real estate. During this time
period, Roulac and Sobolik (1985) presented a long-cycle historical perspective on
real estate tax policy. By considering the interdependency of the relative impacts of
tax rates, depreciation and tax structuring elections over time, the relationship between
tax-related benefits and economic (non-tax) benefits of owning real estate over the ten
major tax acts from 1939 through 1984, including the 1985 proposal (that became
law in 1986), were quantified. The long-cycle real estate tax relationships are
illustrated in Exhibit 19.
Roulac and Sobolik asserted that the mid-1980s were characterized by an ‘‘ever-
changing tax environment.’’ Investors should understand that ‘‘although new tax laws
Exhibit 18
Cycle Positions and Rental Growth

Exhibit 18 (Cont’d.)
Cycle Positions and Rental Growth
influence investment decisions, they neither impose penalties nor confer benefits on
new investors. Those who win or lose as a result of tax changes are those who own
assets when a new tax law is passed.’’ As previously discussed, short and long cycles
involving tax law changes are cycles that must be carefully evaluated and weighed in
terms of their potential impact on investment returns and risks.
Roulac Market Forces Model

Roulac (1993) advanced a model to promote understanding of the interconnectedness
of the multiple cyclical forces that determine real estate market results. For each of
six four-year periods, from 1972 through 1995, eight basic measures of real estate
markets, including the overall economy, office demand, construction, property values,
volume of transactions, debt capital available for speculative real estate, equity
investor interest and tax incentives, were addressed. The interaction of these eight
factors for the commercial real estate market is depicted in Exhibit 20.
The Roulac market forces model vividly illustrates that ‘‘the condition, activity and
direction of change of the multiple and divergent real estate markets are influenced
by a multitude of cyclical forces. Sometimes many market segments move in a
common direction, while at other times, some market segments thrive at the expense
of others.’’ Additional assessments for the major capital sources, including pension
funds, financial institutions, foreign investors, securities and corporate investment,
Exhibit 19
Long-Cycle Perspective on Real Estate Tax Policy
Source: Roulac, Stephen E. and Douglas E. Sobolik, Real Estate Tax Reform: Historic Perspectives
and Economic Implications, Real Estate Finance (Summer 1985), p. 19.
were provided. Further, the implications of these market cycles were addressed for
space users, real estate services providers, developers and the public sector.
Global Real Estate Cycle Models

The past decade has been a period of globalization in the world’s financial and
investment markets. Not only has access to international investment data broadened,
and barriers to cross-border investment been eased, but the highest rates of return
have been achieved through investments in emerging markets (Goetzmann and
Wachter, 1994). While these statements were made in the context of non-real estate
types of investments, these trends are generally considered to be true for real estate
as well. Real estate investors and portfolio managers can no longer ignore the
implications of global business and real estate cycles and their impact on real estate
returns and risks.
The opportunities for developing global real estate cycle investment models are
enhanced as more and better quality data are becoming available from such
international research firms as Jones Lang LaSalle Research, CB Richard Ellis
Research, the Prudential Realty Group and the International Property Bulletin (Baen,

Exhibit 20
Commercial real Estate Market Cycle Factors
1972–1975 1976–1979 1980–1983 1984–1987 1988–1991 1992–1995
Economy Begins with stall, Recovery Strong recovery, Strong expansion Growing sense of Constraints
ends with recession followed by fragility, followed imposed by surplus
recession in 3rd Q by recession 1991 of capital goods
1992 and excess debt
Office Demand Weak Strongly growing Strong (relative to Very strong Sharply Declining Stagnant
construction)
Office Construction Strong Limited Strong upsurge Extraordinary boom Starts strong Sharp slowdown
because of pipeline
projects, then
sharply declines
Property Values Sharp decline Prices surge Strong Price escalation Prices decline Declines continue,
appreciation stalls in 1986 and then stabilize
reverses in 1987
Volume of Begins brisk, ends Moderate Brisk Very brisk Substantially Moderate
Transactions restrained reduced
Capital for Real Begins difficult to Readily accessible Extremely easily Not readily Extremely difficult
Estate Begins fairly come by, ends fairly accessible accessible to come by
REAL ESTATE CYCLES AND THEIR STRATEGIC IMPLICATIONS
accessible, ends accessible

difficult to come by
Investor Interest Begins strong, ends Beings restrained, Strong and Softens in 1986 Begins cautious, Begins reluctant,
weak ends moderate growing ends nonexistent ends selective
Tax Climate Uncertainty about Elimintion of Extraordinary End of real estate Lack of tax Reintroduction of
tax reform favorable capital stimulus from stimulus in 1986 incentives felt incentives to
gains treatment 1981 tax reform tax reform stimulate economic
(1976) recovery
Source: Roulac, Urban Land, August 1993.

53
1994, 1995). Although the risks of investing in properties in foreign countries can be
substantial, the potential returns can also be higher on a risk-adjusted basis than
available in U.S. property, and depend substantially on the differences between cycles
of each country.
Following the completion of the ‘‘first global real estate cycle’’ of 1985–1994, which
includes the worldwide real estate crash of 1992, the academic community and the
commercial real estate industry has renewed and increased their interest in
international real estate investing. Renaud (1997) suggests that closer links between
real estate and capital markets and less restricted flow of capital spread the value cycle
of real estate to a global dimension. Dehesh, Egan and Pugh (1995) in their extensive
examination of world markets, study the causes of modern property cycles from three
perspectives: endogenous causes and processes, exogenous instabilities and structural
economic change. They conclude that cycle causes are varied, including interaction
between deregulated finance, increasing internationalization of finance and economic
relationships, and fundamental economic conditions such as varied rates of savings,
interest rates and uncertainties about currency exchange risk.
An early work by Baen (1994) develops a generalized risk analysis model and decision
matrix for global property investments presented in Exhibit 21. His research advanced
the theory that there is one generalized, theoretical property cycle and that each
country, and each property market, is located discretely on this ‘‘conceptual’’ cycle.
Through a combination of interview techniques with participants in the World
Congress Assembly, along with objective study of each country’s economic data, Baen
developed a generalized world real estate cycle model and located each country on
that cycle (1994) in the context of five market phases: (1) recovering markets; (2)
improving markets; (3) maturing markets; (4) overbuilt markets; and (5) falling
markets, as illustrated in Exhibit 22. In a subsequent related paper, Baen (1995),
advocates the development of a world property index and standard data collection
methodology and reporting system for systematizing the study of market cycles
throughout the world.
Although global real estate cycle modeling is in its infancy, additional research and
development of global cycle models and strategies will be accelerated in the future
and promises to produce high returns to those investors who learn how to utilize the
information in structuring their global investment portfolios.
Strategic Implications
Given the state of the art of cycle theory, analysis and modeling, and the few empirical
studies that are based on limited and often flawed data, what can one conclude about
the strategic implications of cycles for investors and portfolio managers? First, we
have noted that ‘‘cycles and their predictability’’ is one of the key subjects that
investors and portfolio managers (worldwide) are interested in, as indicated by 685
plan sponsors who control over $500 billion of assets. Second, it is clear that
individual and institutional investors will be placing greater emphasis in the future on
strategies that explicitly consider real estate cycles and their underlying determinants.

Exhibit 21
A Theoretical Approach to Global Property Investments, Decision Matrix and
Risk Analysis
Source: Baen (1996:74).
In the following two sections, strategy implications for investors and portfolio
managers are addressed and discussed.
Strategic Implications for Investors

The strategic implications of cycles for investors has been discussed throughout this
study, and can be summarized in the following eight points:
Exhibit 22
Synchronicity of Various Real Estate Markets
Overbuilt
Markets
Maturing
Markets
Falling
Improving Markets
Markets
Recovering
Markets
Note: Assumes each country is somewhere on the same conceptual property cycle. Real Estate
Cycles at each location may vary in amplitude and velocity (time) as each market is unique.
Source: Baen (1996:78).
n The impact of cycles on real estate performance and wealth is dramatic.

It may be the most important strategic concept to deal with in the
investment world for investors who seeks to maximize wealth,
outperform the competition and beat the market average—or even for
investors who are happy to be ‘‘average.’’
n The basic strategy is to buy at the bottom of the cycle and sell at the
top. But, that achievement is not easy given the number of different
types of interrelated cycles that must be dealt with, the lack of good
data, models, forecasting techniques, and the dynamic and complex
nature of most markets and submarkets.
n Cycles affect an investor’s acquisition and disposition strategies, and
the optimal holding period of each investment. These strategies will
change depending on which city, submarket and property types are
targeted by the investor.
n Depending on the cycle projections made, the investor will develop
different optimal strategies for leverage, lease structures, capital
expenditure plans, and operating policies. For example, if an industrial
market is ‘‘hot’’ today but a downturn is expected in two years, leases
can be structured on seven–to ten–year terms and designed to attract
credit tenants who are not likely to default during the downturn. Using
this strategy, current high rent rates at the top of the cycle can be locked
in, allowing the investor to ‘‘leapfrog’’ the market downcycle and
recovery period. In addition, the investor might also refinance this low-
risk property at its ‘‘top of the market’’ value with a 75% non-recourse
loan with a ten–year term, then use the refinancing proceeds to establish

a substantial liquidity fund for use during the downturn when distress
properties can be purchased at distressed prices.
n Analysts must alter the nature and scope of their market research and
types of data that needs to be collected and analyzed. Cycles affect the
direction of market research and the questions that need to be answered
by researchers. Market researchers must collect information and market
data that enable investors to identify economic scenarios that better
reflect cyclical economic realities in real estate markets, then translate
those economic scenarios into input values and assumptions for
investment analysis.
n Analysts must restructure their cash flow models used to evaluate
projects and portfolios. Investors must model the dynamic linkages
between investment variables, lead/lag periods, rent-rate catch-up
cycles, equilibrium benchmarks, etc., in order to estimate rate of return
and risk parameters that reflect the economic cycle scenarios forecasted,
and which form the basis for property and portfolio decisions.
n Cycles affect the types of properties purchased and the countries, states,
cities and submarkets where investments are made. The investor must
now be more mobile and cognizant of constantly shifting returns and
risks associated with different geographical locations and property types.
n Investors must change their view of the world. The view must be away
from trends, herd mentality and perpetuity capitalization models, and
toward a cycle view of the world—one that is dynamic, constantly
changing, never in equilibrium (except perhaps for an instant), and
where flexibility and a degree of contrarianism is important for
investment success.
Strategic Implications for Portfolio Managers

With regard to strategic implications for portfolio managers, eight points should be
stressed:
n All of the above eight conclusions apply. Portfolio managers are

fiduciaries for investors, and although they have many more constraints
than entrepreneur investors, they should adopt the same cycle framework
and strategic viewpoint.
n New paradigm for portfolio diversification. In order to enhance return
performance and/or reduce risk, portfolio managers should develop
strategies to diversify by countries, cities and submarkets that have
different macro cycles and micro cycles. Acquisitions and dispositions
should be timed to capture the upsides of cycles of different property
types and locations, and avoid or minimize downcycle impacts.
n More dynamic portfolio revision strategy. Portfolio managers must be
willing to develop a more fluid and dynamic portfolio. They must be
willing to shift from real assets to financial assets in a declining inflation
rate market, and vice versa. They must reorganize their staffs to
eliminate some of the bureaucracies and turf battles that frequently occur
between departments and specialists who are product type and
geographical location advocates.
n More future oriented. Decisions should be based on forecasts of things
to come, rather than historical data that provides an optimal portfolio
mix on the ‘‘efficient frontier’’ for a cycle phase that is history, and
which results in buying high and selling low.
n Further development of theories and models. Cycle theories and models
must be developed and adapted to a portfolio management system.
n Adaptation of new technologies. Portfolio managers must introduce new
technologies and software systems that exist so that cycles can be
analyzed in a portfolio context. To be successful, these technologies and
systems must adapt to existing on-site property management and
accounting systems, reporting procedures and portfolio management
organizations. Specifically, integrative technologies that link individual
properties and local financial analysis and reporting systems, to the main
frame portfolio model in the corporate office, are needed. An Austin-
based high-tech software company, Express Star Systems has pioneered
such an integrative technology, which is based on artificial intelligence
systems developed at MCC (Microelectronics and Computer
Consortium, a joint research effort funded by the federal government
and the major high-tech companies in the U.S.), and which has been
field tested with a number of major real estate firms.
n Better forecasting models, techniques and data. Most of the cycle
research being undertaken in the industry is typically based on historical
data. For example, the latest work by Mueller/Laposa is constrained by
an ex post framework and historical data, without a definitive strategy
for converting to an ex ante framework and model that uses forecast
data. Further, their cycle strategy conclusions are based on a cycle
construct that defines the vacancy rate as the key measure of the real
estate cycle, as contrasted with property value (as Pyhrr and Born
suggest) or more sophisticated total return and risk measures.
n Allocation of more time and money for research. Portfolio managers and
investment advisors must spend more time and money on research of
cycles, models, databases, forecasting technologies and applications, and
strategic implications, and should focus on property value as the most
critical indicator of the cycle and component of property return.
Another suggestion for researchers who seek to better understand the dynamics of
real estate cycles and strategies that take advantage of cycles, is to turn some attention
to behavioral studies of individuals and entities who have utilized successful cycle
strategies in the past. Much can be learned from successful entrepreneurial investors
who have lived through numerous cycles and who understand the dynamics of their

local marketplaces. Other behavioral considerations are addressed in the following

section.
Implementing Real Estate Cycle Strategies: Behavioral Considerations

While the strategic implications of real estate cycles for investors and portfolio
managers are straightforward, implementation of the concept of real estate cycles into
investment decisions can be very complex, because of the interdependency of multiple
cycle phenomena. Notwithstanding this implementation complexity, three crucial
interdependent themes need to be considered by investors and portfolio managers who
would incorporate the lessons of real estate cycles into their investing strategies—
detachment, persuasion and flexibility.
Detachment. Detachment is needed to have the independence of perspective to perceive
how real estate cycles influence a specific real estate decision. Because real estate
cycles are much more readily recognized on a posteriori rather than a priori basis,
inevitably the detachment to recognize real estate cycles parallels contrarian thinking
concerning market conditions and future outlooks.
Persuasion. Once one has determined the applicability of real estate cycles to justify
a particular decision, the next challenge is the persuasion to motivate those who must
decide amongst alternative resource allocation opportunities to act. This persuasion
challenge can be daunting, since the action sought will often be directly contrary to
consensus thinking and what is perceived to be consistent with the collective ideas of
the majority of market participants. Those who possess the detachment to perceive
the implications of cycles are in the minority, and those who can combine that
detachment with the persuasion skills to motivate senior executive and board decisions
as well as to attract institutional investors’ capital commitments are a still smaller
minority.
Flexibility. The real estate investors and portfolio managers who would incorporate
real estate cycles insights into their business must be both flexible in how they pursue
certain fundamental tasks, such as leasing, and also in the relative priority and
emphasis directed to different real estate business activities. Flexibility concerning
leasing takes the form of customized leasing rates and terms, tenant selection criteria
and duration. The role of flexibility follows from assessment of market conditions. In
particular, in markets that are perceived to be moving strongly upwards (recovery or
expansion phases), lease terms might be less stringent, leases might be of shorter
duration and tenant assessment criteria more relaxed. In softening markets (contraction
phase), by contrast lease terms would tend to be more demanding and of longer
duration; stronger tenant quality and credit strength would be emphasized.
Depending on market cycle conditions, investors and portfolio managers might move
between an emphasis on buying troubled existing properties, land investment and
development opportunities, as markets move from very weak (trough of cycle) to
strengthening (recovery) to strongest (expansion) levels. Similarly, as markets are
weakening (contraction phase), development involvements would be reduced, land
positions sold, both to mitigate downside exposure and also to free resources to
respond to future opportunities to purchase properties on advantageous terms.
Effectively implementing the shift of emphasis between opportunistic purchase of

problem properties, asset management, land acquisition, development and building
may strain the orientations and capabilities of many investors and their advisors.
Although a common collection of market knowledge and research expertise is needed
for such decision making, from the implementation and operations perspective many
investors and portfolio managers would be challenged to redirect the organization’s
resources from the extremes of highly creative and entrepreneurial activities to those
that are more managerial operations-oriented. The organizations that can effectively
marshal such realignment of capability are many fewer than those that possess
particular distinctive competence in the specialized domains of investment in troubled
properties, implementing, acquiring and managing existing income property portfolios,
engaging in land acquisition and development, or pursuing new development projects
through construction and lease out.
For those individuals and organizations who have multiple capabilities, pursuing
different types of involvements in multiple real estate investment markets, the reality
of cycles offers the opportunity to have certain parts of their business perform better
in certain market conditions than in other market conditions. Beyond the recognition
that some parts of the business will prosper relatively while others are suffering
relatively, those investors and portfolio managers that have the capability to shift their
mix and emphasis over time should enjoy superior results over those who do not.
Conclusion
Real estate cycles have a significant impact on the financial successes and failures of
real estate investments because of their pervasive and dynamic impacts on real estate
returns, risks and investment values. Because of this recognition, investors and
portfolio managers are placing increased emphasis on the identification, analysis and
decision-making implications of real estate cycles. In one recent study of 685 real
estate plan sponsors, the results show that approximately 40% of the sponsors rated
Real Estate Cycles and Their Predictability as the most important research topic that
should be studied, and 80% rated it among the top three. Despite recent interest in
the subject, there remains a group of academics and industry practitioners who believe
that real estate cycles are not relevant and therefore can be ignored.
The purpose of this study is to synthesize relevant research and commentary on real
estate cycles in a micro-decision-making context and to discuss their strategic
implications for investors and portfolio managers. The study includes an extensive
review of the macroeconomic, microeconomic and practitioner literature on cycles,
which evidences the growing interest in real estate cycles at all levels of decision
making. While in the past, the concept of market cycles has been oversimplified and
used more to support self-serving assertions about market recovery than as a guide
to investment decisions, increasing numbers of decision makers appear to understand
the dynamics and complexity of real estate cycles and their strategic implications.

Also, there is a growing recognition of the importance of global real estate cycles,
which is given special emphasis in the study.
The second major section of the study presents the basic theory of cycles, including
a discussion on cycle definitions, the basic mathematical sine-wave construct, cycle
phase nomenclature and economic characteristics, and cycle concepts. The nature and
dynamics of real estate cycles are examined, and the many different types of
interdependent cycles that affect real estate performance are identified, and strategies
for dealing with these multiple interrelated cycles are presented. Successful cycle
strategies that achieve above-market risk-adjusted returns are said to be dependent on
the key ingredients of good market timing and a degree of contrarianism—a
willingness to follow a path contrary to that of the masses. Investments must be bought
and sold before cyclical impacts are fully reflected in real estate prices and activity.
Few studies have sought to model cycles on an ex ante basis and measure their
resultant impact on cash flows, rates of return, risk, and investment and portfolio
decisions. The following section of the study reviews eight such models that have
been developed in the 1990s. Each presents an analytical definition of cycles, seeks
to measure cyclical impacts on key investment variables in an ex ante framework and
provides insight into some aspect of investment timing or other property/portfolio
decisions. The modeling studies highlight the need for: (1) beginning each investment
analysis by identifying alternative economic scenarios that represent cyclical market
realities; then (2) developing an ‘‘assumption base analysis’’ that identifies and
quantifies the important linkages between cyclical economic variables at the macro
level with supply and demand factors at the market and submarket levels, and finally
with specific cash flow variables in a DCF model. Empirical studies, using regression
analysis and factor analyses to identify lead/lag periods and sensitivity coefficients
between variables (such as price inflation, rents, vacancies and capitalization rates),
can be conducted for developing these key linkages in a cycle model. Global real
estate cycle modeling, while in its infancy, is another important subject addressed in
this section of the study.
The final major cycle topic addressed in the study is strategic implications for investors
and portfolio managers. Among the key implications for investors are: (1) cycles affect
acquisition and disposition strategies, and the optimal holding period of each
investment; (2) different optimal strategies for leverage, lease structures, capital
expenditure plans and operating policies will depend on the cycle projection made;
and (3) the nature and scope of market research, the types of data collected and
analyzed and the structure of cash flow models need to be redesigned to accommodate
cycle analysis. Among the key implications for portfolio managers are: (1) a new
paradigm for portfolio diversification is required to correctly time acquisitions and
dispositions in different countries, cities, submarkets and for different property types;
(2) adaptation of new integrative technologies and software systems is needed so that
cycles can be analyzed in a portfolio context that links together individual properties
and local reporting systems to the main frame portfolio model; and (3) investment
managers need to understand the behavioral considerations for successfully
implementing real estate cycle strategies in institutional organizations that do not
readily accept ‘‘out of the box’’ thinking and flexible strategies that require decisive
action on a timely basis.
Agenda for Future Research

The body of knowledge on real estate cycles and cycle strategies, as presented
throughout this study, provides some insight regarding the focus of previous efforts
to study real estate cycles. The preponderance of research has clearly focused on
macro issues and cycles, (inflation, long and short real estate cycles, business cycles,
etc.) with the more micro issues and cycles (occupancy and rent growth, investment
decision modeling, portfolio strategies) gaining momentum and popularity in recent
years. Continued emphasis on the latter micro subjects and cycle issues will produce
the greatest rewards for researchers in the near term future, in our opinion. Specific
applications to property and portfolio decisions in an ex ante decision framework
should especially be emphasized.
A cycles research agenda for the future should emphasize the following seven subject
areas:
1. Theory. Cycles are dynamic, complex and interrelated, thus are difficult
to study. To date, the theory of real estate cycles is not well developed.
Research emphasis should be placed on all aspects of cycle theory,
especially on the integration of macro and micro cycle theory in a
decision-making framework.
2. Empirical research. Very little empirical research has been published to
guide the study of cycles in a micro-decision-making context. Extensive
research is needed on the critical linkages between economic factors and
cash flow variables, including properly specified empirical models to
determine the mathematical relationships between critical variables.
3. Market information and data. Available market data is generally of poor
quality and often unreliable. In addition, market information is not readily
available for modeling alternative economic scenarios or for performing
the empirical research described above. There is a critical need for
systematic collection and standardization of real estate market data for
cycle analysis.
4. Forecasting techniques. Shifting analysis to an ex ante cycle framework
requires the development of forecasting and estimation techniques not
commonly used in real estate analysis today. Since all exogenous factors
cannot be quantitatively measured, qualitative variables also need to be
integrated into realistic frameworks for evaluation of future economic
and market scenarios.
5. Project and portfolio modeling. Project and portfolio models that
incorporate cycles and their impact on returns and risks need substantial
development to be useful to decision makers. Models should include
linkages between macroeconomic factors and investment cash flow
variables, and explicitly provide for sensitivities and lead/lag
relationships.

6. Strategic frameworks. Strategic and analytical frameworks for investment

decisions that incorporate cycle concepts and strategies need to integrate
all of the above considerations, in addition to other investment
alternatives such as stocks and bonds in a mixed-asset portfolio, as well
as global real estate alternatives.
7. International/global cycles. Further studies of global cycles and
property-specific cycles (office, retail, industrial, etc.) among countries
are needed to better understand the relationships between physical market
and capital market cycles in those countries. The impact of international
portfolio diversification on portfolio returns and risks is another
productive area for research.
Concluding Comment
We consider this study to be a pioneering attempt to synthesize the body of knowledge
on real estate cycles (primarily in North America) and to develop a strategic
framework for thinking about real estate cycles in a micro-decision-making context.
Clearly, the development of an analytical framework and models for cycle analysis
involves numerous interrelated and unresolved theoretical and analytical problems.
Nevertheless, we hope that it is obvious what the benefits will be of further research
in the seven areas described, both to real estate academicians and practitioners.
It is important to explicitly and systematically incorporate real estate cycles into the
investment and portfolio management framework so that the mathematics of cycles is
not left to the four horsemen of the implicit decision-making apparatus: judgment,
hunch, instinct and intuition. Further, it is hoped that such explicit and systematic
study of cycles will result in cycle relevancy—making better decisions that result in
greater wealth over the long run.
Endnotes
1
In 1998, Equitable and Yarmouth were merged, this time with the Australian-based firm Lend
Lease Real Estate Investments, Inc., which became the surviving entity.
2
This study draws primarily from published literature in the U.S., although a growing body of
cycles research is also available in European, Asian, and Pacific Rim journals, conference
proceedings and industry publications. The authors are developing a database and bibliography
on real estate cycles by authors who publish their research outside the U.S.
3
The seminal work on efficient capital markets was presented by Fama (1976). The underlying
assumption is that price fully reflects information at each point in time and that all information
is freely available to everyone and, thus can be known by all market participants (Fama and
Miller, 1972).
4
For a discussion on the three types of long cycles identified, see Downs (1993).
5
‘‘Standard procedures’’ for modeling of office markets refer to models developed by Rosen
(1984), Wheaton (1987) and Wheaton and Torto (1988).
6
The Royal Institution of Chartered Surveyors (1994:7), quote by Howard J. Sherman on ‘‘The
Business Cycle.’’
7
These are the basic physics and engineering cycle characteristics definitions. There are a few
others that come from mathematics and economics. The slope of the path of the wave changes
over time. In Exhibit 6, this is measured by the first derivative of the sine with respect to time
or the angle of rotation; this mathematically is d(sine) / dt, where t is in radians of rotation. Note
that at p / 2 radians or 90 degrees, the slope is zero, which in this case, is the maximum or
peak. A minimum or trough occurs at 3p / 2 radians, or 270 degrees (there are 2p radians in
one rotation or one cycle). In physics this is referred to as the speed or velocity. Note that the
speed of excursion from the abscissa is zero at the peak and trough; the direction is being
reversed. From the zero radian point the slope gradually decreases from some positive slope to
zero at the peak, continuing to some maximum negative slope, then begins to return toward
zero slope at the trough. The point at which the rate of change of slope is zero is the inflection
point; and d 2(sine) / d 2t equals zero at that point and the absolute value of d(sine) / dt is maximum
positive on the path to a peak and maximum negative on the path to a trough. Also note that
when d(sine) / dt is minimum, d 2(sine) / d 2t is maximum. D 2(sine) / d 2t is the acceleration (change
in velocity) in physics. In the sine plot in Exhibit 6, the second derivative is zero as the path
crosses the abscissa either rising or falling. This can be likened to a piston in an automobile
engine in which acceleration forces are maximum at top and bottom dead center; that is where
the direction of piston movement has to be stopped and reversed. Other types of waves may
have inflection points that occur at some point other than where the path crosses the abscissa.
Now, this physical and mathematical explanation needs to be translated to real estate economics.
We may view that portion of the path between trough and subsequent peak as a real estate
upcycle (recovery and expansion phases) and that portion between peak and subsequent trough
as a real estate downcycle (contraction and recession phases).
8
Note that other researchers use rates of return, vacancy rates, absorption, construction starts
and other measures for identifying various phases of the cycle, depending on the focus of the
study.
9
See Pyhrr et al. (1989:498).
10
An example is disposition timing during a period of disinflation (declining inflation). ‘‘Caught
in a downside inflation cycle, an investor might feel that cutting losses short and disposing of
a property quickly is the best strategy. However, the analysis indicates just the opposite strategy
can result in a higher real IRR,’’ (Pyhrr, Born and Webb, 1990).
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Journal of Real Estate Research

ISSN: 0896-5803 (Print) 2691-1175 (Online) Journal homepage: https://www.tandfonline.com/loi/rjer20

Real Estate Cycles and Their Strategic Implications

Stephen Pyhrr, Stephen Roulac & Waldo Born

To link to this article: https://doi.org/10.1080/10835547.1999.12090986

Published online: 17 Jun 2020.

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Real Estate Cycles and Stephen A. Pyhrr*

*SynerMark Investments, Inc., Austin, Texas 78731 or spyhrr@synermark.com.

VOLUME 18, NUMBER 1, 1999

The Relevancy of Cycles

Comprehension of cycles, specifically understanding, planning for and exploiting

With growing contemporary interest in both history and futurism, reflected by an

The Case for Ignoring Cycles

Distinction between Macroeconomic and Microeconomic Literature

VOLUME 18, NUMBER 1, 1999

levels. This classification also includes comparative analyses to identify investment

Cycle Relevance: Macroeconomic Literature

VOLUME 18, NUMBER 1, 1999

Recent thought regarding the implementation of counter cyclical monetary policies to

Downs’ (1993) work concluded that differences in equilibrium vacancy rates in

VOLUME 18, NUMBER 1, 1999

be expected to be important in the future. He evaluated real estate markets influenced

VOLUME 18, NUMBER 1, 1999

Cycle Relevance: Microeconomic Literature

A number of authors have addressed the strategic importance of measuring the

VOLUME 18, NUMBER 1, 1999

research (i.e., through an objective evaluation of current and projected market

Pollakowski, Wachter and Lynford (1992) suggested that it was inappropriate to

VOLUME 18, NUMBER 1, 1999

In a follow-up study, Clayton (1997) evaluated condominium housing price cycles

VOLUME 18, NUMBER 1, 1999

Cycle Relevance: The Practitioner Literature

VOLUME 18, NUMBER 1, 1999

Security of Income Growth-Oriented

Opportunistic Growth Balanced Income

R&D/Flex Hotel (Limited Service)

Apartments Power Center

Hotel (Full Service)

2nd Tier - Regional Mall

VOLUME 18, NUMBER 1, 1999

Office & Industrial Market Cycle Analysis

Cycle Relevance Conclusion

Basic Theory of Cycles

VOLUME 18, NUMBER 1, 1999

many things—such as rental growth, absorption, vacancy and construction activity—

The Basic Mathematical Construct

Cycle Phase Nomenclature and Economic Characteristics

Fundamental Cycle Concepts

For example, an investor’s strategy (Step 1) will define cycle-determined investment

VOLUME 18, NUMBER 1, 1999

Source: Mueller and Laposa (1994).

As previously concluded, virtually every phenomenon in social affairs, political

Economic Characteristics of the Real Estate Cycle (Pritchett, 1984; Wheaton,

VOLUME 18, NUMBER 1, 1999

Source: Pyhrr, Cooper, Wofford, Kapplin and Lapides (1989:90).