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The Psychology of Real Estate Market Cycles

December 20, 2022

Implicit in the term “cycle” is that the real estate market is constantly in a state of flux.

Real estate market cycles are specific to a submarket and property type.


They are also specific to classification (A, B, C, or D) within a property type within a submarket. So, in most cases, it is out of context to simply state that industrial pricing is increasing, or office pricing is decreasing.


Office demand could be increasing in a suburban submarket and decreasing in an urban submarket, for instance.


Furthermore, within a suburban submarket, Class A office may be in a completely different phase of the cycle relative to Class B.


National trends rarely perfectly reflect what is happening in a given submarket.

Nor do they account for the variability of consumer behavior; thus, it's important to be critical of the information we consume and apply to the markets we serve.

Why understand submarkets and property types?

As appraisers, our job primarily includes market analysis.

Therefore, identifying where we are in the cycle is at the crux of our profession.


Other reasons why identifying where a market is at in the cycle include:


  • How long a valuation may be relevant or reliable 

  • Absorption rate for new or currently vacant supply

  • Where future competition may come from

  • What capitalization rate may be applicable to current income

  • What yield rate may be applicable in discounted cash flow

  • What rent growth (or decline) to expect during holding period


Power of the consumer mindset.

There are many external influences on property value included, but not limited to: changes in interest rates, overbuilding or underbuilding, changes in tax laws, changes in construction costs, population shifts, job creation or loss in a local or regional economy, changes in effective buying power, and market participant psychology.

Market psychology arguably affects commercial pricing more than the other factors, essentially driving markets through the four phases of the cycle: recovery, expansion, hyper-supply, and recession.


Unlike investors in bonds and stocks, however, some commercial property owners prefer to force appreciation through their operating expertise. Therefore, an argument can be made that market psychology influences value-add investors less, because they are always in the market searching for deals.

Nevertheless, a buyer or sellers’ perception of the market – whether rational or irrational – will positively or negatively influence their decision-making calculus.

Most influential based on the way we now consume media, is that one's perception may be materially influenced by national trends that have little or no applicability to the participants property type or submarket.

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How the two markets affect the cycle

There are two markets that influence the cycle: the physical market and the capital market. 

1. Physical market analysis answers the question: How much demand is there for space among users? 

2. Capital market analysis answers the question: How much demand is there for investment properties among investors? 

The physical market is influenced by changes in employment, population growth, and effective buying power. It is the interaction between users (demand for space) and developers/owners (supply of space) in an individual market.


With exception to residential property types, the physical market is influenced by demand among businesses. An individual business space requirement may or may not be consistent with the overall market trend for that property type in that submarket.


For instance, office may be overbuilt in a submarket in which multiple companies are breaking ground on an office development during a recessionary or recovery period whereby building is not financially feasible.

The physical market for most commercial real estate asset classes is incredibly inefficient as a lack of transactional data precludes our ability to discern the state of the market cycle in real time - also known as inefficient price discovery.


Simply put, with most commercial real estate property types, there are typically not an abundance of sales of a particular property type in a given submarket during a short period of time to assert with a high degree of certainty where the property type is trending in pricing.

Contrast that with market pricing in the residential market cycle and the stock market. Both exemplify efficient price discovery, which is based on plentiful transactions and timely data. 

Furthermore, shifts in CRE pricing generally occur over a long period of time as buyers and prospective tenants are typically accustomed to benchmark values or metrics in a given submarket.


These benchmarks are reimagined over time given outlier transactions which are retroactively understood as the beginning of market shifts. Only in hindsight can we recognize these once outlier transactions were the start of a larger market trend.

In the capital markets real estate investment competes with bonds, stocks, mutual funds, venture debt, hedge funds, among other vehicles. Real estate uniquely benefits from depreciation write-off and is uniquely diversified in that the return of and on capital can come from increasing net operating income (physical market) or price appreciation (capital market), respectively.

For these reasons, many investors aim to allocate a portion of their holdings in real estate.

The essential role of buyer confidence 

Ultimately, many commercial real estate transactions are prompted by

1) personal or collective investment criteria, 2) tax implications, or 3) individual space requirements.


Any of these factors is incredibly specific to each buyer or seller making the purchase or sale decision.


These individual transactions are defined as investment value which is a separate and distinct concept from market value which is what appraisers, for instance, are tasked with analyzing in most circumstances.


Market value in practical application within CRE can be loosely defined as a range of potential sale prices evidenced by at least two similar transactions.


Identifying properties that have recently transacted and have similar economic and physical characteristics as your subject are many times few and far between.


Furthermore, the buyers and sellers of these transactions are typically motivated by completely different factors which is why pricing for most commercial property types can widely vary.

In this way, pricing is more of a reaction to consumer confidence or individual space or investment needs at a specific point in time rather than robust data in support of a list or sale price.

Therefore, a more appropriate way to analyze most commercial real estate markets may be to characterize patterns as "behavioral cycles" rather than "market cycles". 

Whether analyzing the physical or capital markets, it is important to remember that pricing for most commercial real estate assets is relatively inconsistent due to nuance of building characteristics and location, individual buyer or seller motivation, and lack of available information regarding supply and demand in real time. Therefore, consumer confidence is a factor to be considered.


If enough market participants believe there is going to be a 20% increase or decline in value for a certain property type – whether rational or irrational – it is very likely that trend will occur (a concept known as groupthink). Real estate markets are driven by emotion and the fear of missing out. Therefore, in times when the economy is good, optimism will influence negotiations to result in higher sale prices. In poor or volatile economic times, pessimism will influence negotiations to result in lower sale prices.


If fundamental analysis reveals that anticipated pricing expectations are irrational, real estate professionals can advise clients accordingly to capitalize on irrational market behavior.

Differences of opinion make the market and perceived value is sometimes more important than the fundamental relationship between supply and demand.


As appraisers, we are trying to measure human behavior which is often times unpredictable and is always uniquely motivated. Nevertheless, we need to consider the whole picture, including consumer behavior, to provide more sound counsel to our clients – even in the face of the most chaotic markets.

Michael J. Rohm, MAI, CCIM, R/W-AC, is a fee appraiser and real estate agent working throughout Pennsylvania.

He is president and owner of Commonwealth Commercial Appraisal Group and is director of valuation advisory and senior associate with Landmark Commercial Realty. Contact him at

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