4 Lessons All Property Investors Must Understand About Property Cycles

Looking back at how previous property cycles played out, I delved back into my memory to see what lessons I could learn from past property cycles and realised that I’ve probably learned more from the many mistakes I’ve made than from the things I got right.

Now there’s a powerful lesson in itself!

Of course, we all know the property market moves in cycles.

And you’d have to be living under a rock not to realise that all around Australia our housing markets have moved to the next phase of the cycle…

Typically the cycle is depicted in 4 stages.

The boom is followed by the downturn, which is followed by the stabilisation phase, which leads to an upturn, which in turn sets us up for the next property boom.

I’ve drawn it as follows:

I’m often asked how long between one property cycle and the next and while many market commentators refer to a  “7-year property cycle”, it is rarely seven years.

In fact, average Australian capital city prices have had multiple cycles over the last 15 years with booms around 2003, 2007, 2010, and 2017 – which was the last time property prices peaked on the east coast of Australia.

House prices have recently once again reached the previous picture of 2017.

Of course, the length of a property cycle has nothing to do with the number of years.

Cycles are driven by a series of socio-economic factors, but over the years I’ve noticed that the nature of our property cycles is changing and seem to be getting shorter.

Also, the cycle is better seen in terms of the rate of property growth, as not all downturns or bust phases have price declines, some just experience a slowing.

Of course, the cycle can also vary from city to city. 

And there are even cycles within cycles within each capital city.

Currently, all the pieces of the property puzzle are falling into place and almost all property markets around Australia, both capital cities and regional locations, are setting themselves up for strong price growth in 2021 and 2022.

But again, not all parts of the property market are in sync and it is likely that CBD high-rise apartment towers and apartments near universities will miss out on the new property upturn that other areas are experiencing.

What factors influence the property cycle?

The main factors driving the property cycle are:

1. Interest rates and the availability of funds to buy property is a major driver of property demand.
   When money is cheaper (interest rates are low) this is positive for property markets. Clearly, the availability of finance (or lack of it) has been a  major influencer over the last few years
2. The Economy – business confidence, employment prospects, jobs growth, and wages growth all create demand.
3. The availability of supply of property to meet this demand.
4. Consumer confidence
5. Demographics – in particular, household formation (again affecting demand.)

Anyway…here are 4 key lessons I wish I’d learned earlier in my investment journey about property cycles:

1. Firstly, the economy and our property markets move in cycles

And the main cause behind these cycles is that we’re human and tend to share the general optimism or pessimism of others.

As I’ve already explained, it’s a common fallacy that Australian property cycles last 7 – 10 years.

Cycles vary in length and are affected by a myriad of social and economic factors and then, at times, the government lengthens or shortens the cycle by changing economic policies and particularly by manipulating interest rates or the availability of credit.

Over the last few years the government, the RBA or APRA fiddled with the availability of credit – either the cost of money such as interest-rate or the availability of money such as tightening the screws to “manage” our property cycle, but of course last year the lockdowns forced by Coronavirus put the nascent property cycle on pause.

Yet it’s my observation that investment markets often “overshoot.”

That is, they move by more than changes in the fundamental influences would seem to require – on the upside as well as the downside.

Take the Sydney property market which experienced significant growth (overshooting its fundamentals) during the previous property cycle, and then dwelling values in Sydney dropped 15% from their market peak overshooting on the downside when in general all the fundamentals for Sydney property were sound in 2018 and 2019.

2. The market is usually wrong about the stage of the cycle

“Crowd psychology” influences people’s investment decisions, often to their detriment.

Investors tend to be most optimistic near the peak of the cycle, at a time when they should be the most cautious and they’re the most pessimistic when all the doom and gloom is in the media near the bottom of the cycle when there is the least downside.

Market sentiment is one of the key drivers of property cycles and one of the reasons why our markets overreact, overshooting the mark during booms and getting too depressed during slumps.

Remember that each property boom sets us up for the next downturn, just as each downturn sets the scene for the next upswing.

3. There is not one property market

While many people generalise about “the property market” there are many submarkets around Australia. 

The fact is, each state is at a different stage of its own property cycle and within each state, the markets are segmented by geography, price points, and type of property.

For example, the top end of the market will perform differently to the new home buyer’s market or the investor segment, or the median-priced established property sector.

And while there is an oversupply of poor quality rise off-the-plan apartments in Sydney, Brisbane, and Melbourne, there are more buyers looking for well-located homes than there are good properties on the market in the middle ring suburbs.

4. We need to allow for the X factor

When most Australians hear about ‘the X factor’ they think about a talent show on TV.

However, ‘the X factor’ is also talked about in the less glittery world of economic forecasting.

Economists refer to ‘the X factor’ when an unforeseen event or situation blows all their carefully laid forecasts away. 

More recently Nassim Nicholas Taleb, a finance professor, and author popularised the term Black Swan events for these deviations from the expected.

I first came across this concept many years ago when distinguished economics commentator, Dr. Don Stammer, used to try and predict the X Factor for the forthcoming year in the January edition of the now-defunct BRW magazine.

Of course, by definition the X factor is unforeseen, so you can’t really predict it.

But it was a little game he used to play and then review his prophecy 12 months later.

And it is a game I also took up many years ago and have had fun with over the years.

These X-factors can be negative (the aftermath of the Global Financial Crisis of 2008) or positive (the China-driven resources boom of 2010-12) and it can be local or from abroad (the US subprime mortgage crisis of 2008.)

The big X factor for 2020 was the Corona virus lockdowns 

These X factors affect the economy at large, which of course affects our property markets, but our property markets also have their own specific X factors – unforeseen events that affect the best-laid plans and predictions like APRA’s unprecedented restriction of bank lending to investors.

So the lesson is while it’s important to take a long-term view of the economy and our property markets, you also need to allow for uncertainty and surprises by only holding first-class assets diversified over a number of property markets and having patience.

Trying to predict the X-factor is futile: if it’s been predicted, it’s not the X-factor, but let’s have a look at a list of major past X-Factors  (many of these are the thoughts of  Dr. Stammer, who now writes for The Australian.)

In 2019 was the “miracle” election win of the Morrison government. Leading up to the election many commentators were forecasting a prolonged property slump assuming the Labor Party would win the Australian federal election.

2017 – Donald Trump assumed office as 45th President of the United States, while back home APRA’s macro-prudential controls brought a halt to the rising Sydney and Melbourne property markets.

2016 Despite many commentators predicting rising rates, Australian interest rates kept falling, prolonging the property cycle and allowing property prices to surge in Sydney and Melbourne

2015 Negative interest rates in Europe

2014 Collapse in oil prices during severe tensions in middle east

2013 Confusion on US central bank “taper” of bond purchases

2012 The extent of investors’ hunt for yield

2011 Continuing problems with European government debt

2010 European government debt crisis begins

2009 The resilience of our economy despite the GFC

2008 The near-meltdown in banking systems

2006 Big changes to superannuation

2004 Sustained hike in oil prices

2001 September 11 terrorist attacks

1997 Asian financial crisis feat

1991 Sustainable collapse of inflation

1990 Iraq invasion of Kuwait

1989 Collapse of communism

1988 Boom in world economy despite Black Monday

1987 Black Monday collapse in shares

1986 “Banana Republic” comment by Paul Keating

1985 Collapse of $A after MX missile crisis

1983 Free float of Australian dollar

Now it’s your turn to play the game and predict the coming year’s X-Factor.

Now is the time to take advantage of the opportunities the current property markets are offering.

Originally published by Property Update