How to recognise, prepare for and profit from the property cycle
2. The stages of the property cycle
In the second of three articles on the 18-year property cycle, we identify its key stages before leading into how investors can work with the cycle to make the most from their portfolio.
Crash
We may as well start at rock bottom: house prices are tumbling fast and construction work may have come to a halt. It's the most dramatic part of the cycle, because the economy has been riding on a wave of false security but everyone is now forced to batten down the hatches.
Banks, which were only recently lending quite freely are now reluctant to agree to any loans. There is panic in the air, propagated by the media. Businesses will go into liquidation or become insolvent, and will be forced to sell any properties they own quickly, while over-leveraged individuals will become bankrupt and be forced to sell or have their homes repossessed, further pushing down house prices. It can be bleak.
The newspapers will be rife with disaster headlines, but don't cave in. Ignore the tabloid advice. Hold on and ride it out, because the slump won't last forever. If you have prepared for this eventuality, you should have kept some capital back from the boom that preceded the crash, because things will be tight. There might be void periods in your buy-to-lets, and there will be a lot of uncertainty, but don't feel under pressure to sell because lots of other people are. You might see a lot of amateur investors panicking and selling their assets before the price falls any further, decisions they might come to regret when they inevitably start to rise again. On the contrary, this is probably the best time to buy, if you can - mortgage lending will be incredibly tight.
It's a cycle, and things will improve. There are lots of opportunities here if you have reserves - those that have to sell will be willing to do so at deflated prices.
Recovery
In the very early days of the recovery period, you'll start to see investors snapping up those distressed assets that offer high yields, because the rental market hasn't suffered in the same way. It's a great time to invest, especially in big cities where the economy improves more rapidly following a crash than in rural areas. With the recession still fresh in everyone's memories, regulation is still tight, as the precautions are in place to prevent anything like that ever happening again (spoiler: it will). It will be tough to get a mortgage, but it's a good time to get in before the prices begin to rise quickly. The newspapers will still be pessimistic as the ripples from the crash are still being felt across sectors, but it's good to step back and look at how these things have played out in the past to give you an idea of what will happen in the next couple of years.
Gradually, more buyers come into the market, and asking prices are steadily climbing. The mortgage approval rate will have improved as banks begin lending with more confidence. It's been a while since the recession has dominated the newspapers. Again, the recovery will happen much more quickly in London due to its economic resilience.
Look at the financial papers for signs of life as larger companies begin to buy up distressed portfolios. It's a good sign that confidence is returning and the recovery phase has solidified.
Mid-cycle dip / correction phase
There might be factors (extraneous political factors, for instance) that cause the housing market to stall or wobble. It will be enough to attract some media attention - 'Prices dip for the first time in ten years' or +6 but it doesn't last long before giving way to a steady rise in property prices...
Boom
Prices are clearly on the up, and rising fast. There are more cranes in the sky as banks become more comfortable lending, and as the economy strengthens and businesses expand, more offices and more homes are getting built. But because land is in short supply, prices are pushed up, which encourages speculation. If we go back to the bread analogy, we could make more bread to keep prices lower, but this is land, and we can't make more land. As prices rise, everyone wants a piece. There are more people re-mortgaging to buy cars and fund better lifestyles, those with large homes want larger homes and are prepared to pay for them. It doesn't mean everybody is getting rich, because it only takes one person to set the market rate by buying at an inflated price, further fuelling the speculation.
Properties that would have remained dormant on the market for months are now snapped up by speculators. As prices continue to rise, banks begin to deregulate and borrowing becomes easier than it has been for years. Almost nobody predicts that prices will drop at any point, because 'it's different this time'! It's different every time. People continue to buy properties well above their asking prices and overconfidence sweeps the nation. Even if banks are aware that they are lending more than they should be, they are under immense pressure from shareholders to lend more.
Meanwhile, experienced investors might use this opportunity to cash in on the mania, perhaps selling parts of their portfolios that have under-performed.
Prices continue to rocket and although it's difficult to predict when the prices are going to peak, there are some indicators. Look out for vast, overblown building projects, and more cranes in the sky
Because the boom is created due to due to people upsizing and expanding and speculators trying invest, the majority of people can't afford to get on the property ladder, because house prices are rising at a rate way out of line with wages.
Yet people will continue to buy as long as they think they are buying something of value. It's not rational, but it is exciting and it is contagious. It's mass hysteria. These final years of the explosion are what economist Fred Harrison calls the 'winner's curse'. It's the worst time to buy, because prices are at their highest, detached from any intrinsic value, and they are about to come crashing down, fast. Although the newspapers might report on how expensive property is, they won't be as quick to predict a crash until it has happened.
And there, in a compact nutshell, is the cycle. A crash is inevitable. It has happened at least once in your lifetime and it will happen again, no doubt.
In our next and final article on the 18-year property cycle, we'll broadly explain how to use the 18-year property cycle to make more money from your investments.
Contact Revolution Brokers for free advice in Essex, Kent, London and Hertfordshire.
