Boom and bust is nothing new in the property sector
Although it may come as a shock to younger readers, recessions are not a new concept. They are an inevitable part of what is termed the ‘economic cycle’ – intermittent periods of growth and decline which have occurred throughout history.
These have impacted on all markets and industries including property. A successful property investor can be defined as one who buys at the bottom of the cycle, thus maximising the financial return.
But how does one spot this crucial moment which determines success or failure for the property investor?
Most economists agree that the economic cycle consists of five distinct stages, each of which flows into the next.
These are generally defined as the peak, contraction, recession, recovery and prosperity. At the peak of a boom stocks and property are considered to be overvalued. Credit providers are heavily burdened with debt.
As the contraction stage comes into play, sources of credit dry up, and property sales grind inevitably to a halt.
The stock market simultaneously declines until the entire economy is in recession. The price of property and shares is at a low ebb and credit is difficult, if not impossible, to obtain. Recovery commences when credit facilities again become available.
At this juncture institutional investors pounce, moving rapidly to purchase undervalued property and shares. The next stage is prosperity. Prices rise once more, the workforce’s salaries rise and credit providers become more amenable to risk.
So when was the last time we experienced this economic cycle? The last significant correction in the UK housing market occurred in 1991.
At that time, banks and other lenders frequently offered 100% mortgages – yes, I know it’s hard to believe but it really did happen. This more-than-generous financing fed the strong desire to own property which inevitably led to the peak of the housing ‘bubble’.
But as the economy slowed a total of 75,540 repossessions followed, partly due to the burden of sub-prime debt – does that sound familiar? This represented the highest recorded in any one year (so far) and spelt obvious heartbreak and misery to those concerned.
The market did not seriously begin to recover until 1994. At that time the UK economy was registering 4.2% GDP growth, the highest level for six years. The sustained economic growth, combined with rising incomes, meant people could afford larger mortgages. Consequently, demand for housing rose.
Most people view property as essentially a stable asset, despite the peaks and troughs that occur at the various stages of the economic cycle. Unlike investment in shares, a property owner has a tangible asset of bricks and mortar. A constantly expanding population will always need somewhere to live, and therefore there will always be demand.
Knowledge of economic cycles and the property market means one can begin to predict the upswing in a market.
The current financial crisis has strong parallels with that of the 1991 crash. The beginning can be traced to early 2007, when the total value of sub prime mortgages was estimated at US$1.3 trillion.
Rising property values resulted in lenders taking more risks. The number of credit providers began to collapse under the weight of defaulted loans, with the most notable example being the once mighty Lehman Brothers.
The scale of the problem was becoming horribly clear. As the flow of credit between banks dried up, the knock on effect included reduced lending to consumers and thus a slowdown in the housing market. Once interest rates are low enough, credit flow becomes liquid once again. At this point institutional investors enter the market, confidence returns and the upswing begins.
Usually upswings begin in the same place the downturn began. The US housing market is therefore key – as soon as it begins to pick up then it can be seen as a sign for the rest of the world. Standard & Poor, the ratings and analytical company who produce the US Case-Schiller housing index, believes the market will reach the very bottom by October 2009. It also states that investors should start to consider purchasing property as credit becomes more available.
Global property investors should also consider countries and regions which have not suffered so savagely in the current economic downturn. Central and Eastern Europe saw a slowing of their economies and Bulgaria in particular has been unaffected by toxic debts.
But, as ever, there is a horrible element of uncertainty in all this. Can anyone really say with confidence that the London property market has reached its nadir? Even as we move out of recession the level of unemployment is certain to rise. If people lose their jobs they clearly cannot pay their mortgages.
Property, in common with all other forms of investment, carries a high degree of risk. Intelligent analysis of the economic cycle can do much to mitigate this, but it can never remove it.