Using Property Cycles to make money.
“While they may not know what lies ahead, investors can enhance their likelihood of success if they base their actions on a sense for where the market stands in its cycle.” — Howard Marks
Cycles are a part of life – the moon, the tides – nobody denies they exist and work. The moon and the tide are very regular and predictable. But there are other cycles that are harder to predict but everyone still believes in them, for example, New Zealand will have approximately one magnitude 8 earthquake every 100 years (GNS Science), and we understand after the earthquake, there will be aftershocks. The earthquakes are totally unable to be predicted but undeniably follow a cycle. Within New Zealand Canterbury has a different earthquake cycle compared to Wellington or Auckland, similarly, the property cycle in New Zealand is not consistent across the country and can’t be predicted with accuracy. Homer Hoyt was the first to study property cycles, he published his dissertation 100 Years of Real Estate Values in Chicago, in 1933. Now it is common knowledge that property markets have cycles where house and land prices go through slumps, upturns, booms, slumps, downturns, busts and periods of stabilisation.
So choose carefully when you invest – some periods are better than others. If you get your timing right the rising tide will lift all boats so you don’t need to be particularly skilled in terms of your purchasing decisions to make money, however, if you are trying to make money in a stabilising, busting or down turning market you will need to be very skilled in property investing to profit.
Historic values in New Zealand
House prices are not an independent phenomenon – they are connected and caused by other factors such as mortgage costs (interest rates), government policy (LVR rules), market supply and demand (population, pricing, council zoning), building costs (wages, red tape, raw material costs), popularity (all my friends are buying houses or they are all selling houses to buy bitcoin and I want to fit in). Each of these and other factors combine to drive the value change of both land and housing.
Here is a graph revealing New Zealand’s property cylce by showing house values over the last 25 years. It uses the RBNZ House Price Index, the HPI is a set of data developed by the Reserve Bank of NZ in collaboration with REINZ and it uses an index to represent value, we can see how long it has taken for house prices to double. You can view the RBNZ dataset here.
Using the data from 1989 to 2018 there are some interesting takeaways about the possibility and length of time taken for properties to double in value:
- To have your property double in value the last possible time to purchase was September 2005 when the index was 1,244 it would have taken you 13 years to double to 2,504 in March 2018.
- The shortest time to double in value was purchases made in March 2002 which saw their value double by March 2007 in just 5.3 years.
Length of time for a property to double in value (New Zealand)
Average 10.1 years, 7.10% compounding per year
Minimum 5.3 years, 13.97% compounding per year
Lower Quartile 8.7 years, 8.29% compounding per year
Median 10.3 years, 6.96% compounding per year
Upper Quartile 11.8 years, 6.05% compounding per year
Maximum 14 years, 5.07% compounding per year
DATA FROM RBNZ 1989 – 2018
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A Typical Property Cycle
House price cycles will generally follow a pattern that has a curve rather than prices falling off a cliff – unless there is a triggering event that was hard to predict such as the GFC. The curve has three phases which are described below.
- Values firm and rise slowly, check median prices.
- House supply excess slowly erodes, check ‘average days to sell’, number of listings.
- Yields start to increase, compare median rents vs median prices.
- The general feel of the crowd is caution, hesitancy with pockets of fear that prices will go down forever.
- Low-interest rates may have contributed.
- Increasing economic performance or consumer and business confidence may have contributed.
- Values are increasing rapidly quarter on quarter.
- The number of houses for sale dwindle.
- Yields start to decrease; people are buying negatively geared property.
- The general feel of the crowd is fear; they are afraid they will miss out, and prices will go up forever.
- Low-interest rates may have contributed.
- High economic performance or consumer and business confidence may have contributed.
- Values are decreasing rapidly quarter on quarter.
- The number of houses for sale explodes.
- Yields start to increase but are hard to calculate because houses are selling under their advertised prices.
- The general feel of the crowd is fear; they are afraid they will be forced to sell at a loss.
- High-interest rates may have contributed.
- Poor economic performance or consumer and business confidence may have contributed.
Is it essential for your house to increase in value?
You can see that the timing of your purchase will have a substantial effect on how long it takes for your house to increase in value, which leads us to an important question. Is it essential for your house to increase in value? At a surface level, the answer is obvious and yes. But when looking deeper, the importance is hugely dependant on what sort of investor you are.
If you are purchasing with negative gearing and interest only loans – the only exit strategy you have is to sell at a premium. The increase in house value is the difference between riches and bankruptcy.
If you are purchasing with a low yield and interest only loans – the only way to make a high return is by selling at a premium (because you just made a low yield while owning). The increase in house value is the difference between riches and stagnation.
If you purchased with a quality yield using principal + interest loans, you don’t need to sell at a premium to have made money. In fact, you don’t ever need to sell because your tenants are paying off your mortgage.
An astute investor will look at the property cycle as a factor to utilise when making purchasing decisions, but most buy-and-hold investors will naturally follow a pattern of buying during busts or periods of stabilisation because their purchasing rules and criteria get them to purchase when yields are high. To work out your next step take the mortgage snapshot today, which will automatically calculate your purchasing ability, potential mortgage savings, or ability to top-up your mortgage.