Wouldn’t it be great to know how our property markets are going to perform this year?
My many years as a property investor have taught me not to try too hard to predict our markets year by year, but instead to take a long term view, then allow for cycles around this long term trend and be prepared for uncertainty, surprises and the unexpected.
The market moves in cycles
It’s important to understand cycles are a continuing feature of the economy and investment markets and anyone who ignores those cyclical swings does so at their peril.
Yet investors have a tendency to perceive risks as being at their lowest during booms, when the cycle has almost peaked. That’s because the media is full of stories about amazing profits, television shows on real estate abound and friends and family are all a buzz with tales of great gains that have been made.
Of course, when property prices are breaking new highs there’s a very good chance that sooner or later they’re going to slow down or turn in the other direction.
Similarly, many investors believe the risks are highest when the markets are down and prices have dropped. At these times the media tends to report the doom and gloom stories of people losing money and these often sap investors’ confidence.
Of course, the reality is that property slumps are often the best time to snap up bargains while prices are cheap.
It’s also more likely that prices will rebound and grow from their low points, whereas there’s not as much room for growth if you buy at historical highs.
Why do the cycles keep recurring rather than finding a nice equilibrium?
Economic cycles exist because we’re human and affected by the optimism or pessimism of others.
The world economy is a collection of many nations, each at their own individual point on the economic clock.
And every nation is made up of millions of people like you and me, each making our own financial decisions in reaction to, or in the expectation of, other people’s decisions.
The sheer momentum of all these economies means they always over-swing the mark and then correct themselves, resulting in cyclical economic movements.
In case you’re thinking: “if economic cycles are well understood and the benefits of being a counter-cyclical investor are evident, why doesn’t everyone make a killing?” But the answer is simple.
Waves of optimism and pessimism sweep the community driving investment cycles and the property cycle.
Investment markets, being forward-looking, are driven by expectations and sentiment, as well as fear and greed, and that’s why cycles will always be with us.
The pendulum swings to far
Interestingly investor sentiment and therefore investment markets tend to “overshoot” the fundamental influences on them – in both directions.
During booms property markets get ahead of themselves and grow too fast but they remain flat for longer than needed in slumps.
In today’s connected society, with the media feeding us a continual conveyor belt of messages, our mood swings seem wider and the cycle seems shorter.
Haven’t we learned anything from the past?
Well some of us have.
I’ve often said you have to invest through one or two complete property cycles to become a sophisticated investor.
However, some people just don’t learn from their mistakes and keep getting carried away by their emotions or fears.
Then every seven to 10 years or so there is a new generation of investors who have grown up and entered the market. These beginning investors haven’t had the opportunity of learning the lessons of history and tend to drive the next property boom and this ensures the cycle continues.
But there’s more to it than that…
Watch out for the unexpected
In the early 1980s economist Dr. Don Stammer taught me to watch out for the “X Factor”, long before there was a TV show of the same name.
He said we needed to allow for uncertainty and surprises.
These “X factors” are powerful influences on the economy and investment markets that had not generally been expected but which, for a time, have a marked effect on them.
They can be from an international source, such as falling oil and commodity prices, or a domestic one, such as the uncertainty surrounding the government fiddling with the goods and services tax or negative gearing.
X factors can be negative for reasons that happened on the other side of the globe, such as the world shock after September 11 or the near melt down of the world banking system in 2008.
At other times they have a positive affect on our economy, such as Australia’s resilience to the Global Financial Crisis because of the demand for our resources from China or the drop in interest rates over the last year when many expected them to rise.
These X factors affect the economy at large, which of course affects our property markets. However, our property markets also have specific X factors – unforeseen events that affect the best-laid plans and predictions.
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.
Understanding the cyclical nature of our property markets, the fact they overshoot and that an X factor can come out of the blue to thwart my best plans makes me a more cautious investor.
Therefore, I protect my assets by owning the right type of property – one that will be in continuous strong demand by a wide demographic of owner occupiers and tenants – by owning them in tax effective structures and by having a financial cash flow buffer for a rainy day.
Examples of X factors:
One of the X factors in 2015 was APRA’s regulations that restricted lending to property investors, which caused many investors to review their borrowing capacity in a way they had not forseen.
Further X factors last year were two interest rate drops in the first half of the year when 12 months beforehand economists were predicting rates to rise.
Then we had the surprise of two rate hikes for investors despite the Reserve Bank’s official cash rate remaining the same.
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 from Dr Stammer, who now writes for The Australian.
The X Factor Files:
2015 Falling worldwide oil prices.
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
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.
Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.