The most important lesson to learn as a property investor

There is no new thing under the sun, but that we simply resurrect the old ones. ‘How do I forecast future cycles?’ You may ask. In order to forecast future cycles, the most important thing is to begin right, for if we have the right beginning, we will get the right ending.

W.D. Gann, Tunnel Through the Air

Whether or not you decide to invest with us, perhaps the single most important thing you can learn as a property investor is the market cycle – it’s a specific sequence of events that seems to play out over and over again. If you get that macro part right, then with a little bit of research most of the other parts will fall into place. In this article we’ll have a deeper look into the property cycle and see why we’re likely to be in the most exciting stage of the market.

Before we start, we have to preface this with the statistical aphorism that “all models are wrong but some models are useful” I would place this firmly in the useful model camp.

The 15-18 year property cycle is a popular and useful model used by investors in England and America and it is gaining popularity in Australia – why it is 15-18 years specifically I can’t say for certain but it’s something I find fascinating. Various theories exist as to why its this specific length of time, such as the 14 year time period it took for Terminating Societies in the late 18th century (the forerunner to building societies) to complete the construction of all houses belonging to its members. Another theory is most vacant land sites in South Wales were held for 15 to 19 years before being developed for urban use.

Or perhaps its linked to our natural lifecycle and generational shifts – each generation is roughly 15 years apart. At some point we all grow up and move out of our parent’s homes, we might move into an apartment, we might have children, then start to look for a house in the suburbs etc

Numerical sequences that drive our behaviour are not just limited to property – they also exist in nature and we can see them play out over and over again in financial markets. The Fibonacci sequence, sometimes called “natures code” or the “golden ratio”, is a specific ratio that we find expressed in the spiral rate of sea shells, garden snails, the number of petals there are in flowers, the number of leaves there are on a branch, the uncurling of a fern, it is also found on the proportion of Mona Lisa’s face, musical scales and Mozart even based many of his piano sonatas off the Golden Ratio. And for whatever reason we also see this ratio play out in the charts of financial markets. The price action in financial markets of course are just a graph of human emotions – greed and fear. That is to say that our actions and emotions are also driven by sequences of numbers.

But getting back to the 15 to 18 year property cycle – this only really seems to play out in the larger East Coast property markets in Australia. Specifically, Sydney, Melbourne and Brisbane. Not surprisingly it also turns out that there is a high degree of correlation between these three markets. The other markets around the country are still small enough to be heavily affected by exogenous factors – primarily commodity cycles.

How much predictive power does this model have for the East Coast? As it turns out, it is remarkably accurate. Other than some price and rent controls distorting the market pricing between 1946 and 1949, the market has averaged 14.8 years peak to peak or trough to trough. Following the peak of the boom there is an average period of correction or consolidation of around 4.4 years before a mid-cycle peak at 5.8 years.

If we look at the most reliable dataset from 1961 onwards, each market cycle features an run up period with an early-cycle top. Followed by a mid-cycle consolidation period where prices flatten off or even decline slightly. And finally a big run up in the second half of the cycle which results in a standard blow off top and correction to reset everything before the new cycle can begin.

One interesting observation we can make is that the cycles seem to be shortening in length moving from 18 years to 16 to 13 to 12 years in length.

So where are we now?

As macro investors, we spend almost all our time thinking about and living in the future. If we extrapolate the above model, it shows that we’re almost certainly at a cyclical turning point and the start of an upswing. If history rhymes, then we can expect around 7-9 years of good growth followed by a blow off top and correction. In risk adjusted terms we’re likely to be at the best point to enter the east coast property market.

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