AKC News // Where are we now in the property cycle?

The downturn will bring opportunities to buy quality properties at rock-bottom prices but investors need to learn the property cycle first, writes Bill Nowlan in The Irish Times

“Getting your timing right is the most important factor when it comes to making money out of property.” That’s what I was told when I started my career as a property asset manager in 1966. It has proven to be sound advice.

Property markets have always performed cyclically, even as far back as Greek and Roman times. What we have experienced over the past 10 years in Ireland is only the repeat of a process that is time-proven and relatively predictable.

The cycle is generally in four phases – a bit like the cycles of nature. The first phase can be compared to early springtime. The first green shoots of a recovery are barely discernible after the ravages of winter.

Despite economic depression, a few business sectors still experience demand for their products or services, need more space and have no trouble finding what they want from the huge over-supply from the last cyclical “bust”.

Property prices are usually well below replacement cost as property owners or their bankers are desperate to do deals, and vendors and landlords are driven by fear and not by greed. As this springtime phase continues, economic recovery gradually accelerates and the over-supply of space gets taken up.

Then the second part of the cycle begins. At the end of the last cycle, low property prices, scarcity of money and the general economic backdrop will have stopped development of new projects. If economic recovery is sustained then demand for space picks up, though still at relatively low prices.

But suddenly, and it happens suddenly, there is no more surplus space from the last “bust” and the demand for new space exceeds supply. Two things happen – prices rise rapidly and development starts again.

This takes us into the second part of the cycle (mid-summer, using our seasonal analogy). In a normal cyclical recovery, prices rise for two or three years while market forces ration supply and new developments take time to come on stream. The “solid” part of the second phase of the cycle will be flagged by businesses taking pre-lettings at record-breaking prices.

By now, however, many people will have made a lot of money from their property holdings, generally by doing nothing other than sitting tight.

But this does not go unnoticed and the media starts writing stories about the phenomenal performance of the property market with example after example.

Then we start to encounter the third phase of the cycle. Several things can happen. The risk of a bubble may influence government to cool things down through taxation, increases in interest rates or restrictions on fund availability. But if the market goes unchecked (as in 2003-2005), then the subsets of the property industry all go into overdrive to service it.

One industry that will add petrol to the fire will be mortgage banks if they have not been checked by regulation or other means. This is when decisions by property owners, made out of fear in the first phase and good business judgement in the second, start to be made from greed. Prices are in the ascendancy. Caution goes out of the window.

At this stage, a wise government should be receiving loud signals about the growing bubble and will/should act decisively, since the next phase is inevitable. If momentum is unchecked, the price of development land rises to phenomenal levels as new and inexperienced players believe that demand will go on forever.

Simultaneously, property yields fall as the supply of investments dips well below demand as gullible people believe that property values will always go up and cannot fall. This is when I, as an asset manager, advise my clients to exit the market.

If we look at the multitude of sale and leasebacks that occurred in 2006-2007 we can see that many experienced property advisors recognised the symptoms and exited. (AIB and Bank of Ireland carried out sale and leasebacks of their HQs during this time.)

The final phase will be driven by what is happening in the real economy.

When demand for new space stops in the real economy it generally does so suddenly due to some fiscal or market-driven event. In 1972/73 it was the oil shock; in 1981 it was oil again; in 1992 it was the currency crisis; in 2001 it was the dot-com bubble; and in 2008 it was US toxic debt.

The constant feature is that in the space of months the property market moves from boom to bust and values plummet. There is an over-supply of property and virtually all demand dries up.

This has two consequences: the development industry, with its two-year delivery timeframe, continues to churn out new space; and the price of land and buildings falls precipitously. The former results in a huge oversupply of empty space and the latter in significant failures in the construction and development industry and collateral damage in banking.

The value pendulum, which had swung too far to the right, now swings too far to the left. This is where the Irish economy is today – property cycle “winter”.

Just as in nature, however, winter sets the scene for the start of the next springtime which will inevitably arrive. But no one knows when, and the focus is on licking wounds.

The proverbial observer from Mars may well ask why this simple phenomenon is not better planned for. A very good question, since it has been happening for thousands of years. As a property asset manager since the 1960s I think that I know some of the answers. First, the need for modern property in a growing economy is undoubted. You can’t have a modern economy without new buildings to work and live in and someone has to provide them. So there must be new buildings and urban expansion.

Second, property has proven itself to be an excellent long-term investment and generally holds its value against inflation if investors can weather the dips and bends in the roller coaster.

Despite the recession, many people at this moment continue to live off rents paid by the many good business and residential tenants. As I noted in a previous article, even at the worst of times 92 per cent of rents in my portfolio are paid.

Third, lucky and skilled people can make money by riding the cyclical tiger. The really wise ones are those who know when to take their chips off the roulette table at stage three of the cycle.

Fourth, there is the political dimension. As a fast generator of jobs and revenue, the property industry is second to none. It is a great way to rev-up the economy, create jobs, bring in taxes and garner votes.

There is also the issue of the unknown length of the phases and, in particular, the third phase. A government who “spoils the party” too early may be seen as a spoilsport and thus there is a huge political temptation to defer decisions.

As to any insight on how long the current phase will last or how deep it will go, I do not know.

Taking an asset manager’s approach gives some insight, however. The start of the next phase of the inevitable cycle should be the focal point. It will be marked by a halted development industry due to an oversupply of space. Values will fall, or will have fallen, to below replacement cost. Property decisions will be made out of fear and not greed.

This current property winter may be particularly long, but it will still bring opportunities to buy quality properties at rock-bottom prices.

The property market is, was and always will be cyclical. If you want to make money you need to be long in perspective, long in patience and moderately lucky – and of course, as always, watch the borrowing levels!

Bill Nowlan is a chartered surveyor and runs a property asset management advisory consultancy.

Date : 06-05-2009