Over 200+ years of documenting real estate has shown that real estate prices go in cycles. Knowing how the cycles work can help property investors not to work in tandem with the masses who get the timing wrong.
For existing property owners it can help them to forecast what to expect in terms of their rents and timing an exit from a property.
The funny thing is that what we generally read in the media conveys the general opinion of the masses but can mislead an investor as to what point in the cycle that the market actually is.
To illustrate this here is a fantastic depiction of how to tell where a market is in the real estate cycle (credit to Michael A. Kupritz) according to the headlines from the New York Times.
The media can counter-intuitively help a person pinpoint the real estate cycle.
Real estate a cause rather than victim of a recession?
Henry George (1839 to 1897) was one of the earliest to propose that land prices and a drive up in prices based on speculation were the causes of economic recessions. In fact he asserted that land speculation was always the cause of economic downturns.
Largely ignored in today's discussions it has gained recognition as the most recent economic contraction has involved a huge speculative real estate bubble.
There is an excellent well-researched paper from 1991 that examines Henry George's theory (view it here). It was published and printed by Fred Foldvary (born 1946).
Fred Foldvary is a lecturer in economics at Santa Clara University in California and is credited with predicting in 1998 that there would be a real estate-related recession in 2008. He even published a booklet in 2007 entitled The Depression of 2008.
The key parts of the above paper which caught my attention specifically regarding a real estate cycle were the following:
"During the downswing, the net income of real estate falls due to falling rents and increased vacancies, while mortgages and other operating costs remain rigid in the short term. There are widespread defaults on mortgages and other loans. The foreclosure rate increases. Unemployment and lower real wages further reduces demand for real estate. Some residents 'double up.' To secure occupants, rents decrease. Many banks fail, having loaned large amounts to illiquid and fallen real estate."
"The low point of the cycle is characterized by high vacancies, low building rates, foreclosures, and an absence of speculation."
"After the old obligations such as mortgages and contracts are gone and the wreckage of the collapse is cleared away, shrewd investors pick up real estate bargains. With debt reduced and prices, including interest rates down, lower costs induce a renewed rise in business and the recovery phase of the cycle."
The US 18 Year Real Estate Cycle
Fred Foldvary makes an interesting observation in his analysis that bears all serious investors investigating closer:
"A distinctive feature of fluctuations of both construction and real estate prices over the last 100 years in the U.S., Great Britain, and other countries is their regularity in long cycles of roughly 20 years (Matthews, 1967, p. 98). Clarence Long (1940, p. 155) observed that a decline in building precedes general business declines in major downturns, and also that the long building cycles have different durations in different countries (p. 159)."
He went on to identify the typical cycle in the United States being roughly 18 years as shown in the following chart. The one exception being the 1943 which would have been the peak of a real estate cycle had building not been dampened by war measures.
The 18-year cycle is well documented in the US.
Regarding the stages of this 18 year cycle there was an excellent real estate 'clock' that was put together by Phil Anderson from Economic Indicator Services. It is chockfull of little indicators which help a person to pinpoint where they would be in the cycle.
Interestingly their research showed that typically there was 14 years of growth followed by 4 years of price decreases.
This analysis proposes 14 years up then 4 years down
Where is the Czech real estate market currently in the cycle?
The million dollar question is to take this knowledge and apply it to our current situation in Czech Republic.
So, based on the above information where would you assess we currently are in the real estate cycle?
Using only the proposal of 4 years of property prices going down we could conclude that the end of 2012 would be the last full year since the price decreases started in late 2008/early 2009.
In early 2009 banks strongly restricted their lending criteria (hour 19). We have also had the economic activity stall (hour 20) with a major contraction in 2009, 2010, 2011 and now going into 2012.
Looking at the descriptive steps on the clock I would personally say that we are in the 21st or 22nd hour since it seems that many Czech banks still have an amount of bad loans on their books although a recent KPMG report proved to me that it is much less severe in Czech Republic than I had originally thought. It is, in fact, 50% better off than the regional averages.
Another extrapolation from the cycle is that existing owners should be able to expect gross rents to be increasing over the next part of the cycle.
What are your thoughts? Where do you think we are right now in the Czech real estate cycle? Weigh in by commenting below or sending me an email at: nathan@czechpoint101.com
Nathan Brown www.czechpoint101.com
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