Week4 Flashcards
changes in the property and business cycles involve either
- Cycle – Change that repeats regularly
2. Trend – A long term shift in one direction, with substantial impact on economic activity and real estate
define a cycle
Change that repeats regularly
explain the business cycle
o Fluctuations in aggregate economic activity in a market economy
o Expansion, recession, contraction and revival
o Recurrent but not periodic
o 1-10 or 20 years duration
o Maybe measure or expressed by indicators such as GDP, trading activity, inflation, unemployment, exchange rates etc
2 types of indicators
- Leading: Influence future performance
2. Lagging: Analyse past performance
explain leading indicators
Leading Indicators:
o Seen as a precursor to the direction something is going; comes before a trend, changes quickly, considered business drivers
Examples:
o Changes in building permits – affecting housing market; economic activity
o An increase in new business orders leads to increased production
o Interest rate changes impact spending and investment
o Baby boomers may indicate future stresses on the healthcare system
Other Key Leading Indicators: o Disposable income o Dwelling prices o Building starts o Retail sales o Consumer sentiment surveys
Housing Market Indicators: o Auction results o Lending finance o Housing finance o ABS house price index o Building approvals o Property market sentiment o Home loan affordability
GDP = Lagging indicator
What is a property cycle? How does it differ from a business cycle?
Property cycles are recurrent but irregular fluctuations in the rate of all-property total return, which are also apparent in many indicators of property activity, but with varying leads and lags against the all-property cycle
explain a development cycle
The main factor driving the property cycle is the cycle in interest rates, with periods of rate cuts eventually driving upswings in the property cycle and vice versa for rate hikes.
Around this, the supply of and demand for property also has an impact, along with job security and unemployment.
look at diagram in notes
why doe we have property cycles
- Exogenous schocks
Property markets are subject to exogenous shocks from a variety of causes such as: - Natural disasters such as droughts, floods, fire, earthquakes, and cyclones, which can disrupt production and cause the destruction of buildings. Foe e.g. We witness the devastating Japanese tsunami of 2011 which involve many destructions and reconstructions
- Epidemic diseases can also be a source of shocks.
- There can be shocks resulting from institutional changes. For e.g. when OPEC secured substantial increases in the price of crude oil in 1973 whilst at the same time also supporting an oil embargo against Israel and the USA. Such events could be expected to have a one-off impact on the property market and with the possibility of further oscillations
- The property industry is inevitably bound up with what is happening in the wider economy. It is a supplier of capital goods (buildings) to industry, so that demand for property is inevitably linked to the demand for investment goods in the economy as a whole. It supplies housing and so must be affected by the economic factors that cause households to demand more or less housing. This might suggest that a cyclical pattern in the property market was just a reflection of a wider business cycle.
- Economic policy is subject to regular changes for political reasons. Cycles in the property market could therefore reflect the electoral cycle of the major economies. Turning points might then be associated with changes of administration and the pursuit of different economic policies or ideologies. E.g. role of population change in creating property cycles resulting from changes in migration policy can stimulate housing demand.
- New features in property design tend also to cluster in time, such as steel framed office blocks, large trading floors, or shopping malls, which could indicate the existence of an innovations-based cycle.
explain weak adjustment mechanism
Low price elasticity of supply. Supply adjustments to changes in demand are slow. Low elasticity can be caused by a number of factors, such as the length of the production (construction lag) cycle, the difficulties the construction industry experiences in response to increasing output over a short period of time (specially labour and materials), and problems in gaining development consent, such as town planning permissions. As a results, oversupply and undersupply are common outcome in the property industry in the short term.
Development cannot easily be reversed because of big sunk capital
(due to big investment). Only a small part of the property stock is renewed each year in response to increase in demand. Hence increases in demand is often be accommodated by adapting buildings to new uses rather than demolition and rebuilding. Similarly, little is actually scrapped during the recession phase but may be left empty or its use changed. This caused very weak adjustment in the property market and caused the property cycle.
explain accelerator model
The process of creating new capital (building) also has a multiplier effect
▸ Accelerator could produce a cycle of activity
▸ The significance of accelerator depend on how developers respond to changes in demand
▹ During upswing -> rate of response is high
▹ As rate of increase fall, investment also declines and feed back through the multiplier and cause investment to fall -> set the cyclical motion in place
cyclical process can be dampened by institutional factors
▸ Tenants - long leases
▸ Landlords - limited ability to get vacant possession to re-let or redevelop
▸ When demand rises, buildings converted to profitable uses rather than demolish and rebuilt
▸ Owner occupiers reluctant to scrap during recession as it is part of their major investment
▸ Investors - long term strategy - may continue to invest at the same rate through booms and slumps
▸ Land owner may be motivated by other factors rather than just profits
explain property bubble
- look at diagram
- youtube
Property bubble = Rapid rises in housing prices initiated by real demand, speculative investors form a growing share of the market
o Falling rental yields are often a sign of speculative demand is exceeding real demand for accommodation
o Low interest rates associated with most financial bubbles as they encourage riskier investments in an effort to generate better returns.
o Housing supply initially lags demand, high prices attract developers and a surge of supply often comes onto the market just as demand starts falling.
o A large over-supply of housing and/or restricted or more expensive debt
- What are the drivers of the business cycle and how do they impact on property markets? (What do they mean for the property market)?
Are Causes and Drivers different? (see pp57-61 of Ch 3)
Causes of business cycles – no one factor, rather a combination or mix of variables:
- War/International conflicts;
- New innovation – radio in 1920s, TV in 1950s, computers 1960s, digital technology in 1990s etc
- Erratic spending by consumers, business and govt (periods of spending/ periods of saving)
- Changes in amount of money and credit in circulation (MPolicy – low interest rate periods)
- Psychological frame of minds (ie consumer and business sentiment)
Drivers of the business cycle – indicators are signs of economic change. Leading indicators are the most important as they forecast future change – are designed to provide early signals of turning points in business cycles showing fluctuation of the economic activity around its long term potential level, although it is impossible to predict the future with accuracy – still better to have an educated prediction than a blind plunge.
Can see that some causes are also drivers – psychological – business and consumer sentiment, changes in amount of money and credit in circulation.
what do leading indicators mean for the property market?
Many of the leading indicators are directly indicative of what is happening in the property market – ie business investment, building permits, house sales etc. Whilst others impact directly on the property market – credit index, interest changes and money supply.
ii. Which property market?
Many different markets – national, local, housing market, units/apartment market, land, retail/industrial etc
iii. What other fundamentals do you find are often discussed in the context of the residential/housing market? Auction results, house prices Vacancy rates, rental prices Lending finance Housing finance ABS house price index Property market sentiment Home loan affordability
summary of property cycle
Heated Market (Prosperity/Peak/ Boom) Prices peak New investment in properties has a multiplier effect through demand for building materials and the new employment created, thus pushing the economy to new levels and property market experiences higher prices, great supply of land or housing. As market confidence grows and demand increases further, prices of houses peak, rents are pushed up and vacancies reduced. The cycle peaks and then enters a decline which is accelerated as more building projects are completed, flooding the market….so go into downswing…
Downswing (Recession): As demand is satisfied, particularly for investment goods, the market peaks and flattens with falling constructions. With prosperity, rents initially increase, but as early projects are completed, initial demand is satisfied and we move into excess supply of premises causes rents to fall and the values of new developments – houses and apartments – prices begin to fall…becomes a buyers’ market.
Depression (Bottom) Prices bottom: As profitability falls, demand decreases and the over-supplied market stagnates. Developers must sit and wait for better times, halt work in progress, suffer considerable losses through spending on the completion of projects that remain vacant, or are forced to sell them at knock-down prices. Rising interest rates and falling rental income puts pressure on the ability of developers to repay loans. Many developers are highly geared and lack the financial reserves to finance incomplete or vacant developments through a recession and a number may go bankrupt.
Cycle goes on…. The cycle turns again as some investors are able to take advantage of depressed prices to buy undervalued assets and investors and financiers anticipate recovery in the property market by responding to signs of rising demand.
Upswing (Recovery): Finally the reduced prices of housing, apartments, land etc are associated with low interest rates. This tends to attract borrowing for housing and starts the property market to move upwards again. From a demand point of view, house prices are low enough to attract people to buy house again. Undersupply of housing, becomes a seller’s market, prices begin to rise again, bringing new construction into the market again. Beside low house prices, low interest rates will also benefit demand for housing. Mortgage rates are generally low as construction picks up.
