We all understand that there is risk associated with any type of investment including property. So in a series of articles I want to briefly touch upon the risk categories that we always figure into our calculations before making a purchase. In today’s article we will look at:
Property is cyclical. Its value goes up and down, and the returns it produces rise and fall over time. It is generally accepted that property follows a 9 - 10 year cycle. from top to bottom.
However this is not set in stone. Government interference, regulatory or tax issues, macro economic conditions, and supply and demand can either shorten or extend this cycle.
The problem is, these cycles are very difficult to predict and even harder to determine what, when and how prices will rise or fall. Trying to time the market is very much a fools game. However, there are few clues to watch out for to give you an edge.
For instance: a high price to earnings ratio that deviates too far from the historical trend is a sure sign that the market is overvalued and contributes towards a market risk. In the UK for instance, the price to earnings ratio is 9.4, more than double what it has been historically, with most of that uptick occurring after the UK government introduced the Help to Buy scheme. Coincidence? Perhaps.
A pick up or slow down in the velocity of money can also signal if the economy is picking up or slowing down, both of which affect the property market. The faster money circulates the more activity there is in the economy which means higher economic growth. With money in their pockets, people tend to want to upgrade to better homes or get on the property ladder.
If bank lending is picking up, then we can also confidently assume that property prices will rise because 60% of that lending is geared towards residential mortgages.
Rapidly falling or low yields should set alarm bells ringing that prices are rising too fast or are overvalued, which could signal higher interest rates. Although in today’s low interest environment, most people no longer consider this a risk.
Nevertheless, interest rates will rise at some point and without warning. And if yields are still low when this happens, many landlords will find themselves in the red we can either expect a price correction or a prolonged period of stagnation, which could force investors to use their own funds to keep finance their mortgager payments.
Market risks can never be avoided or dodged. Sadly however, many property investors tend to minimise the events that lead to market risks, only to find themselves in hot water when the tide turns.
So the next time you read in the paper that bank lending is up you know what's coming next.