Is it possible to make the property cycle go away?

Definition: Property Cycle

Property cycles are recurrent but irregular fluctuations on the rate of all-property total return, which are also apparent in many other indicators of property activity, but with varying leads and lags against the all-property cycle (Investment Property Databank,1999) The property cycle means the tendency for property demand, supply, prices and returns to fluctuate around their long term trends or averages.

Modern History of Property Cycle

Importance:

Property accounts for around 44% of the nonfinancial assets of UK companies (McWilliams, 1992) Property market boom-bust cycle creates destabilizing economic effects

Major Events:

Early 1990s crashes: adaptive behaviour of lenders & adaptive behaviour of investors (Beardsley,1995) Pattern between 2002-2004 Property market downturn starting from 2009

Historical Data & Global Comparison

120 100 80 UK Index 60 40 20 0 100 90 80 70 60 50 40 30 20 10 0

U K and W orld Property Q uarterly Fair Value Indices (Mar 1992 - Jun 2011)

* Data retrieved from DTZ Property Fair Value Index Database (Oct 11 2011)

Ju n9 Ju 2 n9 Ju 3 n9 Ju 4 n9 Ju 5 n9 Ju 6 n9 Ju 7 n9 Ju 8 n9 Ju 9 n0 Ju 0 n0 Ju 1 n0 Ju 2 n0 Ju 3 n0 Ju 4 n0 Ju 5 n0 Ju 6 n0 Ju 7 n0 Ju 8 n0 Ju 9 n1 Ju 0 n1 1
U K (All) G lo b a l (All)

M M /Y Y

Global Index

How the building cycle works

How the building cycle works

Rent & Stock

Knowing the stock of real estate, what rents are people willing to pay?
where R = rents S = supply E = office workers

Rent R () R = 40 (S/10E)

Stock S (sq. ft)

Price & Rent

Estimating user costs in relation to rent levels

P=R/

Rent R ()

where = yield

Price P ()

Prices & Construction

Construction costs
Price P ()

Why? Lower C excess profits Higher C unprofitable

C = (P 200)/5

Construction C (sq. ft.)

Construction & Supply

Stock S (sq. ft.)

Construction output has to be converted into the stock of real estate

S = 100 C Construction C (sq. ft.)

Four Quadrant Model

The building cycle: Market shock leads to increased demand Rent rises Prices rise Construction increases Stock increase leads to oversupply Rents fall below the initial equilibrium

Rent R ()

Price P ()

Stock S (sq. ft)

Construction C (sq. ft.)

The determinants of property cycles

Source: Wheaton,1999

Source: Wheaton,1999

Market reaction to a 50% demand shock

Market reaction to a 50% demand shock

The determinants of property cycles

The volatility of the cycle is dependent upon the strength of the transmission process

How fast will the market react to changes in vancancy rate? How fast will builders translate price changes in building output? How long is the construction lag?

Can you make the property cycle go away?

In theory yes but not in practice due to: Market imperfection such as:

Construction lag Uncertain market predictions about future prices Inelastic demand for buildings because of long fixed leases and high transaction costs Demand for buildings is relatively price inelastic beacause of: long fixed leases, high transaction costs

Can you make the property cycle go away?

Integration of real estate and capital markets

Accelerating innovation in occupier activity and growing investment demand for real estate assets

Integration of property cycle and the business cycle

It results in rising volatility of both Instability in wider economy changes in occupier activity changes in building investment changes in interest rates affected profitability and investment returns In reverse situation property booms reinforce economic cycles by boosting investment, consumption and borrowing and experience downturns during the property slump.

Globalisation of property cycles

It may strengthen economic growth and urban development but at the same time may result in

References

Ball M, 1994, The 1980s property boom,Environment and Planning A, Vol 26, pp 671-695 Baum, Evidence of cycles in European comercial real estate markets and some hypothesis, Henderson Investors, London and the University of Reading, Reading Barras, R., 2005, A Building Cycle Model for an Imperfect World, Journal of Property Research. 22(2):63-96 Barras, R., 2009, Building Cycles. Growth and Instability, WileyBlackwell Goodman A., 2000, Four quadrant model, available at: www.econ.wayne.edu/agoodman/7800/week3/re_dw1.ppt Henneberry J and S Rowley, 2002, Developers decisions and property market behaviour , in S guy and J Henneberry (eds.),Development and Developers: Perspectives on Property, Oxford: Blackwell, pp 96-114 Scott and Judge, 2000, Cycles and steps in British commercial property values, Applied Economics, Issue 32, p. 1287-1297 Ratcliffe J., Stubbs M., Keeping M.,2009, Urban Planning and Real Estate Development, 3rd Edition, Routledge Wheaton, W., 1999, Real Estate Cycles: Some Fundamental, Real Estate Economics. 27(2): 209-230