UK 18 year property cycle and the end of the long term debt cycle.
You’ve heard about the 18 year property cycle, but may be you wanted more information? Hopefully this article will help you understand enough to make some sensible investment decisions.
My opinion…the 18 year property cycle exists. We are now on the final ‘explosive’ leg where the property market is going to get very heated.
Note: This is geared to UK investors, but the principles behind the 18 year property cycle apply to nearly every property market where there is an unconstrained property market.
There is a window of opportunity which will probably close in three years from now. If you buy after that, you’ll probably be subject to the winner’s curse, where property prices are likely to keep climbing until 2026/2027 and then we will see the most serious of property crashes.
Why do I believe in the 18 year property cycle?
Obviously, I’ve been listening to the Propertyhub podcast.
Property hub YouTube video https://www.youtube.com/watch?v=U5sBw5Wk-Hc
If you want more detail…
There are some interesting Commentators who specialise in forecasting economic cycles such as Cathy Stacey and analyst and author Phil Anderson
Cathy Stacey Speaking in a recent podcast about the 18 year property cycle:
https://www.youtube.com/watch?v=NENu4eNeXqs
Phil Anderson’s book the secret life of real estate and banking: https://www.amazon.co.uk/Secret-Life-Real-Estate-Banking/dp/0856832634/
And of course Fred Harrison, the person who originated the notion of the 18 year property cycle ref https://www.amazon.co.uk/Boom-Bust-Prices-Banking-Depression/dp/0856832545/
I have read Boom Bust: House Prices, Banking and the Depression of 2010
This summarises the book: “The reason for the instability, Harrison explains, is not the housing market itself but the land market on which all buildings stand. Land is in fixed supply — as Mark Twain noted: ‘They’re not making any more of it’.
Therefore, as the demand for land for new homes and offices rises with population growth and economic expansion, market forces, which normally increase supply to reduce prices, have the reverse effect: prices rise. This encourages speculation, with banks lending more against escalating asset values and reinforcing the upward spiral.
Under existing government policies, the only way land prices can be brought back to affordable levels is a slump, undermining the banking system and causing widespread unemployment and repossessions.”
Essentially, you can’t ‘make’ land and there are huge constraints on building new property, so you end up with inelastic supply. Combine this with:
- Property generally being a very tax efficient store of wealth
- Historically low interest rates
- Banks progressively lending more money as fears of creditworthiness decline
- Fading memories of the 2008 crash
- Brexit, with the UK government doing whatever they can to stimulate the economy and win votes
All of this means I am certain we are in for an incredibly heated property market over the next five years.
The property cycle looks like this in Malaysia:
And this chart shows UK house prices adjusted for inflation going back to 1955. When house prices peak in this chart, it shows they are relatively more expensive. Clearly, there are cycles in the UK property market.
But there’s more….
One of my favourite thought leaders is Ray Dalio, the founder of Bridgwater, one of the largest hedge funds in the world.
He has made billions of dollars forecasting economic cycles. His opinion: we are now at the end of a long-term debt cycle which began roughly 80 years ago after the Second World War.
The long-term debt cycle:
- There is a massive economic reset. (end of World War II)
- There are smaller economic cycles which create minor booms and busts
- For every cycle that passes, governments try to reinvigorate the economy
- Over the last 30 years, the UK government has reduced interest rates on every 10 year economic cycle.
- When interest rates get to ‘zero’, and debt increases to unsustainable levels, governments have to ‘print money’, also known as quantitative easing
- When there is too much money in the system, it has to be absorbed somehow, so that’s either by increasing interest rates ( very painful and risky ) or allowing high inflation to erode the value of the debt over time
- At some point, there will be a huge reset because inflation gets out of hand, the market economy can’t function properly
- The reset occurs and everything starts again.
This diagram visualises the cycle.
If you’re interested in economic cycles, I highly recommend his book big debt crises.
- Summary here: https://ismailalimanik.medium.com/ray-dalios-big-debt-crises-ee4625a6a9e1
- Free download of the book from Bridgewater associates: https://www.bridgewater.com/big-debt-crises/principles-for-navigating-big-debt-crises-by-ray-dalio.pdf
This diagram shows how interest rates have progressively declined since the 1980’s and how US government debt has ballooned. It’s a similar story in the UK.
Clearly there is a correlation between very low interest rates and ballooning debt. Since debt must be repaid at some point, creditors will only keep lending if they’re confident of repayment.
At a macro level, how much debt can the United States sell before borrowers have had enough of US debt?
This chart shows the rise and fall of reserve currencies over the last 500 years.
Empires rise and fall along with their reserve currencies.
Confluence of cycles
The difference between previous property cycles and this one…the confluence of the end of a long-term debt cycle and an 18 year property cycle.
It’s easy to scaremonger and say this is the end of the economic world as we know it. However in probability, the outcome will be bad, but not society destroying.
This time round, at the end of the current property cycle, it’ll probably coincide with the decline of the US dollar as the global reserve currency and the ‘mother’ of all economic resets.
As investors seek better returns to cope with rising inflation, they look for assets which defy inflation.
Buy to let property has 3 features which makes it very special to investors:
- Rents increase with inflation, because rents are based on income. Income generally rises in line with inflation
- Debt on property declines in value as inflation increases, assuming interest rates remain low. In other words, you borrow £100,000 today which has a purchasing power of… £100,000. In 10 years time, that £100,000 will have a purchasing power of £50,000 in today’s money.
- You benefit from the capital growth on the whole value of the property, yet if you borrow to fund the acquisition, you might only have 25% of the equity. In other words, the bank don’t benefit from your capital growth. You do.
For these reasons, investors put their money into property. Prime central London property is a store of wealth as opposed to an income generating investment. Investors make all their money on capital growth.
For a typical buy to let investor, 25% of your return would be rental income and 75% from capital growth, assuming you invest in the right areas.
This chart shows house price affordability from 1845. Arguably the last long-term debt cycle ended after the Second World War (the vertical red line in diagram). And you can see an approximate 18 year cycle with peaks in low affordability. Affordability decreased from 1995 as interest rates declined.
Using this chart as an indicator, you could say that when interest rates normalise to 3%-5% interest rates, property prices will decline to an average of five times earnings (horizontal red line).
If properties normalised to 5 times earnings on average, we are in for massive inflation-adjusted declines in property prices over the next 10 years.
Psychology
There’s one other element to the property cycle: psychology
Most investors lose. You don’t hear about them, because after they’ve lost their money, they usually hide. The winners brag about their success, leading you to think everyone wins. But that’s not true.
This diagram shows the emotions of a typical market cycle.
Humans are social animals that work within a ‘Zeitgeist’. I.e. we use social proof and other indicators to see what others are doing and then likely follow them.
However, good investors are contrarians. They go against the norms of the day and profit.
As Warren Buffett says: ““Be fearful when others are greedy. Be greedy when others are fearful.”
Even if you’re not interested in crypto currency, you will have heard about bitcoin. Not long ago, we had the second bitcoin market peak.
This chart shows bitcoin against United States dollar from August 2016
And here’s a chart from Google showing interest in bitcoin also from August 2016.
Source: https://trends.google.com/trends/explore?date=today%205-y&q=bitcoin
Notice a correlation? When markets get heated, your friend who [is not knowledgeable on whatever it is] tells you they’ve made good money from [whatever it is that’s getting overheated]…you know there’s a problem.
This chart shows interest in ‘buy to let’ in the UK from 2004.
You can see the bottom of the buy to let market in 2010 coincides with people not searching ‘buy to let’ on Google .
Source: https://trends.google.com/trends/explore?date=all&geo=GB&q=buy%20to%20let
Here is keyword ‘mortgage’ From Google trends from 2004
Notice interest in the word ‘mortgage’ bottoming out around 2011 and peaking with the stamp duty holiday.
Fortunately, we haven’t hit ‘frenzy’ level on buy to let, but interest in mortgage lending is very strong.
I’m confident we will see an uptick in interest in ‘mortgages’ and ‘buy to let’ property over the next four or five years.
For property investors this means:
- Keep track of sentiment. Use tools like Google trends to watch what people are searching for and be aware if interest in these topics gets to high, or low…
- Be self-aware. Are you being influenced by the ‘herd’?
- Be logical. Understand that people are emotionally driven, when times are good they overdo it, when times are bad they under do it.
- Remember everything works in cycles.
- History never repeats itself, but it does rhyme
- People drive property markets. People are driven by greed and fear.
What is all this mean?
If I were to guess…
Over the next five years, I suspect house prices will rise by another 50% or so. Bear in mind, that is not an inflation adjusted number. Inflation-adjusted, the market will probably rise by 25%.
I would say property prices will possibly decline by 25%-35% from peak around 2026–27. However, when you factor in inflation, I assume the market might decline by 15%? Or less? I.e. you’ll have property values declining over a three or four-year period, with total inflation during that time of perhaps 20%, leaving you a total real decline of perhaps 15%.
If you can buy property sooner than later, fix interest rates and wait it out, inflation will do its magic for you i.e. water down the value of debt on property. And as long as you can achieve enough capital growth to outweigh capital decline post crash, you will be a winner.
