In my opinion, this is one of the key principles to property investing and I’ll even go as far to say life! I would say that as a Business and Economics teacher, but anyway, you get the point, I think it is important.
The state of our economy influences our jobs, our pay and even our confidence, so it is important we have a grasp of it.
Here is an extract from my book ‘Money lessons left at the school gate’, the book is targeted at young people, hence the reference to school, however, hopefully it explains each stage of the economic cycle:
It may seem an unusual comparison to make between the economic cycle and life, but the economic cycle goes up and down like life can. It is important that people realise that difficult times don’t go on forever and at the same time, try not to forget what the challenges can be like during the good times. The economic cycle refers to the good times as ‘booms’ and the bad times as ‘recessions’.
Below you can see a diagram which is known as the Business Cycle. It shows the stages the economy is going through, and this is all based on Gross Domestic Product (GDP). GDP is a way of showing how much a country is producing at a given time. The presumption is that when this is high, and an economy is producing more, it is classed as a ‘boom’. When this is falling, it seems that we are declining into a ‘recession’. Just because it is falling does not mean that we are in a recession, but it is when an economy’s GDP is falling for a prolonged period.
The presumption is that when GDP is falling, businesses are less productive and as a result will bring in less income. This will mean that they create less jobs. If less jobs are created, then less people are likely to be earning money. If they are earning less money, they are likely to spend less on buying items, so demand will fall for a business’s goods.
How does this link to property?
During ‘Booms’ property prices will generally rise, the country is producing more, so businesses need more staff to help them to continue to produce more. This creates more jobs and wage rises, which means that property becomes more affordable for people as they have more disposable income which will enable them to build up deposits quicker and have more capability of servicing a mortgage.
Sit back and enjoy the ride, I try and avoid buying during this period, it can lead to buyers speculating that there will be further price rises which will lead to people over paying.
Once we get through this period of excitement and the GDP growth starts to slow, businesses start to realise that they have over employed and over invested in capital (business assets). As a result, they have to think about slowing down recruiting, or even laying off some staff. This causes unemployment to rise slightly. The key is slightly, it may only be a slight rise in unemployment and fall in GDP, however, as humans we often follow the herd and react with our emotions rather than reasoned logic. This leads to a loss of confidence and people start to fear further drops in the market. The media will often fuel this further by writing negative news stories, negative news sells.
Start preparing for the decline, ensure you have cash in reserve to deal with any of your properties that may drop in value and/ or ensure that you have cash available in order to make the most of opportunities that arise as prices fall.
Technically a recession occurs with two negative quarters of GDP growth; unemployment is high, confidence is low. These are often the key ingredients for house prices dropping. They are also key ingredients for rental demand being high, as fewer people are looking to buy. This can make property really add up as an investment, as prices are low and rents are stable or even rising.
Have to be brave and buy. There is far more up side as this stage than downside. The opposite is true in a ‘Boom’ yet the uneducated investor will buy.
The economy starts to recover, those early investors have invested during the recession and realised the excellent returns on offers. This then starts to give others confidence to invest and the market starts to recover. This is not only in a property context but a whole economy context as businesses start to see the potential for growth again and start recruiting and investing in assets to grow their business.
Should still be thinking of buying. Just make sure you check your numbers, for example, rents, and sold prices in areas.
There is a lot of crossover between the economy and the property cycle, something I previously covered. So that mini series is definitely worth a read. Having a basic knowledge of the Economy is key, it is part of all of our lives, whether we like it or not. It is important that you have knowledge of the cyclical nature of the economy and that you are pragmatic in your attitude towards it. There will be ups and downs, the ‘booms’ don’t last forever and the ‘recessions’ are not terminal, sometimes the media will tell you otherwise, as will the people around you.
Next week I will look at why we get the cyclical nature of the economy and why I am confident that over the long term trajectory will be a positive one.
Enjoyed this blog, why not check out my new book, ‘Money lessons left at the school gate’, available in paperback or on Kindle.
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