nature of property cycles: past, present and future...2017/05/09 · nature of property cycles:...

Nature of Property Cycles:

Past, Present and Future

Robin Goodchild MA PhD FRICSInternational Director, Global Research & Strategy and Visiting Professor, University of Aberdeen Business School

9th May 2017

LaSalle Investment Management | Nature of Property Cycles – CULS / IPF / SPR | 2

• The Past: pre-2014

• Nature of Cycles in the UK and other Markets

• Academic Literature

• The Present: 2014-Today

• What is the nature of the current cycle?

• Similarities and Differences

• The Future: The Next Decade

• Understanding the causes of cyclicality - lessons learned

• Can the Credit Cycle be tamed?

• Conclusions and Forecasts

Nature of Property Cycles : Past, Present and FutureAgenda


The Past: (pre-2014)


UK All Property Real Capital Value change % pa

Sources: LaSalle, MSCI

UK Property 1968-2013: Three Significant Cycles

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012



Sources: LaSalle, MSCI,

UK Property 1968-2013: Three Significant Cycles

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012

2004-091972-76

1987-92


Annual Capital Value Change (local currencies)

Source: IPD (Australia, UK), NCREIF (US) Data through 2013

Developed Markets show similar cyclical pattern 1980-2016

-30%

-20%

-10%

0%

10%

20%

1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014

Australia

UK

US


All Real Estate Markets are CyclicalReal Office Values in Major Global Markets

Sources: PMA, Wheaton & Barranski, Vallis, Devaney, Turvey, RICS, Bjorklund & Soderberg

0

100

200

300

400

500

600

19

76

= 1

00

in

fla

tio

n a

dju

ste

d

New York Frankfurt StockholmTokyo Sydney SingaporeLondon City


All Real Estate Markets are CyclicalReal Office Values in Major Global Markets: Especially Volatile in Hong Kong!

Sources: PMA, Wheaton & Barranski, Vallis, Devaney, Turvey, RICS, Bjorklund & Soderberg

0

100

200

300

400

500

600

700

800

900

19

76

= 1

00

in

fla

tio

n a

dju

ste

d

New York Frankfurt StockholmHong Kong Tokyo SydneySingapore London City


-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

-35.0 -30.0 -25.0 -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0

Real Capital

Growth % pa

Real Rental

Growth % pa

Example from UK: Property Cycles 1968-2013

9

Sources: MSCI/IPD, LaSalle Investment Management

'Equilibrium’ 2011 –?

1995-2003

1979-86

Boom 2004-6

1987-8

1972-3

Bust 2007-9

1974-6

1990-2

Recovery 2010

1993-4

1977-8


Real Capital Value change %


Decomposing UK Property CyclesA Comparison of Three Cycles

Real Rental Value change %

-50

-40

-30

-20

-10

0

10

20

30

Booms Recoveries

1970s Late 1980s GFC

Busts

-30

-20

-10

0

10

20

30

40

Booms

1970s Late 1980s GFC

Busts Recoveries


What else does this tell us?

• 2008/09 was not exceptional in real estate terms (at least in the UK)

• 16-18 years between cycles – is that just a coincidence?

• Types of economic cycles:

– Kitchin: 3-5 years – inventories

– Juglar: 7-11 years – fixed investment (business cycle)

– Kuznets: 15-25 years – infrastructure investment

(18 year US property cycle - Foldvary 1997; 15-25 years in UK – Barras 2009)

– Kondratiev Waves: 45-60 years – technological changes / financial manias?

• Cracking Stories:

– Early 1970s – Plender, J (1982)

– Late 1980s – Ross Goobey, A (1992)

– GFC – ‘Big Short’ etc.(& World Economic Forum (2015))

The Present: 2014 - Today


Sources: LaSalle, MSCI

UK Property 1968-2016: The PresentDid we experience a Boom in 2014/15 so are we now about to have a Bust?

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016


UK Property Transaction Volumes: The PresentThe Pattern of Transactions looks suspiciously like 2005/07

Value and Number of Commercial Property Deals in March of Each Year

Sources: Property Archive, Capital Economics


Real Capital Value change %


Decomposing UK Property CyclesCapital Gain in 2014/15 not sufficient to be a ‘Boom’

Real Rental Value change %

0

5

10

15

20

25

30

35

Booms

1970s Late 1980s GFC 2014/15

-5

0

5

10

15

20

25

30

35

Booms

1970s Late 1980s GFC 2014/15


Sources: Thomson Reuters (Datastream), CBRE, LaSalle Investment Management

UK Asset Class Yields 1975-2017 Q1Spread between Property & Gilts has never been wider

-2

0

2

4

6

8

10

12

14

16

-2

0

2

4

6

8

10

12

14

16

1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017Q1

Yie

lds %

UK All Property Yield

10-year Gilt

FTSE Dividend Yield

Prime West End Office Yield

20-year index-linked Gilt


0

2

4

6

8

10

12

14

16

1700 1720 1740 1760 1780 1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000

Inte

rest R

ate

%

Yield on Consols 1700-2015(undated Government bonds)

Sources: Bank of England, PMA

But the Post-War period is an Aberration relative to history What is a ‘normal level’ for the Risk Free Rate?

What drives Property Cycles

The Future

Sources: LaSalle, MSCI, ONS

UK Property Cycles 1968-2016: Three Significant OnesStrong relationship between Property Returns and Economic Growth

-10

-8

-6

-4

-2

0

2

4

6

8

10

-30

-20

-10

0

10

20

30

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

Total UK Commercial Property Real Returns % pa GDP % pa (RHS)

-10

-8

-6

-4

-2

0

2

4

6

8

10

-30

-20

-10

0

10

20

30

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016



Economic Downturns don’t have to cause a Property BustBig Cycles have occurred every second Economic Downturn

1974/5 1980/1 1990/2 2001/2 2008/9


Too much office development can also be problematic UK Office development 1980-2016

Sources: LaSalle, BCIS, ONS

£1,000

£1,500

£2,000

£2,500

£3,000

£3,500

£4,000

£4,500

Feb-80 Feb-84 Feb-88 Feb-92 Feb-96 Feb-00 Feb-04 Feb-08 Feb-12 Feb-16

UK

Offic

e C

on

str

uction O

utp

ut:

Con

sta

nt 2

01

3 p

rice

s £

’ mill

ion


UK Lending to Corporate Real EstateHighly correlated with the 3 Cyclical Peaks


How the Building Cycle worksProperty Market Fundamentals Capital MarketsReal Economy

Recovery

Increasing property demand

Credit Expansion

Falling vacancy

Rising rents/Falling yields

Upswing in building starts

Speculative building boom Credit boom

Rising construction costs

Increasing supply and slackening demand Credit tightening

Prosperity

Recession

Rising vacancy

Falling rents/Rising yields

Downswing in building starts

Property slumpDepression Credit crunch

Accelerator +Multiplier +

Accelerator -Multiplier -

Source: Barras (2009) p 80


-10

-8

-6

-4

-2

0

2

4

6

8

10

-30

-20

-10

0

10

20

30

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016



Economic Downturns don’t have to cause a Property BustBig Cycles have occurred every second Economic Downturn

1974/5 1980/1 1990/2 2001/2 2008/9

But no accident that worst recessions usually coincide with the Busts


Why is CRE lending so cyclical?Write-off rates on lending to UK businesses

0.00

0.50

1.00

1.50

2.00

2.50

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

% L

oss R

ate

s o

n L

oan

s

Private non-financial corporations Commercial real estate companies

Lending by UK monetary financial institutions. The series are calculated as annualised quarterly write-offs divided by the corresponding

loans outstanding at the end of the previous quarter. The data are presented as four-quarter moving averages and are non seasonally

adjusted. Lending in both sterling and foreign currency, expressed in sterling terms.

Source: Bank of England and Bank calculations

‘Time and again financial

earthquakes are thrown up by

excessive risk taking on borrowed

money in property. Indeed,

property seems to have a unique

capacity for inducing collective

memory loss among bankers.’

John Plender FT 02/05/2017


Similar data for USA show GFC explosion in Loss RatioDelinquency Levels for US CMBS loans 2000-15

0

200

400

600

800

0

20

40

60

80

2000 2002 2004 2006 2008 2010 2012 2014

To

tal

Vo

lum

e B

illio

ns U

SD

Billio

ns U

SD

30 Days 60/90+ Days

Non Performing Beyond Maturity Foreclosure/REO

Total Loan Volume (right scale)

Source: Trepp LLC


Some lessons from three big Property Cycles

• Debt driven real estate markets are dangerous

• Contradiction between prudent lending and building a market leading

banking business in commercial real estate

• Too much development is also dangerous

• ‘Greed and Fear’ rule - pay attention to Behavioural Economics

• Property looks a very easy business in a Boom

• Beware managers in senior positions who have not experienced

a Big Cycle

• If commercial property values increase by over 25% real (in a 2/3 year

period) - there is a very high probability of a Bust

• Ways to exploit property cycles

– ‘Catching the falling knife’ - buy in the Bust to exploit the Recovery

bounce

– Long term investing between big cycles selling into the next Boom


Bank Lending to CRE as a % of all Lending

Sources: Bank of England, MSCI/IPD

UK Commercial Real Estate (CRE) Lending 1969-2016The current situation looks comfortable, i.e. mid-cycle

0

20

40

60

80

100

120

140

160

0

2

4

6

8

10

12

14

1969 1974 1979 1984 1989 1994 1999 2004 2009 2014

Real

Cap

ital

Valu

es I

nd

ex

(196

9 =

100)

% o

f B

an

k L

en

din

g t

o C

RE Bank Lending % All Property Real Capital Values


Pros

16-18 years from 2007/8

Time for professionals without experience of

a Big Cycle to reach positions of seniority

Debt market is attracting new players who

may not have any institutional memory

Bank of England will not be sufficiently brave

to remove the punch bowl in time

(as in 1986/7 and 2005/6)

So: When will the next Big Cycle occur?circa 2025 or some other date

Cons

The 2008/09 crash was so devastating that its

effects will stay longer in corporate memories

Better information about real estate markets will

prevent a recurrence:

- Property Vision report recommendations:

‘Long term’ valuations

Loan data

Recovery from the GFC will be so muted that

there is not enough confidence to generate a

Boom (cf. recovery from 1930s)

Better education – CULS, IPF and SPR achieve

their mission


Bank of England’s Investment Valuation Approach (Q2 2015)

Sources: Association of Real Estate Funds (AREF), Bloomberg, Investment Property Forum, MSCI and Bank of England calculations.

Investment valuations are based on assuming property is held for five years with the cash flows from the rent and sale discounted. It is assumed

that the property is sold at a rental yield (in line with long-run averages fifteen years). The sale proceeds and rental income are discounted by the

ten-year gilt yield plus a risk premium. The swathe represents varying assumptions on the average through the cycle risk premium, given the

inherent uncertainty in measuring it; the lower end of the range is from a survey of investors from AREF and the higher end is a risk premium

derived from the long-run relationship between gilt yields and property yields. For more details see Crosby et al. (2011),


• The Past: pre-2014

• Property Cycles have a very long history

• Four market phases – Boom, Bust, Recovery & Equilibrium

• Key causes:

• Combination of Economic, Debt Availability, Excess Development

and ‘Memory’

• The Present: 2014-Today

• Strong Equity Driven upswing but not a Boom

• Market likely to remain in Equilibrium, i.e. no Bust

• The Future: The Next Decade

• A Big Cycle around 2025 is not inevitable but …..

Nature of Property Cycles : Past, Present and FutureConclusions and Forecasts


Final Thoughts: Hope over Experience

Ross Goobey, A (1992)

“Whenever the [new cycle] starts, there will be new

participants, who will be less constrained by the

experience of this recession than those who lived

through it. They will repeat many of the mistakes of

the 1980s, as many of the companies repeated the

mistakes of the 1970s. The market will then be

driven to levels which will prove unsustainable.”


Contact details: Robin Goodchild PhD FRICS

E-mail [email protected]

References:

Barras R (2009) ‘Building Cycles – Growth & Instability’ Wiley-Blackwell, West Sussex, UK

Benford, J & Burrows, J (2013) ‘Commercial property and financial stability’ Bank of England Quarterly Bulletin Q1 pp 48-53

Cosmetatos, P (2016) ‘Improving the effectiveness of CRE debt risk management’ , Chapter 21 in Petersen, A (Editor) (2016)

Commercial Mortgage Loans and CMBS: Developments in the European Market 3rd Edition, Sweet & Maxwell, London

Crosby, N and Hughes, C (2011), ‘The basis of valuations for secured commercial property lending in the UK’, Journal or European

Real Estate Research, Vol. 4, No. 3, pages 225–42.

Foldvary, F. (1997) "The Business Cycle: A Georgist-Austrian Synthesis." American Journal of Economics and Sociology 56 (4)

(October): pp 521-41.

Goodchild, R (2015) ‘Property Cycles: Reflections by Dr Robin Goodchild’ LaSalle Investment Management, Chicago

http://www.lasalle.com/documents/Global-Real-Estate-Universe-February-2015.pdf

Goodchild, R (2016) ‘Nature of Property Cycles’ , Chapter 2 in Petersen, A (Editor) (2016) Commercial Mortgage Loans and CMBS:

Developments in the European Market 3rd Edition, Sweet & Maxwell, London

Korotayev, A, & Tsirel, S (2010) ‘A Spectral Analysis of World GDP Dynamics: Kondratieff Waves, Kuznets Swings, Juglar and Kitchin

Cycles in Global Economic Development, and the 2008–2009 Economic Crisis’ Structure and Dynamics Vol.4. #1. P.3-57

Ormerod, P (1994) ‘The Death of Economics’ Wiley, London

Plender, J (1982) ‘That’s the way the money goes – The Financial institutions and the Nation’s Savings’ Andre Deutsche, London

Real Estate Finance Group (2014) A Vision for Real Estate Finance in the UK Investment Property Forum, London

Ross Goobey, A (1992) ‘Bricks and Mortals: Dreams of the 80s and the Nightmare of the 90s – Inside Story of the Property World’

Random House Business Book, London

Trepp LLC (2016) The Mid Year – CRE Market on the High Wire Commercial Real Estate Direct, Doylestown PA, USA

Wolf, M (2014) The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis Penguin Group,

New York

World Economic Forum (2015) Emerging Horizons in Real Estate: An Industry Initiative on Asset Price Dynamics, Executive Case

Studies WEF, Geneva

mailto:[email protected]

http://www.lasalle.com/documents/Global-Real-Estate-Universe-February-2015.pdf


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nature of property cycles: past, present and future...2017/05/09 · nature of property cycles:...

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