A Theoretical Overview of the Real Estate Cycle

Real estate cycles have been with us for 300 years. Such cycles have repeated in times of inflation or deflation, high interest rates or low interest rates, and with trade barriers or free trade.

They occur in the face of government subsidies and high taxes or low taxes, or even no taxes at all. The only single constant element present in all of the cycles has been a ‘collective land monopoly’.

The term collective land monopoly refers to the capitalisation of the rental value of land into a tradeable priveledge. Government legislation sanctions and protects this right.

Whilst this factor remains unchanged, the real estate cycle will repeat.

At the bottom of the cycle, cheaper land and lower interest rates will allow production to expand in the economy once again, particularly after business confidence begins to return. Demand for land will increase as a result of the expansion in activity.

Land, however, is in fixed supply. If we consider it a commodity, which it is not, it is the only commodity whose supply cannot be increased to match the increasing demand. Land prices will rise. A price rise of any other commodity would eventually attract more supply, ultimately lowering prices. Not so with land.

There is another difference also with the land market. As land price rises, owners will hold out for yet further price rises; the higher the price, the more it is hoarded.

As land becomes scarcer, a noticeable shift in investment activity begins, away from industry and commerce, to land speculation. (More visibly in what is built on the land, though in reality it is the land price increasing, not the buildings.)

Interest rates will have bottomed and then start rising. The percentage rises are more important than the actual figures themselves. Wider forces such as the Kondratiev Wave, and lower forces like the decade cycle play a part here, so too banks and the creation of credit.

Higher rent charges and the increased cost of borrowing for working capital or investment capital begin to squeeze the productive sectors of the economy. Higher returns in the property sector are seen by all now — the speculation intensifies.

A mid cycle slowdown is likely at this point. The decade cycle in operation. Do not confuse this cycle with the longer and more deadly real estate cycle. Bank collapses are usually not involved at this point, though the stock market may see reversals.

The one area where business can cut costs is wages. Pressure builds to exercise wage restraint. Governments agree, supported as they are by vested interest groups and the owners of the government granted licences, especially in real estate.

Unions, seeing nothing but living costs escalate, push for wage increases to cover them. At this point, it can be easy to confuse the symptoms of the economic illness — higher interest rates, increasing unemployment, government intervention etc — as the cause of the illness, which in reality is speculation in government granted licences.

It is very important to note that the land market is not subject to the same economic competition as is the entrepreneur. Therefore, the normal pricing signals won’t act to give real estate speculators the ability to see the excesses. Property owners simply continue to press for ever higher rental demands from the tenant.

The point will arrive when the productive sectors of the economy can no longer afford the rent. The downturn is imminent (and inevitable), the severity of which will be determined not only by the height and intensity of the boom, but also the extent to which banks have become involved in lending upon land value.

A bank collapse usually marks the passing of the peak: it may set off a panic. Other events however, like the oil crisis of 1974, almost always take place simultaneously — since economic activity is frenetic at the peak — which disguise the completion of the real estate cycle. It soon becomes obvious to all that a downturn has taken place, for which absolutely everything else will take the blame except the real culprit, the privatisation of the rent.

The real estate cycle, trough to trough, has usually measured about 18 to 20 years for each US cycle since 1790. Eighteen years has been the average so far.

Phillip J Anderson