A week has gone by since my last post, and I hope you were able to read it and digest all the facts. ‘Secrets of the Canadian Real Estate Cycle‘ is designed to give you an in-depth and technical look into what is really happening with our real estate markets. I use ‘markets’ as a plural because there is no single real estate market in Canada.

It may seem that way with how the headlines on our national news sources read, but let me assure you that real estate in our country is as vast and differing as the geography that stretches from coast to coast. Averages don’t do us much good when what we’re really looking for is a microscopic view.

With all that in mind, here is part two of my four part series as I share the second chapter of ’Secrets of the Canadian Real Estate Cycle‘. Don’t hesitate to take a few notes and really think about what is written here.

Moving Forward: Cycle Predictability

Our research indicates that the real estate cycle is predictable because it follows a basic pattern. This pattern was the subject of a book written almost 80 years ago by the grandfather of the real estate cycle concept, Homer Hoyt. In “100 Years of Land Values in Chicago”, written in 1933, Hoyt analyzes the movement of Chicago’s land values, and notes that a recurrent succession of causes and effects impacted on these values during the hundred years from 1830 to 1930.

Hoyt concluded that a real estate cycle certainly existed, and he was the first to identify some of its consistent key drivers. Generally speaking, he noted that key drivers, such as population growth, often initially created increased demand for real estate. Increased demand was followed by a sharp rise in rents, which resulted in increased land values because of the greater financial returns available from buildings. Hoyt then observed significant increases in the construction of new buildings as a result of higher margins being achieved by construction firms. Finally, too much new construction produced an oversupply of real estate that eventually resulted in rent reductions and subsequent real estate price erosion. This pattern is still in evidence in real estate markets today, and is possibly even more apparent now, due to the ready availability and quality of statistical data.

The Cycle Is Predictable, Its Duration Is Not

Strategic real estate investors have often heard the phrase, “But this time it’s different because . . .” to justify why a current boom should last longer than a previous boom. They understand that the basic principles of the real estate cycle always remain the same, and many have used this knowledge to increase their financial net worth while minimizing their investment risks. The real estate cycle provides many telltale clues that clearly indicate what is in store for the real estate market.

The following graphs show the distinct pattern of the real estate cycle in several countries from the mid- to late 1980s. They reveal varying degrees of real estate price growth, but the three stages of the real estate cycle can still be seen in each country.

Some experienced investors reviewing these graphs may cry foul. They may recognize that one nation’s real estate cycle does not reflect what happened in their city or region during a particular time period, and they would be correct. These graphs represent national findings and may be out of sync with more local markets. Fear not. Our later discussion of key drivers will help you identify real estate cycle phases as well as market anomalies created by what we call market influencers (rather than key drivers) in your local market.

The graphs show that the most extreme house price growth is recorded in the UK (graph 2.2) and Australia (graph 2.3) during the late 1980s when house price inflation peaked in those countries at around 35 per cent per annum. Both of these countries then experienced a long slump phase. In contrast, the United States (graph 2.4) and Canada (graph 2.5) experienced a smaller rate of residential price growth (which peaked in the late 1980s), followed by a much shorter slump phase than what occurred in the UK and Australia.

While the data are not sufficient to draw a strong conclusion, it appears that periods of very strong house price growth may well result in an extended slump phase. Moreover, while the duration of each phase may differ from cycle to cycle, strategic investors recognize a larger truth: the cycle itself does not change.

Graph 2.2: UK House Price Index (% Change), 1984–2010

Graph 2.3: Australia House Price Index (% Change), 1987–2010

Graph 2.4: U.S. House Price Index (% Change), 1988–2010

Graph 2.5: Canada House Price Index (% Change), 1984–2010

Cycle Duration

While the duration of a complete real estate cycle has not proved to be consistent, it has typically lasted anywhere from seven to eighteen years. The longevity of each real estate cycle obviously varies depending on the state of the key drivers for each country. Smaller economies can experience faster cycles, and this may well be due to the increased volatility and limited inertia of the key drivers of the real estate cycle in those economies.

Click here for Part One.

Click here for Part Three.

Click here for Part Four.

Secrets of the Canadian Real Estate Cycle will give you insight into the economic fundamentals that you may not have realized before. Make sure to look out for the next post in this series, coming out next week. Good luck and happy investing!

Cheers,
Don