The cyclical pattern

Property prices follow a cyclical pattern. Property prices rise and then property prices fall. The reasons why will become apparent further on, but for some reason they do rise and then fall. So what is the best time for an investor to become interested? When the prices start to rise, of course!

If we were to speed up this process over a notional 12-hour period, with 12 noon being the point when they first rise and 6 o’clock being the point when they first start to fall, then we would have the following diagram:

At 12 noon prices increase until 6pm and then they start to fall. We can see that anyone who has any sense gets interested anywhere between 12 noon and 6pm. So who buys between 12 noon and 6pm? Everyone! Who is everyone and why do they buy? The following people buy exclusively and their reasons are as follows.

Buyers	Why?
Professional property investors	A professional property investor will buy a property which will enable them to buy other properties and put money in their pocket. It will enable them to benefit from capital growth so that they can remortgage and buy further properties, and when rented out it will, after voids, letting agent’s fees, tax and other expenses, provide a positive cashflow.
Novice/speculative investors	A novice/speculative investor will invest in a growth area because they will believe that the trend upwards in price will continue. They are less concerned in fundamentals as they are not aware of the fundamentals – they simply believe that the trend is upwards.
Owner-occupiers	The owner-occupier will buy because if they delay buying it will cost them more. So it is in their interest to buy sooner rather than later as their overall purchase price will be higher the longer they leave it.

So who buys between 6pm and 12 midnight? Prices are falling now so the novice/speculative investor becomes uninterested as there are no capital growth prospects and the owner-occupier will wait until the prices drop further. The only buyer remaining is the professional investor.

Buyers

Why?

Professional property investors

The only time a professional property investor will buy in this market is if the investment puts money in their pocket. They will invest in a falling market due to the property market providing a better return on their other investments such as the stock market, other businesses or a bank or building society. It is the professional property investor who prevents the property market falling to nothing. It is the professional investor who provides the cushion to the fall.

Based on the table above we can see that:

• The professional investor buys on known information i.e. the property purchase puts money in their pocket.
• The novice/speculative investor and owner-occupier buy based only on the fact that the trend of prices is rising.

So how does the professional investor estimate whether a property will put money in their pocket? It’s called gross yield. Gross yield, in mathematical terms, is:

Now annual rent is a pretty static figure. Rents do not rise and then fall. They simply rise slowly and steadily the same way wages do. So in real terms they remain the same. However, property prices are far more volatile. Property prices gather momentum far in excess of the rate of wage inflation and hence rise and fall at a greater rate than the rate of inflation – but we will get to that later.

Assuming we agree with the stability of rental prices and the volatility of property prices, we can show that:

That is to say that as property prices rise the yield falls. Let me show you this example:

Yield is then:

Now let’s say that property prices increase to £110,000 in six months. A professional investor considering the market will now consider the yield to be:

So we can see that as the property price increases from £100,000 to £110,000 the yield decreases from 10% to 9.1%.

Using this same example let’s say that property prices fall from £100,000 to £90,000 in six months. A professional investor considering the market will now consider the yield to be:

So we can see that as the property price decreases from £100,000 to £90,000 the yield increases from 10% to 11.1%.

This is called an inverse relationship as the yield and property price move in different directions. So if we were to create a yield vs time graph then it would be the exact opposite of the real price vs time graph.

Fitting the yield curves into the clock it will look like this:

When you should invest

So if you’re a sensible investor then you will invest during the periods 12 noon to 3pm, and 9pm to 12 midnight. This is because, as with any investment you make, you will make money as the investment puts money in your pocket because it’s a positive yield.

If we superimpose these two strategies then we come up with the face of the property clock:

What pushes the clock round

But every clock needs power to move. I call this power the drivers. The clock hands need power to take them round the clock. So what moves the clock hands round?

The following drivers push the property clock round with regularity:

So we can see that:

• everybody drives the price from 12 noon to 3pm;
• speculative investors and owner-occupiers only drive the prices from 3pm to 6pm;
• interest rate rises then drive the price downwards from 6pm to 9pm;
• professional investors drive the price downwards even further from 9pm to 12 midnight but prevent the prices from falling to zero.

The clock quarter regions (being 12 noon-3pm, 3pm-6pm, 6pm-9pm and 9pm-12 midnight) can be named quite specifically as:

Clock quarter	Name
12 noon – 3pm	Hot spot
3pm – 6pm	Cooling spot
6pm – 9pm	Cold spot
9pm – 12 midnight	Warm spot

The reasons why they are so named will be explained later. However, we now have the complete face, drivers and names for each clock quarter for the property clock:

This clock is relevant to any property market that exists within the following conditions:

• 1.Variable interest rate environment
• 2.Easily obtainable buy-to-let mortgage environment
• 3.Lack of long-term fixed interest rate mortgage (typically greater than ten years) environment.

The UK market fits this model. If any of these conditions is eliminated then the clock slows down. If all conditions are eliminated then the clock STOPS! Assuming that none of these things happens then the strategy is:

a) Know when the clock strikes 12 noon most importantly and

b) Know when the clock strikes 3pm, 6pm and 9pm.

In the rest of this book I am going to ignore wage inflation. Even though a house costs twice as much in 20 years you can be sure that you will be earning twice as much. I am going to assume real prices. This makes the figures simple. Actual prices rise and fall but real prices remain the same.