I recently introduced my Cycles, Trends & Forecasts readers to another methodology that demonstrates the peaks of the cycle in advance — but also indicates when it’s a good time to buy and when it’s a good time to sell.
It’s called the Speculation Index.
It’s based on charts put together by our friend, data analyst Philip Soos, co-founder of LF Economics.
You can get the full report on the Speculation Index by signing up for Cycles, Trends & Forecasts here.
But today, I thought I’d share part of this report, which debunks a few myths on the key drivers of the 18.6-year cycle so you can understand how and why the Speculation Index works.
Without this clarity, you’ll always be confused — or walking blind.
Let’s get into it…
***
The myths about boom/bust cycles and what can start or stop them come from economists that are frequently featured in the mainstream media.
They always have a plethora of reasons to explain why we have high house prices in this country and, thus, why a housing cycle exists at all.
The main census is ‘if we only built more accommodation’, the market would somehow become affordable.
Most recently, property settlement group PEXA and real estate agency LongView piled in on the argument with their whitepaper ‘What drives house prices in Australia?’.
Their paper remarkably argues (pulling on some RBA analysis) that migration pouring into the cities of Sydney, Melbourne, and Brisbane (which account for 51% of Australia’s population) — and running up against zoning laws that restrict density — are the primary driver of land price inflation in Australia and thus, the cause of unaffordability in this country.
I won’t unpack any more of the analysis here — you can read it for yourself if interested here.
However, I want to (briefly) debunk any notion that the boom/bust driver of the 18.6-year land cycle has anything to do with zoning laws and migration patterns before I present the metrics that really matter.
It’s not that these things don’t shift the dial. Population growth (demand), increased immigration, regulation of land markets, restrictive planning policies, low lending rates and inflation, housing shortages, foreign investment, the mining boom, and so on and so forth are all influencers of price movement and relevance.
They all affect the volatility of the cycle to one degree or another, and these supply/demand metrics can also help analyse which ‘hotspots’ to target to capture short bursts of land price appreciation within the context of the 18.6-year cycle.
However, population growth running against zoning restrictions is not the primary driver of land price inflation and, thus, the 18.6-year cycle.
If local governments were to rezone every capital allowing for high-density construction in every neighbourhood, it wouldn’t stop the cycle.
In fact, it would most likely produce a feast of speculation from landowners in prime locations pocketing rezoning windfalls and ploughing it back into the market elsewhere.
These metrics are not the cause of ‘bubble’ land prices in this country — or any other country that exhibits a land boom/bust cycle.
If that were the case, the cycle would theoretically be eliminated if there were no zoning restrictions and cheap land on the outskirts of cities was amply available for newly formed families.
We only need to take a step back into history to debunk any evidence that this is relevant as the trigger for a boom/bust cycle.
We have long-term housing data to draw upon in Australia, England, and areas of Europe such as the Netherlands for our analysis.
These countries show repeated land cycles, some in a regular, almost unbroken 18.6-year pattern that existed well before restrictive planning, zoning, and development regulations that were implemented throughout the 20th century.
Evidence from history that debunks the myths…
Australia
Australia’s early land price booms are evidenced in the 1830s, the 1880s, and the 1920s, just prior to the Great Recession.
The 1890s depression was the worst economic depression in Australia’s history.
It occurred long before Australia had a federal government, and state and local governments regulated land supply.
Furthermore, Australia recorded its highest-ever rate of residential construction during the 1880s.
There was ample supply.
There was no rapid rise in nominal rents at the time (such as we’re seeing today) that gave any indication that the market was overly constrained.
(Note: Rising rents are always a primary indicator to show genuine supply shortages — immigrants needing to rent before they can buy.)
However, despite an almost unlimited supply of land and minimal regulations, the 1880s land bubble formed.
Immigrants discovered large nuggets of gold in areas such as Castlemaine and Bendigo.
A ‘credit boom’ of sorts.
They poured their wealth into the real estate market, banking on speculative gains.
By 1889, the value of land in parts of central Melbourne was as high as that in London.
The most successful developed an intricate web of land banks, mortgage companies, and building societies.
It was all set up on a web of complex cross-ownership and financial arrangements.
As long as confidence held, the boom in land values kept growing.
Foreign investment also played a role.
Many British investors saw Australia as a promising market, and they poured money into the country, particularly in the form of mortgage lending.
It was all fuelled by land speculation shares in the companies that backed it.
‘Thousands of acres of suburban land were subdivided and resold many times, each time at a higher price … anyone, it seemed, could make a fortune in this incredible economy.
‘[Everyone] grasped at the chance of quick wealth and invested their savings.
‘Many borrowed widely to invest more than their assets were worth, and later formed a pitiful kite-tail to the catalogue of insolvencies.’
Michael Cannon
The Land Boomers, 1967
The downturn that followed (at the end of the 18.6-year cycle in the 1890s) was the deepest and longest Australia ever weathered.
It was worse than the downturn during the 1930s Great Depression, worse than the downturn in the early 1990s, worse than anything we have seen since.
The lesson was a harsh one. Land prices didn’t rise again until the 1920s.
England
In his writings, Fred Harrison debunks similar myths.
From the mid-17th century onwards, he shows town planning laws did not prevent construction. They did not prevent or exacerbate the property cycle.
Land simply became easier to speculate upon.
From Harrison’s 2005 book, Boom Bust: House Prices, Banking, and the Depression of 2010:
‘But for a clinching argument, we can return to the UK. In the 150 years before 1947, the housing and land markets featured prominently in the booms and busts of the business cycle.
‘To what do we attribute those previous episodes?
‘We certainly cannot blame planners!
‘In terms of price volatility and supply falling short of demand, the patterns were consistent throughout two centuries.
‘Land planning did not mitigate — but nor did it exacerbate — the dynamics of booms and busts.’
The Netherlands
The land cycle is also apparent in The Netherlands.
The Herengracht Real Estate Index covers more than 350 years’ worth of data. It shows a series of repeat sales figures for a small but significant strip of real estate that has seen minimal changes over the centuries — high-density terrace housing with very little room to extend or add to the interior space.
Yet, it’s a strip of land that has always attracted speculative capital. The benefit of the index is that it records closely the locational change of value only.
Significantly, the boom/bust pattern evident at the start of the index occurred during a period when leaders authorised one of the earliest and most far-reaching urban planning schemes in history.
It was a massive undertaking that doubled the size of the city.
The periods of inflation and deflation came on the back of wars, financial crises, and credit excesses, such as Tulip mania of the 1630s and post-Second World War — not urban containment policies!
The two primary drivers of the 18.6-year real estate cycle
To sum up, 18.6-year boom/bust cycle has two primary drivers…
Credit growth
(The amount punters can borrow/spend.)
Grants and incentives that put money directly into purchasers’ pockets influence this metric, such as the stimulus from the COVID-panic that exacerbated the boom in the regional areas against the supply/demand constraints at the time.
Interest rates are also relevant. However, they’ll only stop the cycle when they rise to a point past which the productive sectors of the economy can afford the debt.
Outside of this, there can be long periods where property prices rise alongside interest rates (as a sign of a strengthening economy)— usually benefitted by fancy mortgage products that buffer the impact from banks that are cashed up (such as they are now.)
A grossly inefficient taxation system
(Allowing landowners to capture and privately appropriate the gains of land price inflation.)
This is the most important driver of the cycle. It is what produces the impetus to speculate in the first place.
It produces owners that ‘grow rich in their sleep without working or economising’, as the late great 19th-century economist, Sir John Stuart Mill, would quip.
Simply put:
1) Without the desire to speculate, you do not have a land cycle.
In other words, the tax policies of a country have to be favourable to landowners allowing them to keep the gains from land price inflation.
2) Without access to credit, you cannot speculate.
Be it in the form of credit from the bank as we have today — a gold boom (or crypto boom), big stimulus packages etc. — the profits of the economy will always find their way into the price of land, benefitting the landowners over the renters.
Everything else can exacerbate or modulate the volatility but cannot stop or produce a cycle.
Neither will supply and demand solutions make housing affordable in markets where speculation is encouraged.
How do you stop the cycle?
Develop laws to stop speculation on rising land values and channel investment into the productive sectors of the economy.
How do you do that?
In the way that 19th-century political economist Henry George and the classical economists (such as Thomas Pain, Adam Smith, John Stuart Mill, etc.) advocate — tax land and remove ALL taxation off labour incomes and productivity.
When you identify what drives the bubble, you can identify when it will crash
Needless to say, the economists that worked out that it’s not the basic fundamentals of ‘supply/demand’ that produce bubbles are the ones that were able to warn authorities a year or so in advance that economies were at the point of collapse.
One, for example, is Steven Keen.
Keen warned of the 2008 GFC in 2006 by showing that private debt had reached unsustainable levels and was *driving* the property bubble.
He used data on the growth of private debt, the ratio of debt to income, and the ratio of debt to GDP to support his argument.
He also analysed the relationship between debt and asset prices, showing that as debt levels rose, so did property prices.
One thing he didn’t do, is muddle around looking at migration and zoning laws and trying to correlate them to housing unaffordability.
Another was economist Dean Baker, who predicted the Global Financial Crisis as early as 2005.
How did he do it?
In his 2005 paper for the Centre for Policy Research (CEPR), titled ‘Will a Bursting Bubble Trouble Bernanke? The Evidence for a Housing Bubble’, he comments:
‘If house sale prices were pushed up by fundamentals in the housing market, it would be expected that rents and house sale prices would rise together.
‘This divergence is quite visible in many local markets.
‘When such divergences occurred in the past, they were usually followed by sharp declines in house sale prices.’
For bankers and almost all economists, ‘land price’ simply does not exist.
They cannot see the speculative influences that drive it higher.
Neither can the PEXA and LongView study that concluded that tax policies have little to do with inflated land values.
If fundamentals were at play, as Dean Baker comments, then rents (the earnings of the property) and prices would be more closely correlated.
But property bubbles also occur in oversupplied markets — at times when vacancy rates are high, and rents are stagnant or falling.
The key to getting out at the top is understanding when the fundamentals outlined by Dean Baker above have well and truly broken down…
(To read the rest of this report, and uncover the Speculation Index, sign up to Cycles, Trends & Forecasts and learn how to advantage of the power of understanding the 18.6-year real estate cycle — in both stocks and property.)
Best Wishes,
 |
Catherine Cashmore,
Editor, Land Cycle Investor
Comments