IN SIMPLE TERMS, you ideally want to be buying Commercial property during a recession … and sell it during an economic boom.
However, picking the precise bottom and the top of any Commercial property market is clearly not an exact science. Furthermore (unlike with shares) Commercial property is seldom bought or sold instantaneously.
And the problem is … if you do miss the top, it then becomes very difficult to sell into a falling market. Whereas with shares … all you need do is simply lower your price to meet the market that day.
As you probably recall, I always recommend you undertake a mandatory 4-year review of your properties. And you need to consciously decide why you should HOLD onto them. (And this is part of the reasoning behind why in the previous Question … where I limit my projected cash flows, to no more than 4 years).
Having said that, you also need to temper your 4-yearly reviews with professional advice on where you are within the current cycle. However, these mandatory reviews force you to focus upon your overall investment strategy – every 4 years.
The Stock Market
If you have invested in shares, you would most likely be familiar with the so-called “Investment Clock” – which attempts to show how the economic cycle influences equities.
In essence, an over-heated economy is followed by rising interest rates and falling share prices. Then, as the economy declines interest rates start to fall and share prices rise again.
Some analysts have tried to devise a similar analysis for Commercial property. But unfortunately, the results have generally not been very helpful.
As you’ll appreciate, Commercial property has several sectors – which don’t necessarily move in unison. For example: Industrial property prices may be sagging, while Retail prices are on the rise.
And there are also regional differences as well. Prices might be hot in Sydney and lukewarm in Melbourne or Brisbane; and vice-versa.
Nevertheless, using a somewhat broad-brush approach, it is possible to place property within the investment cycle as follows:
- The economy begins to slow
- Direct property prices stop rising, and may decline
- The authorities inject liquidity into the economy
- The stock market and listed property trusts rise
- The economy starts to recover
- Direct property prices start to rise
- Inflation may also rise
- Interest rates rise
- The stock market and the property market fall
Historically, the main three Commercial property sectors have moved in cycles, which tend to vary in length. And broadly, that’s depicted in the chart below.
To help give you a clearer picture for Commercial property, here are five key Phases based on economic and supply-demand factors.
Phase #1: This is the bottom of the cycle, when the market is generally in a condition of over-supply — due to both a weak economy and too much new construction, from when the economy was still strong.
Vacancy rates may be high and rents falling significantly. Therefore, any new construction ceases; while demand slowly starts growing again, and the existing over-supply is gradually absorbed.
Phase #2: Demand for new space begins to grow. But with little new construction, rents rise — sometimes quite sharply. This leads to developers once again to initiate construction of new buildings; until at some point, you regain a rough balance between supply and demand.
Phase #3: Demand continues to rise; but supply is now growing faster, and rental growth may begin to slow down.
Phase #4: The market is approaching a point of over-supply, due to over-building; with the situation perhaps aggravated by a weakening economy.
Phase #5: Vacancy rates climb sharply, causing rents and prices to begin falling. This leads to a general decline in investor confidence. And so, you re-enter Phase #1 once more.
As you can see from the graph above, each Commercial property sector operates over a different time-frame for its cycle.
Historically, Offices have spanned around 18 years from “peak to peak”. Whereas, the Industrial and Retail cycles have tended to be about 9 and 6 years respectively.
Obviously, the key is in knowing where you are in any particular cycle. Because, unusual influences (like the mining boom) can cause disparities for Commercial property, between the various capital cities.
Furthermore, there will always be variations within each capital city. However, this chart above is an attempt to give you a broad picture of where their Office markets presently sit at the moment.
And for a more detailed analysis … you can read this recent article about the CBD Office markets, within the various capital cities.
Stick to the Basics
For me, the best way to find a good investment is to focus on the fundamentals – the numbers and potential upside for the specific property.
When I look back some of the best deals, they were when market sentiment was clearly negative.
These properties have withstood the test of time; and have been through several ups and downs of the market. And this stems from … choosing the right location and type of tenant; ensuring rentals were at market level; plus, identifying ways to quickly and easily add value.
Also, having an ongoing focus on the day-to-day management will also help you maintain and grow your investment return.
Many investors suffer from analysis paralysis, as their major problem, when starting out. And that’s why I believe that it is best to initially concentrate on a single portion of the market – so you can become more confident (and competent) in one sector at a time.
This way, you’ll quickly become an expert on the top of properties you’ve chosen. And will find it easier to quickly sort out good potential properties, from the not so good ones.
So, when to Buy and Sell?
Of course, you want to buy just as the market hits rock bottom and starts to rise; and sell at the top of a boom.
However, you can make money on property at any time, if you buy for the reason, at the right price and in the right areas. Plus, if you have a strong tenant on a long lease, you’ll position yourself to straddle any downturn in the market.
Furthermore if there is an opportunity to upgrade or subdivide, you’re able to add additional value to your property – for whenever you may choose to sell it down the track.
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