What Are Economic Cycles and How Do They Affect Property Investment?

Economic cycles (or business cycles), are fluctuations in economic activity that researchers like Akhil Patel say creates an 18 year property cycle.

These economic cycles are significant because they influence a wide range of variables like employment rates, consumer spending, and investment levels. For property investors, understanding these cycles is important as the economy affects the property market more than you may know!

Knowledge of where the economy stands within its cycle can help inform your investment decisions, timing, and strategy and affect your profitability and risk management.

In our latest podcast episode, Akhil Patel, the director of Property Sharemarket Economics breaks down his framework for understanding these all-important property cycles, including his famous 18-year model for the Australian market.

What are Economic Cycles?

Economic cycles are recurring phases of economic growth and decline that economies typically go through. These cycles are divided into four main phases.

Expansion

This stage is marked by increasing economic activity, characterised by rising Gross Domestic Product (GDP), higher employment rates, and greater consumer confidence. During expansion, businesses invest more, consumers spend more, and economic indicators such as stock prices and property values generally rise.

Peak

The peak represents the height of economic activity in the cycle. At this point, the economy is operating at full capacity, unemployment is at its lowest, and inflation may start to become a concern. Property prices are often at their highest during this stage, and the market can show signs of overheating.

Contraction

Also known as a recession, the contraction phase is when economic activity begins to decline. This stage is characterised by decreasing GDP, rising unemployment, and falling consumer confidence. Businesses cut back on investments, and consumer spending diminishes. In the real estate market, demand decreases, leading to lower property values and higher vacancy rates.

Trough

The trough is the lowest point of the economic cycle, where economic activity is at its weakest. This stage is often followed by stabilisation and the beginnings of recovery. Unemployment is high, and consumer spending is at its lowest. However, this stage also presents opportunities for investors to acquire properties at lower prices, setting the stage for future gains as the market recovers.

The Impact of the Four Phases of Economic Cycles on the Property Market

Expansion Phase

In the expansion phase, the property market typically thrives. Increased economic activity leads to a higher demand for properties, both residential and commercial. As more people secure jobs and incomes rise, more people seek to buy homes, driving up property values due to increased demand. 

Similarly, businesses looking to expand operations increase demand for commercial real estate. This surge in demand results in rising property prices and higher rental yields. Real estate developers also respond to the positive market sentiment by initiating new projects, further fueling the market’s growth.

This phase could be a good time to look at investing in commercial property. 

Peak Phase

During the peak phase, property prices often reach their highest levels. The property market is characterised by increased speculative investment as investors seek to capitalise on rising property values. 

This can lead to market saturation, where the supply of property exceeds demand. While property owners may enjoy substantial gains during this time, the market’s inflated prices and potential oversupply can also create risks. As an investor, you need to be cautious of entering the market at this stage, as the peak is typically followed by a downturn.

Contraction Phase

In the contraction phase, the property market experiences significant challenges. Decreased economic activity leads to a reduction in demand for properties, both residential and commercial. 

Property values begin to fall, and vacancy rates increase as businesses downsize or close and people put off home purchases. The rental market also suffers, with lower rental yields and higher tenant turnover. 

For real estate investors, this phase can be difficult, but it also presents opportunities to acquire properties at lower prices, preparing for future recovery.

Trough Phase

In the trough phase, property prices often bottom out, presenting an opportunity for savvy investors. 

With the market at its lowest, properties can be bought for significantly reduced prices. While economic activity remains low, early signs of stabilisation can appear, such as improved business sentiment and gradual increases in consumer confidence. 

Investors who buy property during this phase can benefit from significant appreciation as the market recovers in the subsequent expansion phase. The trough phase, while nerve wracking, can be the best time for strategic investments in anticipation of future economic growth.

What Economic Cycle Phase is Australia in Now?

The current market, as analysed by Akhil Patel in our latest podcast episode, shows signs of robust activity. Economic indicators such as employment rates, consumer spending, and business investments are on the rise. The fact that Taylor Swift is in the middle of a billionaire dollar world tour that included seven sold out Australian shows proves that positive sentiment. 

The real estate market is experiencing increased demand for properties, both residential and commercial, leading to higher property values and rental yields. Patel emphasises that while the market appears strong, it is important to recognise the underlying factors that might indicate a future shift.

He suggests that the real estate market is likely to continue its growth trajectory in the short term. However, he advises caution as the market may be approaching its peak. The combination of high property values and increased speculative investment indicates that a market correction could be on the horizon.

Factors that will Influence Future Property Cycles

Government Policies and Interventions

Government policies are critical in shaping the trajectory of economic cycles and the property market. Policies on housing, taxation, and interest rates play key roles. For instance, lower interest rates can make borrowing cheaper, leading to increased investment in real estate as financing becomes more accessible. 

Higher interest rates can reduce market activity by making loans more expensive, which can slow down both demand and property value growth.

Government incentives like grants for first-time homebuyers can help stimulate market activity, while higher property taxes can deter investment.

Global Economic Trends and Events

The connectivity of the global economy means that overseas economic conditions, trade relations, and geopolitical events can have large effects on the Australian property market.

For example, economic growth or recession in major economies like the United States or China can affect investor confidence and capital flows worldwide. 

Geopolitical events, including political instability, conflicts, and changes in government, can also affect market conditions. These events can lead to economic uncertainty, which may result in cautious investment behaviour and reduced demand for properties. 

Technological Advancements and Shifts in Consumer Behavior

Technological advancements and evolving consumer preferences are reshaping the real estate landscape. Innovations in proptech, such as crowd sourced real estate data for market analysis, and virtual reality for property tours, are making the market more efficient and accessible. These technologies can enhance transparency, reduce transaction costs, and attract a broader range of investors.

Shifts in consumer behaviour, such as the growing trend towards remote work, are also influencing property demand like increased demand for properties outside of traditional city centres with suburban and rural areas seeing a surge in interest and investment.

Strategies for Property Investors During the Expansion Phase of the Economic Cycle

  • Focus on high-demand areas and properties with growth potential
    In the expansion phase, economic activity is on the rise, employment is increasing, and consumer confidence is high. You should target properties in locations with strong job markets, good infrastructure, and potential for future development. These areas are likely to see increased demand, leading to higher property values and rental yields.

  • Be cautious of over-leveraging and speculative investments
    While the expansion phase offers profit opportunities, it is important to avoid over-leveraging and speculative buying. High levels of debt can become problematic if the market turns, and speculative investments can be risky if based on short-term trends rather than solid fundamentals.

Strategies for Property Investors During the Peak Phase of the Economic Cycle

  • Consider diversifying investments to mitigate risk
    At the peak of the cycle, economic activity is at its highest, and property prices have often reached their highest. Diversification can help you spread risk across different asset classes, regions, or property types, reducing the impact of a potential downturn.

  • Evaluate the sustainability of high property prices
    It is important to critically assess whether the current high property prices are sustainable. You should look for signs of overheating in the market and be prepared to adjust your portfolio to protect it from potential declines.

Strategies for Property Investors During the Contraction Phase of the Economic Cycle

  • Look for undervalued properties and distressed sales

The contraction phase is characterised by declining economic activity, rising unemployment, and reduced consumer spending. This period can offer you opportunities to purchase properties at lower prices. You should look for low priced properties and distressed sales, which can be bought at a discount and offer substantial upside potential once the market recovers.

  • Maintain liquidity to take advantage of opportunities
    Having access to liquid assets, like stocks or Exchange Traded Funds (ETFs), during a downturn can be a serious advantage. This liquidity enables you to act quickly and capitalise on opportunities that arise, such as properties sold below market value due to financial distress.

Strategies for Property Investors During the Trough Phase of the Economic Cycle

  • Invest in properties with long-term growth potential
    The trough phase marks the lowest point of economic activity, but also the beginning of stabilisation. This is an ideal time to invest in properties with strong long-term growth potential. You should focus on areas and types of properties that are likely to benefit from the next economic upturn.

  • Prepare for market recovery and future expansion
    As the market begins to recover, you should position yourself to benefit from the upcoming expansion phase. This involves not only acquiring valuable properties at a low cost but also ensuring that your portfolio is well-balanced and ready to leverage the growth opportunities that will follow.

Help With Economic Cycle Investing

Understanding economic cycles is fundamental for making informed property investment decisions. Each phase of the cycle—expansion, peak, contraction, and trough—presents you with different challenges and opportunities. 

If you would like help with economic cycle investing, then you can read Akhil Patel’s book, The Secret Wealth Advantage, or sign up to his free newsletter.

Or feel free to have a chat with our investment brokers who can help you better understand how to make the current economic market work for you! 

If you are cycle-aware and can anticipate market movements, you will be better able to handle the ups and downs of the Australian property market. You will not only be able to better protect your investments during downturns but also capitalise on growth opportunities during economic recoveries and expansions.