Speaking to HCH Founder, James Varley, Rob discussed a host of topics, including his latest book, The Price of Money, the 18-year property cycle, and the power of inflation for property investors.
What is the 18-year property cycle?
The first insight is that property is cyclical – the price movements are not random. It was popularised by an economist called Fred Harrison, who was actually using it to argue for a land value tax to stop it being cyclical. We've since taken it and twisted it. But he had looked at hundreds of years of data and tracked the fact that property tends to move in this roughly 18-year pattern where prices tend to rise for seven years, then rise more aggressively for another seven years into a peak, before there’s a crash and prices come down for four years before the whole cycle starts again. It is useful, but you have to be aware of the limitations of it because the 18-year part is an average. You can't set your calendar by it.
And just because you can go back and see something happened in the past doesn't mean it's inevitably going to happen in the future. So, the great example is the only time that the cycle has not historically applied has been around the World Wars. That's something so major, it knocks the normal pattern off track. So, we've had COVID recently – is that equivalent to a World War in terms of what it's done to economies? We don't know. It's hard to say if the cycle is still on track.
It's useful to recognise that property is cyclical. There are repeating patterns, and each cycle starts from a higher point than the last. So even when you have the crash, it doesn't take you all the way back down to the starting point of the previous cycle – the implication being that if you hold property for a really long time through multiple cycles, you will always end up further ahead, even if there are some peaks and troughs along the way.
Property spends most of its time going up – but then it can correct very suddenly and very dramatically. What you tend to see just before it corrects is the most optimism that you'll ever see, with sealed bids and people wanting to get in now because they’re afraid it will be out of reach if they wait any longer. When you see the biggest and tallest buildings being opened, that’s normally a sign that you need to be cautious. The benefit of the cycle is it gives you some perspective to moderate your activity and avoid the worst. You can avoid the worst excesses of getting swept away and also have the confidence to buy back in at the times when confidence is at its lowest, which of course is when bargains are going to be around.
Why can inflation be a property investor's secret weapon?
The great thing about inflation is that it erodes the real value of your debt. So, if you borrow £100,000 on an interest-only basis, then you will need to pay off £100,000 – no more, no less. That's it. But then the value of your asset is going to go up over time, even if it's just in line with inflation. There will be years when property lags inflation and years when property crashes in value – but over the long-term, it’s going to go up at least in line with inflation.
So, if you're taking out a mortgage with a 75% loan to value, then what's that loan to value going to be in 10 years? What's it going to be in 20 years? It's going to be significantly lower. So, you'll be in a position where you could have a portfolio that starts relatively highly leveraged, but by the time you are 10, 20 years in, you could just sell one or two of the properties in your portfolio to completely clear the debt on everything else. You've also got the fact that inflation lifts your rents. Again, not in a smooth predictable way, but over the long term.
So, inflation is lifting everything except your debt. And of course, debt against property is probably the best type that you can have. You can buy a high proportion of what the asset value is worth. And it's relatively non-volatile. As long as you keep it to a sensible level, you're not going to end up in a position where you get your mortgages called in. And so as long as you can keep making the payments, you're going to be able to ride it out and have the benefit of investing over the long term.
I go into this in far more detail in the book [The Price of Money] but because the government is so highly indebted, the government needs inflation to happen to help it pay off its debts. And so, you're kind of putting yourself on the same side as the government. They need inflation to happen and you’re going to be the beneficiary of it.