Knowing where in the property cycle to invest

Investment returns in the buy-to-let sector come from two sources: capital appreciation and rental yield. Understanding the dynamics of these two factors enables professional BTL investors to assess the optimal time to invest.

Capital appreciation
Property prices are cyclical. For ease of representation, we can model the property cycle over a 12 hour period. At 12 prices first start to rise and at 6 prices start to fall. We therefore have rising prices between 12 and 6, and falling prices between 6 and 12. Assuming symetry of price movement, the peak rate of price growth will occur at 3 and the peak rate of price decline will occur at 9.



Rental yield
Rental incomes are pretty static compared to property prices. They do not rise and fall cyclically. The trend with rental income is a slow, steady rise over time, approximately in line with inflation. There may be short term seasonal or economic fluctuations, but these have little effect on the long term trend.

Rental yield is calculated as:



From this definition it is clear that property prices are inversely related to yield, so yields are also cyclical and their movements are opposite to those of property prices.

In our 12 hour period, yields would be falling between 12 and 6, and rising between 6 and 12. The long term trend rental yield would therefore occur at 3 and 9 during the period. This means that between 9 and 3, yields are above average; and between 3 and 9, yields are below average. This is shown on the diagram below:



If we put the capital appreciation and rental yield diagrams together we see the four phases of the property cycle:



Note that the labels for each section are from the professional investor's point of view. The 'Cooling spot' on the diagram above will quite often be what the novice investor thinks is the 'Hot spot'. If you’re a sensible investor, you will invest during the warm and hot spots. This is because the investment has a positive yield relative to the long term trend and is cashflow generative. You are also acquiring assets at lower value and holding on for maximum capital appreciation.


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* Based on information from "Beating the property clock" by Ajay Ahuja