Timing the residential property market: A Strategy for fools or sage?

Peter Wu

28 July 2010

For as long as I can remember, I often hear of home owners who are thinking of putting their house on the market and going renting, so as to maximize the price they could achieve in a falling market, then wait for the market to bottom out before going back in and picking up a bargain. This is, in fact, the textbook definition of market timing. It simply means selling high and buying low, and we all know that this is the key to successful investing.

The thinking is sound and exploits significant, recognisable and repeated swings in economic activity called business cycles – periods of booming activities and low employment and periods of low capacity usage and high unemployment. In other words, the boom and bust cycles.

Clearly the success or otherwise of this strategy depends on timing the cycle correctly and is extremely risky, as many would have found out in 2004-2005 in the UK, Canada, US, Australasia property market boom. Many sold out thinking that the residential property market had peaked. As it turned out the market did not peak for another two years. It costs those home owners hundreds of thousands to buy back a property similar to the one they had sold.

As an investment tool, market timing is logical, attractive and has a wide appeal, as it is deceptively simple. Unfortunately, however, in many ways the term ‘economic cycle’ is misleading because ‘cycles’ seems to imply that there is some regularity in the timing and duration of upswings and downswings of economic activity. The vast majority of people I’ve come to know perceive ‘cycles’ as having a perfect bell shaped curve (as below).

This could not be farther from the truth, especially in real estate. This is shown by the upswings and downturns in the New Zealand residential real estate market since 1980.

This diagram completely debunks the myth of the ‘perfect bell-shaped curve’ property cycles, it also clearly demonstrates that booms and recessions occur at irregular intervals and last for varying durations.

Just as there is no regularity in the timing of economic fluctuations, there is no reason why fluctuations have to occur at all. Despite the fact that successful market timing may be even more difficult to predict than the weather, everyone wants to try, to some degree. Buy houses when they increase in value, and sell them when they begin to decline. Keep your cash holdings as a safe haven when you are not sure. Does it sound familiar?

Regrettably, there is no guaranteed way to anticipate market movements successfully, so attempts to clock market timing almost always fail to deliver optimum results. And this is true of the small investor as it is for, well ... Donald Trump. Our economy is affected by so many extraneous and totally un-expected factors and how we react to them is impossible to account for and factor in these influences into the forecasts. Despite repeated hikes in interest rates since 2006, the property market remained stubbornly buoyant. The deflation of the real estate bubble come from two entirely unexpected quarters: – the US sub-prime crisis and the ensuing credit crunch, and the sky-rocketing petrol prices and the steep increase in costs of living, which undo what repeated hikes in interest rates could not do.

Does anyone see them coming? Have the forecasters factor them into their forecasts? And if so, by how much? So far, I have not seen anyone putting their hands up.

As much as fluctuations are difficult to predict and that the market is next to impossible to be timed, fluctuations do occur, because there are disturbances in the economy of one sort or another. While the influence of interest rates is important in real estate, it is not as important as it once was, because of the cushioning effect of being able to put your mortgages on a fixed interest rate, and off-shore funding for some of the loans provided by lenders. In other words, borrowing from places where the interest rates are low, instead of relying on locally generated term and other deposits to fund the lending.

So therefore, because of the fact that fluctuations do happen, with perfect 20/20 hindsight I can tell everybody precisely when a market turnaround has occurred. Furthermore, if I look back far enough I may even see patterns to the movements of the market, which repeat themselves sufficiently often so as to convince me that they will occur again, given the same conditions, at some ‘predictable' later date. This is, in fact, the principle upon which computer programs at the forecasters work: they analyze market patterns and try to anticipate major trends to come. Computer modelling, as it is called, is employed nowadays in practically every industry.

But notwithstanding all technological advances, no one has ever been able to anticipate market or economic swings with an accurate and acceptable level of consistency.

If you are a market timer, bear in mind that you have to be right in their predictions not once, but at least twice in a row. In other words, you not only have to exit the market just before the downwards spiral begins, you have to be adept at identifying peaks before they begin, not after the fact.

Sometimes what looks like a downturn or upswing is just a temporary resting place. Also, there are those investors who simply take the contrarian approach and start buying when everybody else is selling. They then take their profits when others are busy buying.

The untold secret of real estate investing is always to buy and never to sell. That is the guaranteed path to wealth. As this, however, is not always possible, the second best alternative is to act when one's own circumstances warrant, without paying much attention to the cycles that may or may not take place.

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