Nick O’Connor – Capital and Conflict (United Kingdom) –
“What will my house be worth in two years’ time?”
When friends and family find out I write and publish financial advice, that’s generally the first thing they ask me. (Occasionally followed by, “When’s a good time to buy my holiday spending money?” To which the answer is usually “2007.”)
I get the obsession with property, though.
For most of us, buying a home is one of the largest single purchases we’ll ever make. It’s generally our most important investment. And given most of us make it largely with borrowed money, it has added significance. Get it right and you can make a fortune, get it wrong and… well… best not think about that, eh?
Given that, you’d think there’d be nothing left to learn about property. You’d think mainstream analysts would have it all covered. But what if they don’t?
What if there was a missing piece of the puzzle that – like a magic eye picture – suddenly helped you see what other people can’t… and make a fortune from property in the process?
According to Akhil Patel, that’s exactly the case. Akhil is a property developer and banker with a highly unusual way of looking at the property market that – he believes – allows him to predict and anticipate booms and busts years in advance.
It’s called the “Grand Cycle”
And according to Akhil and his loyal following, it explains more or less everything that’s happened in the financial markets for the last 200 years.
Perhaps we’ll go into the theory another time. (Or you could watch this presentation to see if Akhil’s argument stacks up to you.) Today I wanted to share a series of much more practical insights Akhil has developed over the years that you could use to understand and profit from property.
I guarantee you won’t have heard of any of them before, even if you’re a seasoned property investor. And usually these kind of property secrets are reserved for Akhil’s paying subscribers. I’ve shared them with you today, with Akhil’s permission, to show you what you’re missing – and to help you make better decisions with your money in the next decade.
Let’s dive straight in…
Insight 1. Land is the real asset (not the building) and it is volatile
What many property investors fail to recognise is that the primary source of the return from a property cycle perspective is down not to the building but to the land on which the building sits. When you watch property programmes on TV, people are always talking about the size and quality of the building, its features etc, rather than about the land (although there is some acknowledgement of the importance of location).
Each cycle brings with it a major increase in the value of land. Land is the real asset. And it is very volatile in terms of price.
If that’s not clear to you, consider this example: let’s say a house (with a replacement value of £50k, – ie, the cost to replace the building if it burned down) sells for £100k at the start of the cycle. Let’s assume that over the course of the cycle it increases to £250k by the peak of the cycle, 14 years later.
This is not unreasonable, by the way – in fact this represents a fairly modest increase of 5% per year (roughly).
Assuming that the replacement hasn’t changed, this would mean that the underlying land price will have gone from £50k to £200k – an increase of four times in the course of the cycle, compared with 2.5 times for the property as a whole.
Similarly if property prices fell 30% in the course of the downturn, the fall would be attributable to the value of the land. While the property would have fallen in value to £175k, the value of the land would have gone from £200k to £125k. A fall of almost 40%.
House prices can fall even further than that in the downturn. A reader pointed out to me in an email exchange that he bought a house in Sunderland in 2009 for around £100k which had been selling for over £500k only a couple of years before that. In other words, the value of the land had collapsed completely.
I think of land increasing in value through three primary ways:
- General gains from the cycle over time (in the sense that a rising tide lifts all ships). As economies progress and prosperity increases, the value of real estate goes up in general across the economy. This gain is the least specific to a location. Essentially if you were to buy in at the start of the cycle and sell at the end you’d be doing so at some sort of profit almost anywhere in the country.
- Gains from the vicinity surrounding the site because of good local infrastructure and amenities – schools, transport links, recreational facilities, thriving local businesses, clean streets and lighting, safe neighbourhoods etc – all of the things that make a place desirable to live and ensure there is demand for living there. Over the course of a cycle, land in desirable locations goes up to a greater extent than other locations.
- Gains from improvements on the site itself – through increasing the building footprint – adding rooms, floors etc. Or adding dwelling units on site.
In fact, the gains from each of these three channels are to do with the rental value of the site increasing. Remember, as economies develop, land takes all of the gains – the law of economic rent in action.
Insight 2. Borrowing to acquire a property in a good location and having someone else pay the interest
The simplest way to profit from this is to buy a good location and have someone else pay off the interest on the borrowing to acquire it. The earlier you buy in the cycle the better, but don’t be afraid to buy even after it has started. There is still plenty of time in the current cycle.
You will find that as the capital value of your property appreciates you will be able to refinance at a higher value, take out some capital and perhaps do the same thing again. In this way you will be able to build a portfolio with a stream of rental income, which you can use to buy other assets or as an income you can live off.
Make sure you don’t over-leverage and pay attention to where we are in the cycle. At the end, your ability to recycle financing is likely to be at its highest due to easy credit conditions. But you don’t want to face a situation during the coming downturn where parts of your portfolio are “underwater” and/or your rents cannot meet interest payments. If you were forced to sell property at this time because you default on a loan (for example) you’d be doing so at distressed prices which could wipe out your equity. Or a distressed property might cause you to sell off a prize asset for less than it’s worth.
Buying into a good location is important. There are any number of books and guides out there to help you do this – how to assess the facilities and access to shops, jobs, schools and recreational facilities that make a place a desirable one in which to live.
There is a variation on this which can help boost your returns even further – buying into a location before it has fully become desirable. This is taking advantage of the fact that prices in some locations start to adjust rapidly because of the development that is currently or about to take place.
This is called the Law of Absorption.
Insight 3. Take advantage of the Law of Absorption
As far as I can tell, this term was first coined by Fred Harrison in his book The Power in the Land. I have referred to this before and some property investors intuitively understand it when they look at a currently undesirable location but see a buying opportunity because of improvements that will cause people to start looking seriously at moving there. Once this starts to happen, prices can start to increase quite rapidly.
The key thing is to know when to do this, and when to recognise that these adjustments have already happened and therefore perhaps you might look elsewhere to invest.
(That’s not to say that even after a period of rapid gains you can’t still buy into an area. Buying at the right time in the cycle should guarantee a good return. And you’ll find that you can rent out at higher levels the more desirable a location is – which tends to happen after some of these capital gains have come about.)
Insight 4. Buying close (but not too close) to new or improved rail stations or transport links
There are a number of academic studies have been undertaken analysing the velocity of real estate gains following improvements to public transport.
Governments tend to keep quiet about these gains because they invariably reveal who the real beneficiaries of these improvements are (who receive gains paid by taxpayers all over the country). It falls to other organisations to tell us what we need to know.
For example, property consultancy JLL published a study of the likely impact of Crossrail on house prices along the route and forecast these would be on average 8% (and as much as 19%) higher than other London property between 2014 and 2020.
This builds on some of the gains that have already taken place. For example, between 2008 and 2013, residential prices in Stratford increased by 44% compared to 31% for London as a whole.
I expect that the overall impact will prove to be greater once you look at this over the course of the whole of the cycle into 2026. Indeed, findings from a broad range of studies show the likelihood of windfall gains in the order of 30% to 120% for residential and commercial property in areas surrounding such improvements. So there’s potentially more upside to go.
The difference in price increase is dependent on proximity to the train station. The closer you are to the station the better… up to a point. Bear in mind, being too close (ie, opposite or abutting the train line) is no better than being too far. So select your property carefully.
In a previous newsletter, I have already referred you to a brilliant piece of writing by Don Riley in Taken for a Ride. As the owner of several properties on Southwark Street very close to London Bridge station (including one that accommodates my Southbank Investment Research colleagues) he had a first-hand view of the impact of the opening of the Jubilee Line Extension on the value of his real estate portfolio.
He found that the increase in real estate values in the order of £4 billion around each station on the line.
So if you are looking at which places to buy, do research on where the government is building its new transport infrastructure and start looking there.
This then leads to the next question about when in the process you should be looking to buy.
Insight 5. When to buy
If you are investing in or around a station you need also to know when to buy.
The biggest gains, percentage wise, will be during the two years prior to construction and the two years following completion. Therefore, buy in as early as you can. However, it’s not too late if construction has already started: during this phase, noise and road works will detract buyers and disrupt business. As an investor, however, this can sometimes provide an opportunity to buy in in order to capture the gains once the line has opened.
Early morning roadworks will be a nightmare for existing residents and some will inevitably want to sell. Keep your eyes open for opportunities as you monitor the market.
Again, even after the transport upgrades are in place, general gains from the cycle make this a fine opportunity to buy – but bear in mind you will only obtain the general gains, not the ones due to development of the new infrastructure.
Six more secrets to becoming a successful property investor
Over his time as a property developer and analyst Akhil has developed many ways of understanding and profiting from property. In fact, he published 11 insights on property investing to his subscribers earlier this week. I’ve shared the first five with you today.
Want to discover the rest?
Publisher, Capital & Conflict