At the beginning of summer 2023, I wrote an article for Economy magazine (economics.bg) titled „Properties and the End of the Euphoria“, in which I commented on the development of the real estate market and what my view is on where this market is headed.

The main points from this article are

Bulgarians continue to buy properties as a refuge from inflation

It is a fact that properties offer protection against inflation. In principle, all hard assets are considered to offer protection against inflation. The hard asset family includes precious metals such as gold and silver, businesses, as well as commodities such as oil, coal, wheat, sugar, etc.

What impresses me is that among this group of assets, only properties provide monthly income. Their prices not only rise with inflation and thus protect you from losing your money, but also bring you additional monthly passive income.

From this perspective, Bulgarians are right to seek refuge from inflation in the property market. It offers such a refuge.

The development of the real estate market affects the entire economy because it affects each and every one of us.

The real estate market is very large and has enormous momentum. It affects many sectors of the economy and above all it significantly affects perhaps the most important sector - the financial sector. In this way, it has the ability to influence the entire economy and the sense of prosperity of most people.

Each of us owns one real estate property or another and accordingly, when property prices rise, we feel richer. This has a positive effect on consumer spending, which in turn drives economic growth.

Real estate and banks are two sides of the same coin

As I said, real estate is closely linked to banks. The real estate market is a very capital-intensive market and it needs financing. And banks willingly finance property, because they rightly consider it to be a very stable asset and accept it as collateral. In fact, they accept almost nothing else as collateral.

This leads to a large concentration of property on banks' balance sheets and when prices start falling, banks are left undercollateralized and begin to create risk provisions. This forces them to restrict financing for new clients and there you have a banking crisis. During this period it is very difficult to find financing for your property investments.

The existence of a stable cycle in this market (article by Prof. Steve Hanke)

There are statistics and studies showing that this market has a serious and very stable development cycle. It is quite long - about 18 years - and this prevents most people from recognizing it. Prof. Steve Hanke wrote a very good article for the CATO Institute about the 18-year cycle of the real estate market, titled „The Great 18-Year Real Estate Cycle“.

In it, the author gives data on the years when real estate prices were at their peak and concludes that they really do reach a new peak every 18 years. Another conclusion from the article is that the cycle of this market was disrupted twice over the past century. The first time was during the First World War, and the second time was during the Second World War. In short, a significantly large global event is needed in order to throw this market out of balance.

Even the pandemic failed to break the market cycle

I thought that the Covid 19 pandemic was a global event large enough in scale to break the property market cycle, but I was wrong. Clearly, this market really does have enormous momentum and even global events that do not last long enough cannot interrupt its normal development. We witnessed how, after a short pause, the market quickly caught up and prices surged upwards significantly.

It is important to watch the acceleration of price growth. When it slows, we are close to the market's „top dead centre“.

Everyone is interested in exactly when the peak is reached, so they can protect themselves from a sharp drop in prices and the disappearance of buyers from the market. For me, a very important indicator is not the property prices themselves, but the acceleration with which they rise during the most dynamic period of the cycle.

When this acceleration starts to slow down, even though prices continue to rise, it is obvious that we are already close to the top. At the top there is no longer aggression in buyers' behaviour. Aggression, pressure have disappeared from the market. Then even the slightest shock can scare buyers.

According to the cycle, the next depression will be in 2025-2026.

We can also orient ourselves by where exactly we are in the property cycle. After all, it is claimed to be 18 years. That is, 18 years after the last price peak, we can expect to reach the next peak, after which a 4-year depression follows.

In his article „The Depression of 2026“ for The Progress website, Dr. Fred Foldvary predicts that 18 years after 2008 the American economy will fall into another major economic crisis caused by the bursting of the property market.

The presence of inflation shows us that we are close to the end of the boom

I have one more indicator for myself as to exactly when we are approaching the peak of property prices. As I mentioned above, I think this market is so important for the entire economy that when it enters a dynamic phase (at the end of the boom), it is capable of independently causing inflation to appear.

Just think about it. When this market enters a dynamic phase, all the media write about it, there are huge amounts of cranes everywhere, and almost all ads in the media are either for properties or mortgage loans. During this period, many people make the biggest purchase of their lives, buying a property. The number of transactions increases and this is proof of that.

When so many people „move“ so much money around the economy within just a few years, it is normal for inflation to appear, because the money supply in the economy increases significantly.

The rich use property and the loans tied to it so that inflation works for them, not against them.

Properties are preferred by banks. They willingly finance property purchases. This is a fact that the rich use to build up huge amounts of debt. In fact, they use properties only as a means to borrow huge amounts of debt from banks. Against nothing else would banks give them such amounts of debt.

And why do the rich want to have so much debt? Well, because debt is a short position in relation to cash. This position wins when cash loses value. The truth is that the world is structured in such a way that cash always loses value. In short, the rich take a market position that is profitable by definition.

For more information, see the free course by Tervel Academy „How to invest during a crisis?“ Above all, watch the lecture „Protection against inflation“ (https://tervelacademy.com/course/inflation/)

 The foolishness of buying a property only with cash

For the reasons mentioned above, many experts consider it madness to buy property without external financing. This means giving up a significant part of the advantages of investing in property. After all, part of the deal is not only the purchase of the property itself, which is essentially taking a long position in the property market, but also the presence of debt, which is taking a short position in relation to cash.

The second deal is guaranteed to be profitable, because the central bank guarantees it with its 2% annual inflation target. In other words, your debt will „decrease“ in burden by 2% a year. This is because property prices and rents are indexed to inflation, but the debt to the bank is not indexed and remains the same. In other words, inflation eats away at it a little each year.

In my view, mortgage interest rates are the main factor that can „cool down“ the real estate market.

Now you will ask what that factor is that ultimately has the greatest influence on the development of the real estate market. My short answer is: mortgage interest rates. In my opinion, only mortgage interest rates can „burst“ the bubble that forms at the end of the boom phase.

Raising these rates drastically reduces the liquidity of the real estate market, because many buyers need a loan to purchase property. When they can no longer afford the high rates and give up buying, that imbalance between supply and demand appears, leading to a shift in the cycle phase.

What should we do and how should we prepare for the depression?

The simple advice is to be very cautious and keep in mind that the market will not continue forever along this trajectory as in 2022 and 2023. There is time, in my opinion, until the depression comes, but not much. Be very cautious and do not use a mortgage with only 10% down payment, but with at least 20-25%. This will give your bank sufficient comfort when the market changes direction and it will not bother you.

The other advice is to invest long term with a horizon over 5-6 years. Even if the depression comes, if you have no intention of selling the property, the low prices will not affect you and you will wait for the bad period to pass. Investment with the aim of creating passive income is the right strategy, in my opinion.

Those of you who need a new home do not have to consider the market cycle. If the family has grown and you need a larger home, then buy what you need. In this case, it does not matter to you that prices may temporarily fall for 5-6 years below the price at which you bought it. After all, you will use it during all those years, won't you?

 

Author: Svyatoslav Delchev https://tervelacademy.com/