The Complete Guide to Property Investment: How to survive & thrive in the new world of buy-to-let

by Rob Dix

Expenses fall into two different categories: capital expenditure, and revenue expenditure.

acquiring assets (in our case, that means properties), and costs relating to anything you do with that asset to materially increase its value.

Capital expenditure can’t be deducted from your profits in the year in which you incur the expense. Instead, you can only reclaim these costs when you eventually sell the property.

Everything that doesn’t fall under the category of capital expenditure is automatically revenue expenditure instead. Revenue expenditure is much more like it: you incur a cost today, and can immediately offset it against your income. Examples include:

When it comes to structuring a joint venture – even with a close friend or family member – I strongly recommend drawing up a formal agreement stating: Who’s putting what in Who will be performing which tasks What security each partner will have What Plan A and Plan B for the project are What happens at the end if it concludes successfully What could go wrong, and what you will do in each situation

On Joint Ventures

And because there’s no supply mechanism to pull prices back down, land prices increase faster than wages and the price of goods. (For the geeks, this is related to Ricardo’s Law of Rent, and it explains why rents account for an ever larger share of the economy over time.

Because property prices increase faster than wages do, property eventually becomes unaffordable for the majority of people. When this happens, the bust comes: property prices plummet, causing chaos for the banks (which have been lending money secured against high-priced property). The banks withdraw lending, building activity stops, and businesses shut down – which all have obvious knock-on effects for stock markets and employment levels. Eventually of course, prices drop to a more sustainable level and everything gradually goes back to normal – at which point the whole cycle starts again. Importantly, each cycle starts from a higher “bottom” than the previous one – so the long-term trend is always upwards, even though there’s a lot of volatility along the way.

The Property Cycle

The stages of the cycle The economist Fred Harrison was one of the first people to identify the existence of the property cycle. He traced it back for hundreds of years to conclude that the length of a full cycle averages out to 18 years, with each cycle divided into distinct stages. I’ll argue later that the “18 year” part is a bit of a distraction, but understanding the characteristics of each stage is the key to recognising where we are in the cycle and taking action accordingly.

The stages of the cycle

We’ll start as prices have bottomed out at the end of the recession, and the recovery phase is just beginning to get underway. Prices have fallen far enough to tempt the bravest investors back into the market, attracted by the high yields that are on offer as a result of prices falling while rents stay pretty much the same. (Rents don’t fall because everyone still needs somewhere to live. Even if renters were brave enough to take advantage of the lower prices and buy, this is the toughest point in the cycle at which to get a mortgage because banks are struggling too.)

As the recovery phase develops, more buyers will have the confidence to enter the market – having the effect of pushing prices gradually upwards. Look out for big companies and pension funds starting to buy up distressed portfolios: they have the market intelligence to get in early but can’t take the risk of getting in too early, so it’s a good signal of the recovery solidifying. The prime assets will always be the most attractive, so this early growth tends to begin in the centres of the most economically powerful cities and “ripple out” from there. Perhaps following a slight mid-cycle dip as the earliest movers take their profits, the recovery phase will give way to the explosive phase. It’s now clear that prices are on the up, and the banks will be over the shock and willing to start lending again. That supplies enough confidence and capital for major building projects to start again, so expect to see more cranes on the skyline.

The final couple of years of the explosive phase, as prices and mania reach their peak, are what Fred Harrison branded the winner’s curse phase. Why’s it a curse to be a “winner” by placing the highest bid for a property during this time? Because the next recession isn’t far away, and it won’t be long before the asset you’ve bought will be worth markedly less.

You obviously can’t know when the “final years” of the upswing are until they’ve already happened and it’s too late, but there’s no shortage of warning signs that we may be near the top if you know where to look. One such sign is the announcement of overblown building projects like “world’s tallest building”, “Europe’s largest shopping centre”, and other sorts of over-ambitious ideas. These projects are conceived at a time of supreme confidence and funded in a permissive lending environment. It’s often the case that the bust has already happened by the time they’re completed, and they sit mostly empty – a monument to the delusion that has just passed. Another surefire sign is the rationalising of the ridiculously high prices that the mania has brought about. Justifications will be found for why “things are different this time” and we’re in for an era of permanently higher prices… yet at some point reality will set in, and the recession phase is imminent.

There are, though, four very basic “rules” you should follow as an investor – and now you know about the cycle, it should be easier for you to do so: Don’t panic and sell a property just because prices are falling. Thanks to the cycle, you know that prices won’t go to zero and it won’t be that long (in the great scheme of things) until they’re back beyond where they were. Don’t put yourself in a position where you’re forced to sell at the wrong point in the cycle. This is the most important point of all, and I’m dedicating an entire chapter to it next. Don’t get carried away (like everyone else is) during the winner’s curse phase. This is the worst possible time to buy a property, because prices will soon fall and won’t recover to the level you bought at until relatively late in the next cycle. It’s an even worse time to remortgage and use the cash for fancy cars and holidays. You might think you’d never be so daft, but plenty of people were last time around. Don’t get mislead by the media. As we’ve already seen, the messages they pump out around the key turning points of the cycle are almost exactly the opposite of what professional investors are doing. Putting on the blinkers and shutting it all out is easier said than done, but it’s vital for making the right decision.

As I said, the most fundamental lesson of all is to be aware that it’s an inevitability that a crash will happen at some point.