Property Booms and Busts: Cycles or Bubbles

The classic property market cycle is conceptualised as a short term adjustment process generated by the interaction of occupation demand, the business cycle, the national credit cycle and supply lags consequent on the development cycle. Within the model yields are a function of the required rate of return for property and expected rental growth. However this model is under_specified as it fails the reality test in the sense that yields are very much also influenced by exogenous factors such as current returns from property and relative returns in other sectors. Dunse et al (2007) demonstrate the importance of the variation in investment funds over time in influencing commercial property yields/capital values. The ëcredit crunchí has highlighted the role of this exogenous factor and emphasises the importance of availability of investment funds to underpin a property boom. A key influence on investment funds, and hence capital values, is the changing perspective on risk. In the aftermath of a bust the euphoria that has driven risk taking is replaced by a more conservative approach to risk assessment engulfed by fear and this in turn slows the recovery. In as much as the cavalier attitude to risk in a boom cannot be justified by rental trends, a major component of the upturn in capital values is actually a ëbubbleí. This paper seeks to identify the components of property boom/busts distinguishing between what can be described as the endogenous component attributed to the time lags of a property cycle and the exogenous influences that can loosely be described as speculative bubble effects. It simulates property yield movements based on rental growth distinguishing between these endogenous and exogenous components in UK cities over the period 1981_2006. As part of the analysis it presents the implied rental growth associated with yields at different points in boom/busts.