How do property markets learn to adapt to changing environments?

As the US presidential elections continue to grab the headlines many analysts have been crunching data regarding the impact of individual political parties on economics and property markets. The ongoing campaigns to decide who will replace President Obama in the White House have seen some investors voicing their concerns about the short to medium term outlook. So, how do real estate markets learn to adapt to changing environments?

Is there a political bias?

In simple terms all political parties stand for a particular cause and often have a different way of looking at the economy as a whole. They will introduce various policies which will impact certain areas of the economy, and also the property market, but the fact remains that very often it is the “middle ground” voters who decide elections. As a consequence, while some of the headline policies may vary significantly between parties the underlying policies are perhaps not as dramatically different as you might expect.

Markets learn to adapt

The simplest way to value any asset is to look at the risk/reward ratio and value the asset accordingly. This is a valuation process in its purest form because economic changes, short-term issues and other aspects of everyday life will impact this. However, where there is a greater risk investors will demand a potentially greater reward hence assets will be valued accordingly.

We only need to look at the recent worldwide economic downturn which began in 2008 to see how property prices fell as the potential for acceptable returns diminished. Investment markets would obviously prefer political policies which encouraged capitalism and free markets but the fact is they will always find a balance to reflect the current situation.

What is an investment market?

The risk/reward ratio which we discussed above is quite simply the balance of opinion between investors in any one particular market. Investors as a crowd will determine this ratio thereby reducing the influence of those towards the far left and the far right extremes of the “average opinion”. If you look at any investment market as a simple “information exchange” where all opinions are entered and a general consensus is created, this will put it in perspective. Is this over simplistic? Well, how else would you explain how markets find a level?

Uncertainty is a killer

There is one factor of everyday life which impacts investment markets more than any other and that is uncertainty. If markets are aware of the best case scenario and the worst-case scenario this will help to formulate an acceptable risk/reward ratio. However, if there is no best and worst case scenario available and markets are moved by speculation this is what causes extreme volatility.

We saw this during the Scottish independence referendum, investors sat on the sidelines because there was extreme uncertainty regarding what currency an independent Scotland would use and the monetary policies a ruling government would put in place. As it happens independence was rejected and eventually investors returned to the market. However, there is still a certain degree of uncertainty regarding the medium term with a potential second independence referendum on the horizon.

When markets are aware of the best and worst case scenarios they will find a balance. When pure speculation takes over from facts and figures this is where we get the extreme volatility we have seen recently.

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