A business cycle refers to the tendency of a business GDP to have an upward and downward movement despite a general upward trend. This can e determined by calculating the long term GDP values of a business (Evans, R. & Mueller, G. 2013, 183). The shifts in GDP have often been articulated to the changes in the rate of growth, stagnation, and/or contractions. The diagram below depicts a classic business cycle.
A business cycle involves the peak and trough cycles which are depicted in the diagram above. This is influenced by the presence of either a recession or an expansion. The business cycle can also be classified according to different periods which include the expansion, crisis, recession, and recovery (Evans, R. & Mueller, G. 2013, 186). Each part of the cycle can depict the different events that influence a business performance. However, it is important to note the difference between a business cycle and an economic fluctuation. The cycle is gradual over a long period of time, usually years. An economic fluctuation is a spike or sudden drop over s short period of time, usually less than a year.
The Effect of Business Cycle in Different Economic Phases
The economic phases have different effects on businesses and the financial sector of an economy. The key phases to focus on in answering this question are the peak, contraction, and trough phases of the cycle. However, addressing the expansion phase is also crucial. The peak phase causes an influx of monies in the business that is experiencing the cycle. However, the contraction causes a lack of confidence and the start of withdrawal of investment. By the time the business has gotten to the trough phase, investor confidence has dwindled to the point that properties are selling at the worst possible prices (McGreal, S., Adair, A., Berry, J., & Webb, J. 2004, 87). This results in a collapse of the business experiencing this phase. However, the expansion phase introduces new consumer and investor confidence. This in turn results in the reinvigoration of market confidence in the given sector. The given cycles will also influence the value of the commodities being exchanged in the given cycles. The value is at its highest in the peak period but starts dropping in the contraction cycle. The prices are lowest in the trough period but start picking up in the expansion period.
What is the Period of Economic Growth?
The period of economic growth refers to a period whereby the per capita income is growing at a faster rate in comparison to the growth of the population. This is normally expressed as a ratio of real GDP in relation to the percentage rate of growth and increase. Therefore, economic growth tends to indicate an increase in the financial muscle of a given population. It is also indicative of perceived growth of the countrys economy over a given period of time. Therefore, the value of the goods being traded in the market will often factor in the inflation that results from the different economic cycles (McGreal, S., Adair, A., Berry, J., & Webb, J. 2004, 87). By considering the inflation over a given period of time, it is possible to determine the true expected economic gains that will be expected. This helps in determining the true value of a given commodity despite the time variation. However, the use of GDP and the percentage change in the GDP provides the economic growth theory with the disadvantages associated with GDP. Therefore, to offset these disadvantages, the theory will be determined on a regular basis in order to have real time results.
Why Real Estate Market is Likely to Follow Economic cycle?
The real estate has been found to likely follow the economic cycle because the economic cycle determines the financial muscle of the populous. For instance, if the economic cycle is in the recession, demand for housing will drop. More people will be open to housing each other and paying for the costs involved in housing. However, the peak period is a season whereby the populous has the right backing of the economy. More people will be seeking to have their own housing. The periods between the two economic cycles have also influenced the real estate market in one way or another (Schatz, A. & Sebastian, S., 2009, 179). This is as a result in the reduction or increase in real GDP. This has also affected the investors as well as the property owners. When an investor determines that the economic cycle is about to enter the contraction phase, possibilities are that the investor will be seeking to exit the market in the shortest time possible. This reduces confidence in the real estate market and thus the value of the commodities in this case real estate properties. However, the expansion phase produces the opposite results.
Explaining Peak, Contraction, and Trough using real Estate Market as Example
The peak phase of the economic cycle refers to a period whereby the populous has been found to experience economic growth. This period is great for the real estate sector as the value of the properties rise, which is advantageous for the investors. The populous has also been found to afford the property being sold and rented out. Therefore, there is an emphasis on quality among those involved in the sector. The contraction period introduces a reduction in property confidence among the different industry players (Schatz, A. & Sebastian, S., 2009, 181). Property values begin to drop as the possible clients begin to lose interest in the real estate sector. If there are individuals who have mortgaged their properties, chances are that they have began being late in their payments. The trough is the toughest period for property owners and individuals who have mortgaged their properties. The result is an increase in property foreclosures. Property owners are also often left with buildings that are without tenants. The value of the properties completely drops during this period.
Relationship between real estate prices and Business Cycle. Which part of the cycle is most appropriate for investment?
The relationship between real estate prices and business cycles is that the real estate prices will react according to the previous business cycle and not the current business cycle. In essence, the real estate prices are often reacting to economic events. Therefore, the best period to make an investment in the real estate sector is when the economic cycle is in the recovery phase. This is often the period whereby the real estate sector is in the trough phase. A shrewd investor will realize that the trough phase in the real estate sector will last a short period of time if the economy has already recovered from its trough. The investment is also appropriate because properties are at their lowest prices during this period.
Evans, R, & Mueller, G 2013, 'Retail Real Estate Cycles as Markov Chains', Journal Of Real Estate Portfolio Management, 19, 3, pp. 179-188, Business Source Premier, EBSCOhost, viewed 22 November 2015.
McGreal, S, Adair, A, Berry, J, & Webb, J 2004, 'Institutional Real Estate Investment in Ireland and Great Britain: Returns, Risks and Opportunities', Journal Of Real Estate Portfolio Management, 10, 2, pp. 85-96, Business Source Premier, EBSCOhost, viewed 22 November 2015.
Schatz, A, & Sebastian, S 2009, 'The links between property and the economy - evidence from the British and German markets',Journal Of Property Research, 26, 2, pp. 171-191, Business Source Premier, EBSCOhost, viewed 22 November 2015.
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