Humans are terrible investors.

While we should base our decisions on facts, figures and insight, too often we get hot under the collar and make rash emotional decisions.

That’s one of the main reasons house prices continually rise and fall in cycles.

Some investors decide to buy or sell a property based on market sentiment (what everyone else feels). When property prices are booming, they pile in, stoking demand and increasing prices further. Then, when prices are heading the other way, they sell or sit on their hands.

This change in demand and supply is based on feelings rather than fundamental economic shifts. And this can cause property booms to be frothier and slumps to be deeper and more prolonged.

So let’s analyse the four main parts of the property cycle and dig into the psychology. That way, you can understand whether you’re making your decisions based on facts or feelings.

Boom

The first stage of the property cycle is the boom. Here, property prices are rising, and investors feel it’s a great time to be in the market.

In the hope of making a quick buck, others join in or they bring forward their purchasing decision. By that, I mean they buy properties today that, in other circumstances, they would have purchased a few years into the future.

This increases demand in today’s market, causing house prices to rise further. Since it takes time to build more houses, supply can’t catch up straight away, and prices continue to climb.

This creates FOMO (fear of missing out) and causes some property investors and homebuyers to overpay for a property – just so they get one.

Investors who get into the market early in the boom will do well. Investors who get in too late risk paying higher prices than if they had waited.

Peak

At the peak of the market, most investors are elated. They can’t believe how well they have done. And a good number of people are still buying, which helps prices to remain high.

But then FOMO begins to be replaced with FOOP (the fear of overpaying) – and investors worry that prices are too high and will fall in the future. This causes some property buyers to pull back from the market.

And the people who pulled their property purchases forward have now satisfied their demand. They don’t need to buy again.

The worry of falling prices causes a self-fulfilling prophecy. People are worried about falling property prices, so they hold back from the market, this decreases demand, and prices start to fall.

Downturn

In the downturn phase, prices fall firmly. FOMO has gone, and FOOP is entrenched.

Initially, some investors will deny that prices are falling, thinking it is just a blip. For others, that feeling of “I’m going to be rich” turns into “I’m an idiot”.

The herd mentality comes back where some investors panic and sell. Then others follow, thinking that they need to get out, too.

This decrease in demand and increase in supply causes house prices to fall, and the self-fulfilling prophecy is proved true again.

Although prices are now lower, people hold off compared to the peak. I’ve often said that property is the only thing most people don’t buy more of when prices fall.

At this point, sophisticated investors enter the market searching for a property bargain. They’ll negotiate hard, especially with panic sellers who are more emotionally driven.

Trough

Once in the trough, property prices have bottomed out.

Despite it being one of the best times to buy – since prices are at their lowest – some people think “only suckers are buying at this point”. Others will think “property prices aren’t ever going to increase again”.

At some point, an economic event will kick-start a new boom, and the whole cycle will begin again.

How do I manage my emotions and make a good investing decision?

Making an investment decision is as much about managing your emotions as it is about managing the numbers. There are two steps investors should take:

1. Identify which part of the property cycle you’re in

Once you see which part of the property cycle you’re in, you’ll understand the emotions you (and other property buyers) are likely to feel.

Today, the property market is in a downturn and has yet to hit the trough. So investors are nervous, and most people will think it’s the wrong time to buy an investment property.

2. Consider the contrarian view

Then, consider the directly opposite view – the contrarian one.

Take the example of the downturn. While most people might think it’s the wrong time to buy, a contrarian investor might say the downturn is the best time to negotiate and get a deal.