A Fairy Tale Ending?

Over two billion people around the world watched the royal wedding on Friday. My hunch is that the overwhelming majority were women (guys aren't that into fairy tales). I have to admit I caught a glimpse of the royal wedding as it ended this morning and thought they were a beautiful couple. Kate looked so poised while William looked a bit nervous but happy.

The royal couple looks very much in love, which along with health is the most important thing in life. Without love and health, all the money in the world is meaningless. Whenever I look at William and Harry, I'm reminded of their mother and the summer of 1997. She died a couple months after I was diagnosed of multiple sclerosis (MS) and while her death was tragic, it helped distract me from my diagnosis and gain some perspective on life.

Opinions are divided on the royal wedding. Cynics will claim that it's a major distraction, opium for the masses to divert attention from the harsh reality of austerity in England. Royal watchers will claim that it's all about tradition and being proud of the royal family. I'm somewhere in between and look at it for what it is, a boon for tourism.

But what's really amazing is how fast London has bounced back after the 2008 financial crisis, leading Brett Arends of MarketWatch to ask if it's the world’s hottest real-estate market?:
I hesitate to use the overplayed word “bubble.” But in the case of London property, it’s hard to avoid.

What’s happening here is absolutely ridiculous.

Markets are being impacted by housing-sales data along with fears over northern European economies and a stronger Japanese yen.

Look in the window of any real-estate agent here and you think people have gone crazy — and then you realize that the prices are in British pounds, and that to convert to dollars you have to add another 60%.

Half a million pounds ($800,000) for a one-bedroom condo with a small garden on the southern, unfashionable side of the river Thames? Really? And $2 million for a modest two-bedroom condo in Chelsea?

As John McEnroe used to say at Wimbledon, you cannot be serious.

While the rest of Britain grapples with austerity, falling real wages and budget cuts, London real estate — super-prime London real estate, the best of the best — is back in the grip of another mania.

According to an index maintained by high-end real-estate firm Knight Frank, prime central London prices are nearing and may even be surpassing the giddy levels seen at the peak a few years ago. The brokers’ windows tell the same story.

It’s like that whole Lehman thing never even happened.

What’s going on?

“London property is the ‘Swiss bank account’ of the 21st century,” Robin Hardy, an analyst at London investment firm Peel Hunt, explained to me. Rich people in places like Egypt, Syria and southern Europe are rushing to get their money away from the turmoil, and for want of a better alternative, they are plunking it down in the “millionaire’s playground” of central London.

“It’s seen as a relatively safe place to put your money if your objective is capital preservation,” he said. They think money is “safer invested in an apartment in Sloane Street than in a bank account in Damascus.”

Foxtons, a high-end real-estate agency, told me that 80% of its sales this year at its Sloane Square branch have come from overseas buyers.

This is just the latest twist to a story that’s been running for some time. Gulf sheikhs. Russian oligarchs. Newly rich Indian and Chinese tycoons. London has become a magnate for the international super-rich: a millionaire’s playground. Russian money has been flooding in for at least a decade. One hedge-fund manager here told me London property was a “laundromat for Russian money.”

You can see it in the fanciest shopping districts, from Jermyn Street and Old Bond Street.

The booms in oil and emerging markets have been very good for prices here for at least a decade. Great Britain, through generous tax treatment of foreign nationals, has cleverly encouraged the trend.

A friend of mine a few years ago described how a Gulf sheikh was steadily buying up more and more of her condo development just north of Hyde Park. The sheikh liked to come to London for two months every summer to escape the Gulf heat, and he liked to bring his extended family and entourage. He didn’t care much about price, and he wanted as many condos as he could get.

There are other factors at work. London has become the financial capital of Europe. The giant money machine has spread far beyond the old financial district of the City of London. High-powered hedge funds and secretive commodity firms crowd the alleys and lanes of Mayfair and the towers of redeveloped Docklands. The windfalls have long been seen as a major driver of property prices.

Housing supply is limited, especially in the best areas. London has tough zoning laws, so there is very little new development.

And you can also throw into the mix low interest rates. A friend explained how his grossly overpriced home cost him very little every year, because he is paying just 1% interest on a flexible mortgage.

To hear people tell it here, this miracle will go on indefinitely. Prices will keep rising skyward. You no longer encounter many bears of London property. Most have given up.

But there are a couple of wrinkles that should give people pause.

First, you see more and more dark windows. On Sunday I went to a pub with one of my oldest friends. He described how more and more properties in central London were simply unused most of the year. You’d look up at the windows as you walked down the street, and very few were lit up.

A recent study by Knight Frank found that one of the top reasons the international elite gave for selling a London home was simply that it was surplus to their needs.

The second concern is that more and more actual British are being crowded out of the city. Over dinners in the past 10 days, both a London member of Parliament and a top executive at a fund firm here have bemoaned the fact that young people can no longer afford to move into the usual London neighborhoods when they start their careers here. They’ve been priced out. Many of the middle-class are suffering the same fate. Ultimately, this simply becomes unsustainable. It will strangle the city’s vitality.

The third problem is that 1% interest rates will not last forever. Sooner or later they will have to rise, and when they do, a lot of home loans will become unmanageable as well as unrepayable. Happy times.

The fourth issue is one that often gets forgotten. In the age of the Internet and modern technology, the comparative advantages of big, expensive cities like London are actually in decline. Twenty years ago, if you wanted to run a hedge fund in the British Isles, you probably had to do it in London. That is no longer the case. It is a lot cheaper — and the quality of life much better — if you move out of town.

The fifth problem, though, is probably most ominous: the plunge in rental yields.

According to Knight Frank, while prime London sales prices have doubled in the past 10 years, prime London rents have risen by less than 10%. The net result is that landowners are getting a gross yield of maybe 3.6% on average, compared to more than 6% a decade ago. Conversations I’ve had — with renters and owners — suggest some are getting even less.

Once you subtract all the costs of buying and selling a home, maintenance, taxes and condo fees, some landlords are making very little — if anything.

As usual, the defenders of current prices are quick with a rebuttal: “But people aren’t investing for the yield,” they say. “They are investing for the capital gains!”

Alas for this argument, in a rational market, yields are the drivers of capital gains. The price of an asset goes up because the current owners are earning so much money that outsiders want in. The idea that people will keeping bidding up prices of an asset that makes no money is quixotic at best.

Will it turn? If so, when? It’s anyone’s guess. But for those living and working in Britain, the conclusions are pretty obvious. If I moved back to this country, I would avoid living and working in London if at all possible. And if I had to be in London, I’d rent.

If I had to live there, I'd rent too but I wouldn't live in London if you paid me all the hedge fund bonuses in the world! Loved visiting the city but it's way too overcrowded and outrageously overpriced. Blame the "Russian oligarchs" or the "Gulf sheiks", but at the end of the day there is a lot of hedge fund money in London that is bidding up prime real estate prices (that's how hedge fund managers compare penis sizes).

It's ridiculous and the same nonsense is happening in Canada. I see condos in Old Montreal selling at ludicrous prices. My buddy out in Vancouver just bought a $2 million home in the outskirts (modest house; no comparison to his $1 million dollar house in Mont-Royal here in Montreal) and could have easily made 10% if he flipped it after a month. He tells me rich Chinese are snapping up properties like crazy so they have have one foot outside China. Little do they know they're contributing to the Canada bubble fed by Canada's mortgage monster which will eventually explode.

Whatever the case, I've heard these stories of "real estate prices can only go up" forever in Greece. Guess what? When people need to sell, they sell, and that's what is happening right now in Greece, Spain, Portugal and even in the coast of France (many British sold their summer houses there for financial reasons). If you're looking for deals, forget London, you're better off looking at these countries first. When it comes to London's property market, I fear there will be no fairy tale ending.

**Please donate to Pension Pulse by signing up to PayPal and then clicking on the PayPal button at the top right-hand side of my blog under the pig.**