Central London Property Boom And Bust?

4th May '14 by Paul Scott

10 comments 11915 reads

We regularly see financial bubbles - in my lifetime there was the big property boom in the 1980s, which then burst spectacularly in the early 90's - remember negative equity? People thought their properties would never rise in price again, yet by the mid to late 90's we were off again - into another, and even more spectacular property boom that has continued to this day.

Then there was the TMT shares boom & bust of 1998-2002. I recall how value investing just stopped working in 1998, and the only way to make money was to throw away the rule book and just buy any old story stock, which just went up and up in price. Until the bubble popped in March 2000, and practically all of the boom stocks joined the 90%, and some even the 99% club - measured by the % fall from their all time high.

Arguably Gold has just been another bubble in recent years, and there are numerous other overseas examples - emerging markets boom and bust, in fact the whole financial system is built around boom and bust. Gradually we are realising that markets are not efficient, and that human beings, even highly intelligent and trained ones, are absolutely not rational for a lot of the time - but tend to operate in herds, where group-think takes hold, and despite everyone knowing that what they are doing is wrong, they continue doing it. Then when the bubble bursts, the carnage can be very ugly indeed.

People who were regarded as geniuses for holding fashionable assets as they roared to ever more irrational over-valuations suddenly become fools almost overnight - we've seen that this year with the ludicrous over-valuation of stocks like ASOS and Ocado - what on earth were people thinking, chasing up the share price of the former to a forward PER of over 100? Or the latter, to a £multiple-billion valuation, despite it having a deeply flawed business model that is missing targets, and arguably looks unlikely to ever make a decent profit, due to cut-throat competition and low margins?

So that brings me on to central London property - surely the latest boom, with potential bust on the horizon? The press have recently reported that a…

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Asagi

4th May '14

Hi paulypilot,

I am shorting Foxtons (LON:FOXT) and have been since around 290p. This was for three reasons:

1) high valuation at that time against existing forecasts
2) expectation that interest rates would rise sooner than was being expected
3) feeling that the London market was being pushed higher by buyers who could soon lose interest

1) Valuation
Foxtons is today on 25 times 2013 earnings, falling to 21 times the 2014 number. The 2013 dividend was 5.44p, so not a great yield.
"The Group's dividend policy is to pay between 35% to 40% of profit after tax"
I think that is expensive for any 'normal' company, let alone one that trades in a notoriously cyclical industry and is likely at the top of that cycle.

The fact that the Foxton's share price has been falling despite reporting very strong numbers tells us something about the valuation.

2) I think that the Bank of England is now kicking itself for not raising rates sooner. I am beginning to seriously question Mark Carney's intellect. Remember his 'forward guidance'? Such arrogance, as if the Bank of England could ever encapsulate IR policy for the next two years in just one sentence. I cannot imagine Mervyn King, ever issuing such a hubristic policy. Now Mr Carney has been backsliding from his forward guidance and is not considering rate rises, even though unemployment has fallen below 7%. So he has magicked up some more wooly criteria and bang, his credibility is gone.

It is becoming clearer from month-to-month that the economy is strengthening. The longer the Bank leaves it before increasing, the sharper rises will have to be. I think that the economy could force a rise soon. This will be bad news for the market. The consumer mindset will be badly shaken as it will be a clear reminder to the consumer that rates can rise, something that has not been experienced in almost seven years.

To this you can add in the new mortgage lending policies that banks have been forced to adopt. That seems to already be having an effect: approvals are falling.

3) Since the Eurozone crisis, London property has been a safe haven investment. However, with crises easing, the requirement for such an asset has reduced. High prices have depressed yields - as you have pointed out. From April 2015, overseas investors will have to pay CGT on any profits too.

Now, what I think will happen is that same as what happened to the precious metals. When there is no yield available (remember, many of these foreign investors are leaving properties empty), investors need greater fools to come along and push prices higher to make money. So, what happens when price growth slows to less than inflation, or stalls? Profit taking, that's what. If the market is being pushed higher by participants looking for capital return/protection rather than utility then I would not be surprised to see a very quick dash for the exit when the music stops.

Foreign buyer withdrawal (due to low yields, or the reduced desire for safe haven assets, stronger pound), new mortgage rules kicking out the lower rungs of the market, tax changes and IRs are all bearish for the London market and I expect that each will become more relevant in the next 12 months.

Regards,

Asagi
(short £FOXT)

harryr

No one minds paying 5% stamp duty in a bull market.

They will on a down market, that,and a nice rate rise will kill the London prime market dead.

Not that hard to understand is it.?

I also am of the view it's not just 30% off that is on the cards.

Try 70% and then flat for years,and years.

If ever bank lending halted your looking at 80% - 85% off prime ,it's all built on a pile of debt.

I have an idea owners at that stage just stop paying the mortgage as the banks will by then have stolen their savings .

All the above may sound way over the top,however if you stand back use your own head and look what the past has show us,it's in B and W.

Other big risks are flooding,loss of law and order, stock market crash,radiation, war, bugs ,loss of electric power, trade war, weather,a foreign country pulling out , or a run on the worlds banks, most of all,the need of the super rich to find cash from anywhere they can.

It's been a long term one way bet. Bets tend to go wrong big time.

emptyend

5th May '14

Hi Paul,

Three points:

1.Air quality is relative. It may be poorer - but a friend complained to me yesterday about the appalling air quality in Hong Kong (a place where he lived 15-20 years ago and still visits several times a year). Apparently it has got very much worse as industrial expansion over the border in Guangdong has accelerated and all the pollution (with unknown pollutants!!) just hangs over Hong Kong in times of high humidity in particular. Chinese buyers are of course prominent in London - and I don't see that changing.

2. I'm very much of the view that much of London property buying is basically money laundering and/or hiding it from home country tax people. In addition, we now grant residency visas for anyone who is prepared to bring enough money with them and "invest" it in the UK. The growth in demand is a sure sign that the government has been far too lax in this area - and IMO what is needed is a vastly more onerous tax regime on property (especially property left unoccupied for 90%++ of the year by absentee foreign owners). I would like to see such proerties taxed at c.10% of their capital value, per annum! The point of this is NOT to raise money per se - but to change behaviour and strongly encourage people not to hoard property and remove it from the market. Such a tax change would reverse the dynamics of the London market overnight, IMO.

3. Interest rates will have no material impact on super-prime property. What a rise in rates may well do though is encourage families to move from London into the regions and to monetise their capital gains. That would be a big net positive for the economy IMO.

I think there is scope for a fall of about 40% in London - and it should be an urgent task of the next government to bring this about. there is, however, no sign at all of the Tories being interested in this - presumably because they have been "bought" by property interests:

Dozens of property firms have given a total of £3.3?million to the party over the past three years, including large gifts from companies seeking to develop rural land.

Developers are also paying thousands of pounds for access to senior Tories through the Conservative Property Forum, a club of elite donors which sets up “breakfast meetings” to discuss planning and property issues.

The disclosures are likely to provoke a new “cash-for-access” row and will give rise to fears that planning policies could have been influenced by powerful figures from the property industry.

jjis

Seems the government now has a vested interest in encouraging and extending the housing boom - outside of London as the FT calculated that George Osborne’s flagship Help to Buy equity loan scheme is poised to generate £4.5 billion in profit for the government, making the Treasury one of the biggest beneficiaries of a housing boom that is drawing concern from policy makers. I guess they figure this will help them get re-elected and it will be interesting to see if the Governor (who was favoured or chosen(?) by George Osborne) of the "Independent" Bank Of England will just talk tough in this regard or actually take some action as specualted about in the press?

cig

Tax on unoccupied property doesn't sound practical, it's too easy to work around (if simply faking the paperwork doesn't work, just hire a sitter who is the nominal tenant but disappears whenever you want to use it, shouldn't be hard to find people willing to do that for a low/discounted rent).

Cig - incentives for the neighbours to rat on the absentees.....
Or make squatting in unoccupied property perfectly legal with a minimum one year to reclaim possession? Entry/exit records from Border Force? There are plenty of solutions with a bit of thinking outside the box.

Fangorn

"Or make squatting in unoccupied property perfectly legal with a minimum one year to reclaim possession?"

That's asking for far too much trouble EE - one can see the headlines of unintended consequences that ensue.

Squatters have too many rights now as it is. The legal home owner should be able to boot them out within 24 hours - some of the high profile squatting in grand houses owned by the Arabs has been disgraceful - disgraceful in that they were allowed to squat for ages without being removed.

Most here are missing the point, London houses are not worth what you have to pay.
Note the new fad to dig down and live in a hole under your house, how silly is that.?
All booms are based on more wood feeding the fire,that fire is burning itself out.
The rich do not trust the banks, paper money and 98% of the worlds governments.
Hence money pours into so called safe haven London property.
That money, for what ever reason will move on at some stage.
Owners will be hit hard and harder still,it may take 25 years plus to hit the floor.
I think you will find the number of prime homes being built or with planning have jumped by a factor of up to 5 in the last few years.
It was not long ago when it was very hard to sell super prime and only the very best in the very best location sold.

extrader

Hi harryr,

My apologies, I haven't been following threads v closely for some time, but I seem to recall that you were very keen on the hidden value in a London-based high-end property developer, the name escapes me.

I saw the value start to be realised (with envy !) then got distracted.

Are you still keen on this company and - if so - how does this reconcile with your current views re London ?

I understand that you may be long-term negative and short term still positive, but that was what Charlie Prince of Citibank said ('whilst the music is still playing, you gotta dance' or similar) .......and we know how THAT ended.......;-<

Look forward to your comments, which I've always found refreshingly controversial.

ATB

Guzziman

6th May '14

"Gradually we are realising that markets are not efficient, and that human beings, even highly intelligent and trained ones, are absolutely not rational for a lot of the time - but tend to operate in herds, where group-think takes hold, and despite everyone knowing that what they are doing is wrong, they continue doing it. Then when the bubble bursts, the carnage can be very ugly indeed."

Paul by this don't you mean momentum investing/trading? Personally am rubbish at this so no longer even consider it.

Central London property boom and bust?

You maybe correct but my feeling is as JIS was possibly inferring? Propety prices and politics in the UK and maybe even the western world are so immesurably intertwinned or have been since Maggie really.

So logic is saying a building bubble which like all bubbles will go ..., but the political agenda has to support our love affair with houses to ensure a favourable outcome politically at the polling station. Increased property prices makes the ruling political party supporters feel better.

How much more personal national indebtedness would there be if lnterest rates rose even a marginal amount?This is why I suspect the powers that be are starting to nervously review the affordability of mortgage applications. Then where would the "recovery" be?

But over and above politics more houses do need to be built to meet the infrastructure the nation requires.

So personally am waiting for the pop but I wonder how long for?

Central London property boom and bust?

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Paul Scott

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