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Crisis? What crisis? We have been hearing about the housing market crises around the globe for the longest time and the global panic has thrown investors into a frenzy of: "What will happen now?" UK house prices are falling. The hyperbole surrounding this development is disproportionate to the significance of property for the economy. The direct contribution of residential housing investment to GDP is relatively small and notions of important ‘wealth effects’ from housing have echoes of 1970s-style ‘money illusion’.
The IMF’s latest World Economic Outlook suggested that UK house prices were almost 30% over-valued, based on an analysis of price gains which cannot be explained by fundamentals. Some economists have cited developments in the commercial sector as a harbinger for residential property. Perhaps the correlation between prices in the commercial and residential markets is far from perfect – e.g., the former never experienced the boom that residential did in the first half of this decade, but this has not prevented a sharp swing over the past year.
The defining characteristic of the UK housing market over the past decade has been inflation, rather than any major upgrading of the nation’s physical infrastructure. And the median forecast in a Reuters poll of City economists is for house prices to fall 5% both this year and in 2009 – hardly catastrophic given the trebling of prices since 1997.
One factor that is overlooked by the economists and the property brokers is the underlying change in the capital structure of global society, the rising middle class based on an extraordinary commodity and asset boom in the emerging markets that help buttress inflow of investments in the property sector in London, Paris and New York; it is for this reason these markets have stayed very immune to the crisis we have seen in Arizona, California and Florida or Spain.
London houses are the best hedge against inflation and are a great asset class when it comes to flight to safety. Normally on the "off peak" season, taking a walk on Knightsbridge, Belgravia, Mayfair, or Rue Francois Premier or Ave Foch, Paris, means walking through the lifestyle of the rich and famous. Predominantly, these areas happen to be owned now by the new global super class. One thing that one gets surprised with is the number of unlit apartments, a clear sign of absentee owners. These are owners who live there only during the summer. London property market is underpinned by these absentee owners who use these properties as a second home and a sanctuary or safe haven in times of a crisis back home. From Russia to Lebanon, any time there is a crisis a higher level of activity is observed in the central London property market. In some ways real estate in central London is one of the most unrivalled markets; it is an investment, a home and a security all packed in one. Therefore, even in times of global financial crisis the values are holding up fine, perhaps in Shires and north of England the market has corrected between 15-20% and will erode by 10% more this year, but central London values have not yet been as seriously affected.
Out of the top twenty theatres of the world, ten are in London, top 7 restaurants out of 20 in the world are in London, out of the top museums around the world London houses seven of them. This lease of fresh gastronomic and cultural activity has brought new life and attracted the rich from the world over. London has become the new Vatican of culture, art and gastronomy.
Over long periods of time (decades rather than years), house prices tend to gravitate in line with economic growth and income fundamentals – despite major and often persistent divergences; this is akin to exchange rates and purchasing power parity (PPP) estimates. This relationship by no means guarantees a large (say, 30%) fall in house prices as there are important structural changes to consider, such as household formation outstripping new construction (partly related to migration flows) and the more stable macroeconomic environment with low interest rates. But, it does serve to illustrate how inflated residential property has become and the likelihood of some mean reversion in the house price to income ratio.
"Winds have changed." This cliché rings true in our current world, a new world of the commodity-rich countries that have added hundred million nouveau riches to the global economy as a whole in the last one decade. Countries like Brazil, India, Russia and China that were monetarily nowhere on the map until the late 90’s have suddenly mushroomed into wealth; and the appreciation of their currencies has given birth to unexpected "new riches." China that had ten years ago approached the IMF for monetary funding and support today holds 1.3 trillion dollars in foreign exchange reserves.
These new riches from English-speaking commodity-rich foreign lands are behind most of the fresh investments in London. According to Savills, they have on their list 1500 names who are looking for houses upwards of 10 million £’s in central London and 5,000 names who are looking for houses in between 4-5 million £’s. A recent development of Candy and Candy known as 1, Hyde Park associated with Mandarin, established a new benchmark of price, albeit not achieved elsewhere, but 5,000 £/sq.ft was achieved last year for the top penthouses.
Today when the new millionaires from these countries gather around a social dinner within their own country, the first question asked is, "Where will you vacation this summer?" followed by a prompt response, "Oh London of course!" and the next most important and imperative question asked is "Will you be renting a house?" which is haughtily responded to by a "No of course not! I own an apartment there".
One has to realize that most of these are English-speaking countries who were under British colonial rule at some point in history or have strong ties with England, which makes language the common denominator and so, making U.K the obvious choice. London's ability of high drama within the context of history leaves many of these larger-than-life characters longing for the action; they become part of history as they play their roles. It is not only investment in Harrods that pays off beautifully but it is a tryst with posterity that gives a bigger kick to Al Fayed. Al-Fayed has his home and memories all set in London. On 1st September 2005, eight years after Dodi and Diana’s deaths, Mohamed Al Fayed unveiled a second remembrance shrine in Harrods. The bronze statue of the couple dancing is entitled “Innocent Victims” and is located at Door Three. It is a life-sized sculpture of Diana and Dodi gazing lovingly into each other’s eyes as they release an albatross into the sky.
Let us understand the difference between high end cities like Manhattan, Central London and Paris compared to the rest of the cities within United States, United Kingdom and France respectively. These cities are perceived as the hub of income generation and house the rich and the famous historically, therefore the effects of such a crises is mild if not insignificant to them. Truth be told, central London has always traditionally been a scalp in the belt for the elite of societies and as the global population of new and rich consumers and investors grow, London will continue to be the jewel in their crown.
You talk to any new billionaire, like Mittal or Fayed of Harrods, they all will tell you they are what I term as ‘Monopoly kids.’ (Lakshmi spent his first years in India, living with his extended family on bare floors and rope beds in a house built by his grandfather). They knew about Park Lane and Mayfair or Knightsbridge much before than their own Cairo or Calcutta neighbourhood; it is for this Fayed lives on Park lane, Roman Abramovich's ends up in Lowndes Square Belgravia and Mittal cannot find an abode more distant than Kensington Palace in the Billionaires row where Sultan of Brunei and other great icons of rich live in harmony and opulence. Recently a rich Indian entrepreneur sent his daughter for an undergraduate degree to the London School of Economics and put her up in an apartment worth GBP 2000 per week without blinking an eye. In another case, a Russian billionaire purchased an apartment in London for his daughter worth GBP 2.5 million. We could not have seen this a decade ago. But this is in fact the reality we are living today. So, what crisis?! |
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