Bubble Stock for Sale

It is hard to imagine, much less find, a better exemplar of how capital gets misallocated in a bubble than British property agent Foxtons, whose stock was publicly listed last week.

To put it in perspective, Foxtons is now trading for a bit more than 20 times what investors expect it to earn next year. That implies investors believe that either it will gain market share rapidly or, as real estate agent fees are a percentage of sales and rental prices, they think London real estate will continue its stratospheric rise.

How Foxtons came to command such a premium price, its journey on the way, and the policies and forces that got it there form a very short tour of what has gone wrong in Britain over the past decade and a half.

House prices in London have more than tripled since 1998, rising far more than incomes and driven by a complex combination of forces. While difficulty getting planning approval has played a role, as has London's popularity with rich foreigners seeking a bolt-hole against political risks at home, much of the gains have been driven by the financialisation of the British economy.

With London perhaps the pre-eminent global banking capital, that created many very highly paid jobs, and people capable and willing to pay up for houses and flats.

Before the financial crisis, there was also the fact that British lenders would lend to anyone, often with only their own testimony to support their ability to repay. That allowed people not making financial services salaries to borrow, and many did, hoping gains in property prices would justify loans no sane banker would make.

That ended with the crash, which began shortly after Foxtons was sold in 2007. London property prices tumbled by 16 per cent, Foxtons proved unable to handle its debts, and the banks moved in.

But we don't live in a normal universe.

British and global monetary policy has been kept exceptionally loose since the crash, at least in part to support asset values. At the same time, while parts of financial services in Britain have been hard hit, a failure globally to adequately regulate the industry means it remains huge in relation to the rest of the British economy.

Britain seems unable, politically or otherwise, to wean itself off its addiction to property price gains. Exhibit A is the government's Help to Buy scheme, where the state subsidises mortgages by guaranteeing a portion to the bank, allowing borrowers to buy houses with as little as 5 per cent down.

Sound like state-sponsored subprime lending? Nice for banks and older property owners to cash out, but not for ordinary people trying to buy ordinary houses on ordinary salaries.

All this has also not been great for Britain, shown by the fact the economy has even now only clawed back about half the 7.2 per cent of output it lost in the crash.

It has however, been fantastic for London property prices, and by extension for real estate agents in general and Foxtons in particular.

Prices in London are now 6 per cent above their pre-crash peak and are rising at the fastest rate in nearly seven years.

For Foxtons it has been a wild ride. The estate agent was partially taken over by its banks in 2010, at which point its private equity owners injected cash and kept 30 per cent, with management retaining a stake.

Just two years later BC Partners bought out its banking investors in a deal published reports said valued the company at about US$400 million.

That compares to the US$1.2 billion the stock market says it is worth today. The lesson? Government policy works; in this case it is working to make London houses expensive and to divert capital and talent to flogging them.

Good luck with that.

Reuters