No Grexit from London Luxury Property Market11. February 2013 by Herman Brodie
International investors are fleeing former financial safe-havens in huge numbers this year. Compare this to 2012, when fears of a Greek departure from the eurozone prompted its well-heeled nationals shift their wealth into more economically-sound destinations within the zone, like, Germany, Austria and Finland or, better still, into non-eurozone countries like Switzerland and the UK.
The high-end London property market, in particular, was one such safe- haven. In the international property market, London’s top addresses are the gold standard. Greeks were not the only buyers; French and Italian buyers, who have a similar affinity with the UK capital, also bid up prices. But they couldn’t outdo the Greeks. A survey by real estate agent, Savills, showed that Greek purchases of prime London property surged by 50 percent in the first six months of the 2012. The rise was particularly noted between the two crucial rounds of Greek parliamentary elections on May 6th and June 17th. For the entire year the volume of purchases probably exceeded 300 million euros.
All of that seems like a long time ago now. Contrary to the worst fears of some, Greece is still in the eurozone. It has also had its debt written down, bought back some of its own bonds at discounted prices, received another bail out, been upgraded by S&P, and seen the yield on its ten-year government paper dip below 10 percent for the first time since 2010. The country seems to have escaped the worst. Those safe-haven London properties in contrast, although their domestic value increased some 8.7 percent for the year as a whole, according to realtor Knight Frank, that gain has been generously trimmed by the subsequent decline in the value of sterling. Greek buyers who rushed into the London property market at the time of the spring elections probably locked in some of the lowest rental yields in the country and then lost over six percent on the currency. They would have done much better to invest in the domestic Greek stock market. Worse still, the transaction may well have stirred the attention of the Greek tax authorities, who is now looking more closely into the affairs of nationals who bought pricey UK properties.
The question is: what will these safe-haven seekers do now? Part of their motivation for shifting money abroad in the first place was invalidated right after the election – an imminent Grexit was not on the cards. In the meantime, they must also have recognised that Greece’s debt situation has improved and that domestic investments would have yielded a better (and less conspicuous) return. At the same time, a harsher light has now been shone on the UK. Its unflattering debt ratio, stagnant growth, and its skidding currency since David Cameron started talking about leaving the EU, has left it looking much less like a safe-haven. Property experts are also predicting a halt to the recent rise of central London property prices; they predict steady prices for 2013, which is about as negative an opinion as one can get from a realtor. The Greeks could resell their recent acquisitions, of course, but I doubt they will. This is because the Greek safe-haven investor has three mental accounts when it comes to London property: an asset valuation in domestic currency, a rental yield also in pounds, and a foreign exchange account. Thanks to mental accounting, even a globally negative situation could still be perceived in a hedonistically pleasing way.
Consider that each mental account has its own value function as proposed by Prospect Theory. The function is concave in the domain of gains, but convex in the domain of losses. Our human tendency towards loss aversion is reflected in the asymmetry of the function between the two domains: losses hurt more than gains bring pleasure. The first two mental accounts have positive balances, to investors’ obvious delight. The third account is in the red. Yet although its deficit eats into the credits of the other two, it might not trouble investors too much because the gains are mentally segregated and therefore perceived as greater. Even if the first account, the asset value, were to turn mildly negative too, the modestly positive yield on the second might suffice alone to assuage investors’ anxiety if the loss on the third account has grown sufficiently large in the meantime. This is because the marginal loss on the currency is perceived with shrinking sensitivity as it gets larger. It is the first pound lost that causes the greatest pain in the mental account; every additional loss hurts proportionally less. So, as the yield account is always positive (or, at least, should be), it is easy to imagine that meaningful losses might have to be recorded on the other two before investors would become disenchanted.