Into Thin Air:  the Property Bubble

There has been much talk about the property bubble in the US and its eventual bursting.  I have a different take on the whole credit crisis.   Rather than blame the crisis on derivatives I simply believe that prices are too high and there is too much speculation. Due to a long protracted period of lower than necessary interest rates we have speculation in the property market like never before.

Here in Toronto, a wannabe world class city of 4 million people, the 4 Seasons recently announced the launching of a residential/hotel complex to be completed some time in 2011.  The Four Seasons has a top quality cache name, evidenced by the sale of the total company last year for a phenomenal price.  The location is on the outskirts of Yorkville- not the best but not the worst location, in my view.  I would rate it a B location.  Suites in the residential section sold for $1,000 a square foot on the opening bid, $2.5m for a 2500 square foot apartment with around $200,000 down and another couple of  $300,000 deposits on contract completion for a total investment  of around $1m (all figures are In C$).  At the time, that was the top price/square foot ever for condos in Toronto and it is around 50% higher than properties that have ground under them, i.e. residential houses.  These condos sold out rather quickly.  That same apartment just 6 months later was priced at $3.25m or $1,300 (May 2007).  Now the market for the same size apartment is $4.25m or $1,700 a square foot., just 3 months later, an increase of 29%.  Remember no real money has changed hands or will for some time and the building will not even begin construction for some time.   The actual return on investment has been, too put it mildly, phenomenal.   As well in a very short period of time considering what little was required in terms of capital.  However, owners cannot sell on their properties until nearer to completion, so it remains unrealized.  Of course, from what I am hearing, many of the buyers are foreigners and many from China/HK.

What we must remember is this is for AIR.  The property has not started to be built and will not be completed for four years. 

But few find this extraordinary in these heady days of property speculation.

In the Sunday New York Times this weekend I checked out the property supplement to see what $1,700 per square foot buys you around the world.   Almost everywhere has prices quite a bit lower than that, with the obvious exceptions: London, Paris and Moscow.    I found only one comparison with such a lofty price:  ironically a loft in Tribeca, a trendy neighbourhood in New York.   It has always been Toronto’s ambition to have New York prices, so I guess something has been achieved. 

I certainly hope that the prices are real because it makes my property worth a whole lot more but I suspect that it is just speculation and the real thing will be somewhat less than the fantasy when the reality arrives.

And that is my conclusion:  the real problem is not the sub prime, not the derivatives but purely speculation, phenomena that has been a part of human nature since the beginning of time.  Even Alan Greenspan concedes that bubbles are a part of life:  “I am coming to the conclusion that bubbles are inevitable.  Human beings cannot avoid them….  They cannot learn” he is recently quoted as saying. 

How does speculation generally work its way out?    Through a reduction in prices and a reduction in volume is the usual result.    Eventually speculators lick their wounds and go home.  We are currently seeing the early stages of the process right now.  Greed has yet to turn to fear.  Once it does we will see the prices of assets reduced to a more normal level.   Remember all those profits have been firmly implanted in peoples’ minds even though not yet realized.  Making money won’t be so easy for speculators in the future as their profits turn into thin air.