That’ll Kill the High-End Housing Bubble in US Trophy Cities

by Wolf Richter, Wolf Street

High-end American homes are hot among foreign investors. Last year, the Association of Realtors reported that they spent $92.2 billion on US homes over a 12-month period, up 35% from a year earlier. Chinese investors spent $22 billion, up 72%. They paid a median price of $523,000. And 76% paid cash. They’re desperate to get their money out of China!

Yet with all the official vigilance and handwringing in the US about money laundering and the crackdown on Americans trying to stash some money overseas to escape the sinewy arm of US tax authorities, no one in America apparently asks foreigners where this money comes from.

Other trophy cities where rich foreigners from corrupt countries like to buy are Washington DC, Miami, and New York. Last month, the New York Times ran a series of articles on how foreigners, particularly rich Russians, hide behind shell companies to buy high-dollar condos at the Time Warner Center and elsewhere in Manhattan:

In the decade and a half since Mr. Putin came to power, Russians have socked away hundreds of billions of dollars overseas. Even as the Kremlin was promoting what it called a “deoffshorization” campaign to repatriate Russian capital, an estimated $150 billion left the country last year….

For many wealthy Russians, a New York condo serves as a double parachute – a safe-deposit box of sorts, and a soft landing spot should the climate back home turn inhospitable or dangerous – even if that apartment sits dark and vacant for most of the year. In the process, the Russians, while not quite as ubiquitous as they are in, say, some of the tonier districts of London, have become the face of a sharpening debate about the impact of New York’s pied-à-terre economy.

Michael Bloomberg, when he was still mayor of New York City, said in an interview that these rich foreigners were “a godsend” to the city’s economy. “Wouldn’t it be great if we could get all the Russian billionaires to move here?” the billionaire said.

But it’s a murky business.

Now Global Financial Integrity, a Washington DC non-profit, and 16 other groups sent a joint letter to the Treasury Department’s Financial Crimes Enforcement Network. It spells out just how murky this business is – and how easy it is to “spend millions of dollars” anonymously in deals that are eagerly “facilitated” by the US real estate industry:

Investors mask the true ownership of property in the United States through anonymous companies. The effects of such companies go far beyond hiding the ultimate owners of Manhattan’s real estate. Anonymous companies allow corrupt politicians and organized crime to transfer and hide illicitly acquired funds worldwide, and fuel an abuse of power and a culture of impunity. The ability to conceal their illicitly-obtained-gains fuels corruption, breeds instability, and diverts resources from those they should benefit.

The letter laments “the lack of due diligence by the real estate industry into buyers’ identities, backgrounds, or the sources of their funds.” It refers to a report by the Senate Permanent Sub-Committee on Investigations in 2010 that showed “how foreign kleptocrats and their close associates were undermining US anti-money laundering controls….”

How can this happen on this scale in the anti-money-laundering capital of the world?

Turns out, buying a home in the US with laundered money is OK for foreigners. But don’t try to do this if  you’re American. And that’s on purpose, thanks to the most un-American, big-brother, insidiously misnamed law that just doesn’t stop giving: the Patriot Act. The New York Times explains:

As signed into law in 2001, the Patriot Act would have required real estate brokers and others involved in real estate closings and settlements to conduct due diligence checks on their customers. After heavy lobbying by the industry, the industry was exempted from the final regulations.

This “temporary” exemption, handed to the real estate industry in 2002, is now under fire. In their letter to the Treasury’s Financial Crimes unit, the 17 groups are asking that this exemption be yanked, that real estate professionals and banks be required to perform due diligence on these foreign buyers. They have to with American buyers. Why should foreign buyers go scot-free?

Alas, I can already hear the howling from the real estate industry.

In California, selling high-end homes to Chinese investors is a huge business. An entire industry has sprung up to bring in Chinese buyers. It starts with marketing in China and extends to Mandarin-speaking real estate agents who cater to this clientele and create a relationship of trust. They show the most suitable homes. They steer buyers from new homes to existing homes when new-home prices outrun those of existing homes. They sort through the complications of buying a home in the US. They’re helpful in a million ways throughout the process.

These realtors don’t want to ask any questions. They want to sell a home, collect their hefty commission, and use world-of-mouth to attract more business from China.

And what would happen to high-end home sales and prices if buyers from China, Russia, the Middle East, Argentina, or even Venezuela were suddenly forced to lift the veil of their shell companies and disclose who they are, how they got their money, and prove that it hadn’t been obtained illicitly and through corrupt practices and subsequently laundered?

Everyone knows what would happen: These folks would go to London or other off-shore havens where none of these pesky questions would crop up. Sales of these high-end homes in Southern California and the Bay Area or in Manhattan would dry up. Prices would plunge. There aren’t enough Americans who can play in this ballgame. And it might just be what would prick the gold-plated end of the new housing bubble.

The housing industry is already fretting about Wall Street firms that have gone on a buying binge that drove up prices over the past three years at the lower end of the housing market. They’re now the largest landlords in the US. But now these PE firms want to exit.


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