London tops European cities at risk of housing bubble

The UK capital took the second spot in the index this year behind Vancouver. Other cities at risk of an imminent housing bubble include Stockholm (3), Munich (5), Sydney (4) and Hong Kong (6), according to the index, which was published this week. Other cities where valuations are 'stretched' include Paris, Zurich, Geneva, Frankfurt and Tokyo.

Europe's low interest rate environment is exacerbating the risk of a housing bubble, according to Matthias Holzhey, a real estate analyst and economist at UBS and editor in chief of the report, who notes that prices in many cities, including London, Stockholm and Munich, have reached record highs once adjusted for inflation. 'London's position in the index is not even influenced by the UK referendum decision to leave the EU as our data is for the first half of 2016. London actually came top last year,' Holzhey told PropertyEU. Over in Stockholm, house prices tripled between 1995 and 2012, he added. ‘The government needs to tighten lending or to increase taxes in order to slow down house price growth,' he added.

Over the last four quarters, property prices in London alone have increased by almost 10%, outpacing those in the rest of the country by more than seven percentage points. Amsterdam has also turned a corner and is on its way to making up for the 25% fall in house prices between 2008 and 2013. Even Frankfurt, which was quite stagnant three years ago, is starting to gain momentum.

What these cities have in common are ‘excessively low interest rates, which are not consistent with the robust performance of the real economy, according to the report. This is illustrated by the Euro zone, where monetary policy is struggling to accommodate macroeconomic differences in member countries. Other countries such as the UK, Australia and Canada are also keeping their interest rates artificially low. When combined with rigid supply as well as sustained demand from China, this has produced an ideal setting for a steep hike in house prices.

At-risk cities
The UBS Global Real Estate Bubble Index is designed to track the risk of housing bubbles in global financial centres. All at-risk cities have witnessed a sharp uptick in house prices since 2011; on average they have risen by almost 50% in the past five years. By comparison, in other less-at-risk financial centres, prices in the period have risen by less than 15%.

'The discrepancies have emerged out of a mix of optimistic expectations, capital inflows from abroad and loose monetary policy. The weak economic foundations of the latest price boom make the housing markets in those cities vulner¬able. A change in macroeconomic momentum, a shift in investor sentiment or a major supply increase could trigger rapid decline in house prices. Investors in overvalued markets should not expect real price appreciation in the medium to long run.'

The index traces the fundamental valuation of housing markets as well as the valuation of cities in rela¬tion to their country and economic distortions, such as lending and construction booms. Tracking current values, the index uses the following risk-based classifications: depressed (score below –1.5), undervalued (–1.5 to –0.5), fair-valued (–0.5 to 0.5), overvalued (0.5 to 1.5) and bubble risk (above 1.5). This classification is aligned with historical bubble episodes. London scores 2.06, compared to Vancouver’s 2.14. Stockholm, for its part, scores 1.92, just slightly higher than Munich, with 1.59.

Interestingly, all European cities are overvalued, according to the index, with the exception of Milan, where house prices have tumbled 30% since 2007, according to Holzhey. The sharpest increase in the UBS Global Real Estate Bubble Index in Europe over the last four quarters was measured in Stockholm, followed by Munich, London and Amsterdam. The valuations in Zurich and Frankfurt rose more moderately. The index declined in Milan, Paris and Geneva.