Munich
Munich, one of the cities analyzed, has left the bubble risk zone but remains highly overvalued.
Imbalances in housing markets have declined sharply, with real house prices globally falling by 5% on average between mid-2022 and mid-2023, with a further downside in prices now likely, according to the latest edition of the UBS Global Real Estate Bubble Index.
Claudio Saputelli, head of real estate, UBS Global Wealth Management’s Chief Investment Office
The global surge in inflation and interest rates over the past two years has led to a sharp decline in imbalances in the housing markets of global financial centres. This year, only two cities - Zurich and Tokyo - remain in the bubble risk category, down from nine cities a year ago. Cities that were previously in the bubble risk zone - Frankfurt, Munich, Toronto, Hong Kong, Vancouver, Amsterdam and Tel Aviv - are now all in the overvalued territory. In addition, housing markets in Miami, Geneva, Los Angeles, London, Stockholm, Paris, and Sydney also continue to be overvalued, according to the report.
‘In inflation-adjusted terms, prices are actually 5% lower now than in mid-2022,’ said Claudio Saputelli, head of real estate at UBS Global Wealth Management’s Chief Investment Office. ‘On average, the cities lost most of the real price gains made during the pandemic and are now close to mid-2020 levels again.’
Prices tumble by 15% in Frankfurt and Toronto
The house price level in both German cities analyzed, Frankfurt and Munich, doubled between 2012 and 2022, which was the strongest growth of all cities included in the study. Solid economic and employment growth, falling mortgage rates, strong investment demand, and supply shortages supported higher prices. However, prices have been overshooting, according to UBS, and rate hikes and high inflation have triggered a revaluation. Peaking in early 2022, real prices in Frankfurt have corrected by almost 20% since then and by 15% in Munich. Both cities have left the bubble risk zone but remain highly overvalued.
House price growth has suffered due to rising financing costs, given that average mortgage rates have roughly tripled since 2021 in most markets, according to the report. Subsequently, annual nominal price growth in the 25 cities analyzed came to a standstill after a buoyant 10% rise a year ago. In Frankfurt and Toronto - the two cities with the highest risk scores in last year’s edition - real prices have tumbled by 15% in the last four quarters. A combination of high market valuations and relatively short mortgage terms also put prices under strong pressure in Stockholm and, to a lesser degree, in Sydney, London, and Vancouver. In contrast, in Madrid, New York, and São Paulo - cities with moderate risk valuations so far - real home prices have continued to rise at a moderate pace.
Frankfurt was among the cities with the highest real estate bubble risk in recent years, according to the report but the sharp rise in mortgage interest rates in Germany has abruptly ended that boom. Higher financing costs have also turned buy-to-let purchases into lossmaking investments.
Overall, Frankfurt´s housing market is now in overvalued territory, according to UBS, due to rents and incomes rising more sharply than house prices in nominal terms. In addition, the growth of outstanding mortgage volumes has slowed down and the price correction is unlikely to be over, unless interest rates fall again. Purchase prices are currently twice as high as they were 10 years ago, while rents have risen by 40% during the same period. In fact, the sharp slowdown in residential construction activity and the rising population in Frankfurt suggest an exacerbated housing shortage as well as accelerated rent increases in the future. But in view of a weak economic outlook, additional demand is likely to be concentrated in the lower-priced rental segment, at least in the short term.
New York, Boston and Madrid all ‘fairly valued’
Other major global cities, such as New York, Boston, San Francisco and Madrid are faring better. These markets are now considered to be fairly valued, according to the index, as are Milan, São Paulo, and Warsaw. This also applies to Singapore and Dubai, even though their reputation as geopolitical safe havens has recently triggered a surge in demand for both renting and buying.
Price bubbles are a recurring phenomenon in property markets. The term “bubble” refers to a substantial and sustained mispricing of an asset, the existence of which cannot be proved unless it bursts. Typical signs include a decoupling of prices from local incomes and rents, and imbalances in the real economy, such as excessive lending and construction activity. The UBS Global Real Estate Bubble Index gauges the risk of a property bubble on the basis of such patterns. The index does not predict whether and when a correction will set in. A change in macroeconomic momentum, a shift in investor sentiment or a major supply increase can all trigger a decline in house prices.
Mortgage lending has halved since mid-2022
The sharp drop in imbalances has not only been driven by declining house prices but also by inflation-driven income and rental growth. As mortgage lending growth has halved since mid-2022, household debt to income has been declining, especially in Europe. And, apart from the US, nominal rental growth has accelerated significantly and has been positive in all locations analyzed.
Predictably, inflation-driven income growth, coupled with price corrections, have not been enough to meaningfully improve affordability. On average, the amount of living space that is financially affordable for a skilled service worker is still 40% lower than before the pandemic began. More downside in prices - at least in real terms - is likely if interest rates remain at their current elevated levels.
Nonetheless, in some cities, the seeds for the next property price boom have already been sown. Hybrid working has not weakened demand for city living and the housing shortage will likely intensify, given that fewer building permits have been issued recently, particularly in European urban centres. As Matthias Holzhey, lead author of the study at UBS Global Wealth Management puts it: ‘Housing demand continues to accumulate and prices may rebound as soon as financial conditions for households improve.’
Affordability in London at lowest level since 2007
One city that is struggling is London, with prices on a downward path since Brexit in 2016. Despite structural supply shortages, prices have lagged behind the nationwide average. In the absence of strong international demand, house prices remain under pressure as local affordability is at its worst since 2007, due to high mortgage rates. It’s a completely different story in Warsaw, where house prices increased by almost 40% between 2012 and 2022. Strong employment prospects, a subway network expansion, and modern housing developments have boosted the market. However, against a backdrop of strong and persistent inflation, mortgage rates spiked, reducing households’ willingness to pay for homes. This has led inflation-adjusted prices to decline about 10% since mid-2022 and has moved demand to the rental sector, which has seen strong growth. However, new mortgage subsidies have triggered a buying frenzy.
Excessive housing valuations in Stockholm and a high reliance on variable-rate mortgages turned out to be a volatile mix. Currently, affordability is stretched and as a result, between mid-2022 and mid-2023, inflation-adjusted prices corrected by over 20%, more than in any other city analyzed.
Real prices in Amsterdam have fallen by 14% - the strongest annual correction since the 1980s. Worsening financing conditions, diminishing household purchasing power due to inflation and regulatory changes simultaneously weighed on demand. In Paris, house prices already started falling in 2021. This decline has accelerated in recent quarters due to diminishing affordability, lending restrictions and a property tax hike.
As a result of the sharp rise in mortgage rates and record-low affordability, housing demand has weakened significantly in the US cities that UBS looked at. Inflation-adjusted prices fell on average by 2% between mid-2022 and mid-2023, in stark contrast to an increase of almost 10% a year ago. Additionally, real rental growth slowed substantially as the pandemic-induced demand receded, new supply was delivered in several markets, and vacancy rates bottomed out. While imbalances in Miami and New York increased over the last four quarters, housing markets in Boston, San Francisco, and Los Angeles recorded lower index scores.
