These 6 cities are at the greatest risk of housing market bubbles

Hong Kong
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Hong Kong

In a world in which more than a third of all government bonds offer negative yields, investing in tangible assets remains popular. So it is hardly any wonder that major urban housing markets are again overheating, just a few years after the last major wave of global correction. We see a significant overvaluation of housing in some key financial centers, with six markets in bubble risk territory.

Although cities at risk of a bubble may not experience a crash, investors should still bear in mind the significant chance of a correction over the medium term.

In the six cities that we see as most at risk of a bubble – Vancouver, London, Stockholm, Sydney, Munich, and Hong Kong – house prices have increased by almost 50 percent on average since 2011. In the other financial centers, prices have only risen by less than 15 percent. This gap is out of proportion to differences in local economic growth and inflation rates.

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.

In North America, the housing market recovery after 2010 has been very uneven. In San Francisco, real prices have increased by more than 50 percent since 2011 and the market seems – despite the fast growth of the local economy – on a path towards bubble risk. Meanwhile, real price growth in Boston has remained close to the national average of 15 percent in the last four years, while New York and Chicago have been outpaced by the overall U.S. market.

While the slow recovery in Chicago can be attributed to fiscal problems and a comparatively weak local economy, the recent price growth deceleration in New York is a sign of weakness of the financial sector. Overall, New York and Boston seem fairly valued while Chicago is undervalued.

"For major urban housing markets across North America, Europe, and Asia Pacific, conditions remain fragile. A sharp increase in supply, higher interest rates or shifts in the international flow of capital could trigger a major price reversal at any time."

Vancouver's housing market has not been dragged down by either the financial crisis or weakening commodity prices. Our research has signaled a significant overvaluation since 2007. Over the last two years, the housing market has gone into overdrive due to strong demand for local properties among foreign investors and a loose monetary policy. Currently, house prices in Vancouver seem clearly out of step with economic fundamentals, and are in bubble risk territory.

In Europe, all major developed market cities are overvalued except Milan. In our view, the sharpest increase in bubble risk over the past 12 months has been seen in Stockholm, followed by Munich, London and Amsterdam. A low-interest rate phase in the growth engines of Europe has contributed to overheating of markets for urban residential properties in recent years.

As a result, prices in London, Stockholm, Munich and Zurich have reached new record levels after adjustment for inflation. Amsterdam is also on its way to making up for the losses after the financial crisis. Following a breather in 2013, Frankfurt too is showing clear signs of picking up momentum. On the other hand, falling inter¬est rates have been unable to trigger any boom in Paris or Milan.

In Asia Pacific, property prices in Hong Kong and Singapore soared by double digits after the financial crisis due to capital shifting towards emerging economies. Subsequently, Singapore managed to cool down the housing market through a variety of regulatory measures. For five years now, prices have been falling modestly and the market is currently fairly valued.

In Hong Kong, however, regulatory steps to reduce the dynamics of price growth were less effective. The city reentered bubble risk territory in 2015, the housing market appar¬ently topped out, and prices have been falling rapidly in the past year.

By contrast, Sydney's housing market is still overheating since the city became a target for Chinese investors several years ago. While Sydney showed the lowest risk score of all our covered Asia Pacific cities in 2012, the market now ranks in the bubble risk category and tops all other cities in the region.

For major urban housing markets across North America, Europe, and Asia Pacific, conditions remain fragile. Even in the cities with the clearest signs of a real estate bubble, it is not possible to predict exactly the timing and duration of a correction. Nevertheless, a sharp increase in supply, higher interest rates or shifts in the international flow of capital could trigger a major price reversal at any time. Investors in overvalued markets should not expect real price appreciation in the medium to long run.

Commentary by Claudio Saputelli, head of global real estate in the Chief Investment Office at UBS Wealth Management.

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