House prices in London are the most over-valued of any major city in the world and are in “bubble-risk territory”, a report by economists at UBS has found.
Foreign investment, the help-to-buy scheme, “alluring” yields for buy-to-let landlords, and ongoing population growth have all led property prices in the city to decouple from local incomes, and there could be a “substantial price correction” if the conditions for investment deteriorated, the report said.
The UBS Global Real Estate Bubble Index looked at 15 cities around the world, including Hong Kong, Sydney, New York, San Francisco and Geneva, examining prices against the economic backdrop in each country.
It found London was less affordable for locals who wanted to buy than any city except Hong Kong, and that it was at most risk of prices falling.
The city rated 1.88 on UBS’s bubble index, and the report said that between 1985 and 2009, whenever the index exceeded 1.0 “a real price correction of on average 30% began within three years 95% of the time”.
It added: “Investors in overvalued markets should not expect real price appreciation in the medium to long run.”
Price increases of 40% since the start of 2013 have more than offset losses during the financial crisis and mean that homes in London now cost more than ever before. On Wednesday, the Land Registry said the average price had almost hit the £500,000 mark, with the annual rate of inflation running at 9.6%.
Meanwhile, wage growth has been sluggish, and the price increases have made London one of the most expensive cities in the world based on price-to-income and price-to-rent ratios, the UBS report said.
“It takes a skilled service-sector worker approximately 14 years of average earnings to be able to buy a 60 sq m dwelling; the expense of buying a flat is comparable to renting it for 30 years,” it said.
In Hong Kong, the same property costs 21 times income to buy, and the average yearly income of a highly skilled worker can buy only around 3 sq m of living space.
The report said the Chinese territory was also at risk of a downward cycle, and that housing prices were expected to fall by more than 10% by the end of 2016.
Prices had also decoupled from incomes in Paris, Singapore, New York and Tokyo.
Unaffordable housing points to high dependence on foreign demand. So the risk of a price correction, should that demand weaken, is elevated, and the long-run appreciation prospects lower,” it said.
Of the 15 cities examined in the report, 12 were found to be either overvalued or at risk of a bubble.
Only New York and Boston were found to be fair-valued relative to their own history, while Chicago was undervalued.
One of the report’s authors, Claudio Saputelli, said: “A mix of optimistic expectations, favourable economic fundamentals and capital inflows from abroad has caused valuations to soar in certain cities in recent years.
“Loose monetary policy has prevented a normalisation of housing markets and encouraged local bubble risks to grow.”
UBS said a bubble could not be proved conclusively until it bursts, “but recurring patterns of property market excesses are observable in the historical data”.