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Despite the worst recession since World War II, residential property prices have continued to rise in many large cities around the world. That shouldn’t be without consequences.
In the city of Zurich, residential properties are becoming more and more expensive.
A year ago, UBS warned of falling residential property prices. It wasn’t long before there was a noticeable correction, he told himself at the time. However, there is nothing in sight that could cause a drop in prices. Steeply rising interest rates, drastic regulatory interventions in the housing market, or a severe recession were named as possible triggers for this. While little has changed in terms of interest rates and regulations, the crown pandemic sparked the biggest recession since World War II. However, so far there have been no signs of a drop in property prices.
In many places, prices have increased dynamically
On the contrary. With Madrid, San Francisco, Dubai and Hong Kong, residential properties have only gotten cheaper in 4 of the top 25 international cities surveyed by UBS in the last twelve months. Since 2006 there have never been fewer cities with negative price growth, the big bank writes in a study published Wednesday.
And where residential real estate became more expensive, this often happened with great dynamism. In nine cities alone, prices increased by at least 5% adjusted for inflation; in Munich, Sydney, Frankfurt and Warsaw it was even more than 8%. Furthermore, the rate of change in more than half the cities last year was higher than in the last five years, which is also surprising in light of the recession.
Three reasons explain the unexpected development
The big bank mentions three reasons for this development. First, many potential residential real estate buyers did not suffer any direct loss of income in the first half of 2020 due to short hours and other supportive measures. Second, during the shutdown, homeowners received government support in various cities, for example, in the form of tax cuts or higher subsidies.
Third, residential property prices are a lagging indicator. Therefore, changes in the real economy are only reflected here with a certain lag. This is also likely to be related to the fact that UBS uses the prices of completed transactions as well as those of advertisements in its analysis. The latter, in particular, tend to change more slowly, as sellers first try to sell their property without a discount.
Certain patterns suggest an exaggeration
If the economy crashes and yet property prices rise sharply in many places, it is obvious that the risk of a housing bubble will also increase. By definition, it can only be confirmed if it is a bubble when it bursts. However, according to UBS experts, different patterns can be observed when there are hype in the real estate market.
Therefore, UBS uses five indicators to measure the risk of a bubble. In addition to the relationship between property prices and household income and income, these are the volume of mortgages and construction activity in relation to economic output, as well as the evolution of urban property prices in comparison with those of rural regions.
The risk of bubbles increases where it is already high
Based on these key figures, the risk of bubbles has often increased where it was already high. With Munich and Frankfurt, the two German representatives top the list of 25 cities, with the Bavarian capital confirming its first position and the financial metropolis of Hesse moving from fifth to second place. Zurich now also receives the “bubble risk” label, albeit with as few points as possible.
What all cities threatened by a bubble have in common is that property prices have risen sharply both relative to incomes and rents and compared to properties in rural areas. In Zurich, for example, residential property prices have risen 50% over the last ten years, while rents have only risen 15%. In Frankfurt, prices have even doubled.
Accelerated price increases are not sustainable
A solid increase in jobs in these cities, as well as extremely favorable financing conditions, ensured that new properties coming onto the market were quickly absorbed. But even if high-bubble-risk cities have coped well with the Corona crisis so far, UBS real estate experts caution against being overly optimistic.
On the one hand, they do not consider the accelerated price increase sustainable in view of the uncertain environment. On the other hand, several structural factors suggest that development will not continue like this.
Affordability is increasingly reaching its limits
First of all, the affordability of residential real estate, which is becoming less prevalent in many metropolises, should be mentioned here. In several major European cities such as Stockholm, Zurich, Geneva or Frankfurt, a well-trained employee has to spend 7 annual salaries, around 60 mtwo– Buy a flat. In Munich and Amsterdam there are already 9 and in London and Paris even 14 and 17 annual salaries.
UBS experts see additional uncertainties for the demand for urban living space due to the consequences of the corona pandemic. Those who work more frequently in the home office tolerate a longer commute, and pressure on family income will also cause many households to relocate to a more favorable location outside of town.
Investors can no longer count on a tailwind
The bottom line is that the potential for further price hikes has been exhausted in many places and an increase in rents is uncertain, sums up the big bank. Investors who have purchased a residential property as an investment (“buy to rent”) should consider whether they want to take advantage of the favorable moment to turn a profit.
Given the historic lows on residential real estate in large cities, an increase in government bond yields to 1% would mean that the latter would be more attractive than real estate for many investors. In such a case, price corrections of 10% and more should be expected without further ado.
Even if this scenario is deemed unlikely for the foreseeable future, investors should be aware of this risk.
