Our Opinion: 2023

Each year UBS (The Union Bank of Switzerland) carries out its Global Real Estate Bubble Index. This year, it concludes that the risk of a real-estate bubble has shrunk.

It puts only two cities – Zurich and Tokyo – in ‘bubble risk’ territory out of the 25 global cities analysed. That compares with nine last year. London is classified as ‘overvalued’, but not in a bubble.There was an average real terms price drop of 5% across the 25 cities between mid-2022 and mid-2023. The biggest declines came in Frankfurt and Toronto, where prices fell back by 15%. The rankings use data such as prices to rent, prices to buy relative to average incomes, and prices compared with a city’s own history to determine bubble risk.

The big surprise is how many European, especially German, cities come near the top of the rankings. Eight European cities are classed as overvalued – including Munich, Frankfurt and Geneva – compared with just two American ones (Miami and Los Angeles). New York and San Francisco are deemed “fair value”.

German house prices are already down by 14% since their March 2022 peak, but further pain is likely as rising interest rates push up mortgage costs. Some 15% of German households spend “more than 40% of disposable income on housing, double the share in Spain and Italy.

Those looking for cheaper European housing should head for Milan, Madrid and Warsaw. Average mortgage rates have roughly tripled since 2021 in most markets. In many places that has triggered a sharp decline in housing market imbalances, although affordability remains historically stretched.

Although the post-pandemic house-buying frenzy has cooled, housing remains undersupplied in most cities. Work-from-home has not, as once predicted, durably dented demand for city-living. What’s more, falling prices have caused a slump in new construction in many urban centres. The seeds for the next property price boom have already been planted.

Some economists had been predicting a significant fall in house prices this year. A huge pandemic era boom meant that by March 2022, the average value of a house in a rich country was 41% higher than five years earlier. Clearly, this leaves lots of downside potential. Yet after modest declines, house prices are rising again in key markets such as Australia and the US.

Why? Firstly, high net migration has kept demand strong. Secondly, strong household finances – high prices have locked poorer people out of homeownership, so today’s homeowners are richer on average and can meet rising mortgage payments more easily than in previous slumps. Finally, the pandemic changed buyers’ preferences, causing people to demand more space for things such as home offices.

Here in the UK, home sellers are cutting asking prices at the highest rate in 12 years. The price cuts are especially large for expensive properties as higher interest rates reduce how much buyers can borrow. The average rate for a two-year fixed mortgage is currently 6.62% and has almost tripled in the last two years.

The housing market slide started one year ago in the wake of the then Prime Minister, Liz Truss’s, mini-Budget. Prices staged a brief recovery this spring, but then embarked on a second drop over the summer as higher interest rates began to bite.

Expesive mortgages are causing would-be buyers to turn instead to the rental market. Rental costs rose by 12% in the year to August, the biggest increase recorded in the decade since property broker Hamptons began tracking rental-price data. As well as exacerbating cost-of-living pressures, shortages in the rental market are hampering people’s ability to move for work. That added friction will do nothing to raise UK productivity or growth.

Nationwide reports that UK house prices fell by an average of 5.3% in the year to August, the biggest annual drop since July 2009. Halifax, which produces a different house price index, reports a 4.6% fall over the same period. Add in high inflation and the real terms decline is now 12% since the August 2022 peak. We may only be half-way through the slump. Assuming that mortgage rates stay around their current levels for another year, a further 5.5% nominal price drop looks on the cards, with the market poised to bottom out in the middle of 2024. That would give an overall 10.5% peak to trough fall in prices, or almost a quarter in real terms.

While house prices are up by about 20% in nominal terms since 2019, in real terms they have already reversed all of their pandemic era gains and have slipped to their lowest level since 2016.

State help for the property market invariably focuses on help for first-time buyers, which only drives up demand for a structurally limited housing stock. Politicians talk about getting families onto the ‘property ladder’ to build wealth. It is true that UK property has performed very well in recent decades, but one person’s house price windfall is another’s living cost inflation. For UK society as a whole, the property market is currently creating an illusion of wealth, not the real thing.

3^rd November 2023