The housing market in Vancouver is a bubble

Real estate price bubble: Munich leads the way and Zurich clearly overvalued

The UBS Global Real Estate Bubble Index puts the housing market in a long-term perspective and is intended to map the risk of real estate bubbles in global cities. The greatest danger of a bubble is currently in Munich. The Zurich market is also one of the heavily overvalued. House prices have risen 2% in the past four quarters, while prices have stagnated across the country.

By Rosalie Basten, Institute for Financial Services Zug

Price bubbles are a recurring phenomenon in real estate markets. The term “bubble” refers to a substantial and persistent misconception of an asset that cannot be proven to exist until it bursts. However, historical data shows patterns of real estate excesses. Typical signs are a decoupling of prices from local income and rents as well as imbalances in the real economy, such as excessive lending and construction activity. A change in the macroeconomic environment, a shift in investor sentiment or a sharp surge in supply could trigger a decline in property prices (UBS)

Price bubble risks are shifting to the euro zone

The greatest threat of a real estate bubble is currently in Munich, followed by Toronto, Hong Kong and Amsterdam. Frankfurt and Paris are newcomers to the risk zone of a real estate bubble. In London, on the other hand, the bubble risk has fallen after further price corrections, so that the city is now only in the overvalued category. The ratings in Vancouver, San Francisco, Stockholm and Sydney have fallen sharply. New York and Los Angeles are also lower, while Singapore has remained almost unchanged (UBS).

The affordability of home ownership in Munich has fallen sharply

Housing market valuations have skyrocketed due to the strong and well-diversified local economy, solid population growth and insufficient supply. Real prices have more than doubled in the last 10 years, while real rents have increased by 40%. Although real incomes have increased by around 15%, affordability has become increasingly difficult: For example, a qualified employee in the service sector has to work for eight years to pay for a 60m2 apartment near the city center. As Germany's economic growth is stalling, an end to the boom on the housing market is expected despite record low mortgage rates (UBS).

Zurich real estate market significantly overvalued

The housing market in the city of Zurich is characterized by a relatively rapid expansion, which has partly mitigated the price pressure due to the lively growth in demand. Regardless of this, the market valuations for residential real estate in Zurich rose significantly in the past year. The market is still grossly overvalued. In Zurich, record-low mortgage rates and a booming economy drove up valuations. The largest price increases occurred in the middle segment. Buying a property in this segment in Zurich only pays off after 37 years - the lowest rental yield of all cities in comparison (see UBS). The returns on buy-to-lease investments have thus fallen to record lows. In terms of both prices and the index, Zurich has now overtaken Geneva (UBS).

Low and still falling financing costs favor demand, as well as robust economic growth in the Zurich region and in Switzerland as a whole. Negative interest rates are key to keeping property buyers willing to pay at current levels. Slowly rising vacancy rates for rental apartments in the agglomeration will continue to put local rents under pressure. Overall, the existing regulations for the mortgage market and an expected slowdown in the local economy should limit price growth in the next few quarters (UBS).

Currently, the demand in the residential segment is already falling due to entry restrictions. Relocation and purchase decisions are being postponed. However, the delays in the construction of rental apartments triggered by the pandemic are initially compensating for the falling demand, so that the increase in vacant rental apartments is not accentuated and rental prices are leveling off at the current level (ZKB). In addition, the number of building permits for new buildings has already decreased last year (UBS).

Slight price reductions are emerging on the transaction market

Before the crisis, real estate companies, pension funds and investment foundations refrained from offering their existing properties for sale in order to avoid additional investment income and thus negative deposit interest (JLL). Private investors and family offices in particular refrained from selling real estate because of the high level of debt financing, as refinancing old mortgages with new, cheaper mortgages enabled equity to be created (JLL). Capital inflows were increasingly being invested in value-preserving renovations or value-creating measures. Previously unused potential was accessed and new development projects initiated (PwC). The remaining transactions were primarily limited to high risk real estate (JLL).

A further push in construction and renovation would have achieved the desired goal of promoting investment by lowering interest rates and thus stimulating the economy, but this would also have resulted in an increase in average rental prices (JLL). In the current economic situation, portfolio managers are trying to counteract the losses with lower capex planning, so that the construction and renovation boom is slowed down (PwC).

The current risk aversion of investors is putting increasing pressure on building land and project prices, and some properties are being withdrawn from the market. This hesitation on the part of investors in combination with the increasing vacancy rate leads to a construction freeze which reduces the already limited supply to a minimum (Fahrländer & Partner). However, homeowners are not ready to accept price concessions for the time being, but slight price reductions are expected temporarily. A price slump is unlikely, as the current low interest rate environment is tempting many owners to keep their properties (Wüest und Partner).

The effects of the pandemic are contributing to healthy pricing in Zurich

The development of the real estate market before the crisis was marked by several warning signals of a price bubble. The low interest rate environment led to increased demand for real estate, which significantly exceeded supply and caused a construction and renovation boom. In the long term, increasing investments in existing properties would have decoupled prices from rents. Economic growth and wage developments would not have been able to compensate for this rapid growth in the long term. Returns on buy-to-lease investments hit record lows before the pandemic, and there are currently no signs of a turnaround.

The slump in consumption has led to a drop in demand and fewer construction projects. This will have a positive effect on the relationship between supply and demand. The small number of transactions will only become noticeable in the next few quarters, as soon as demand rises again. Overall, there are signs of a price bubble on the Zurich market. However, a collapse in property prices can be ruled out for the time being due to the high demand and the favorable financing options.

For more information, please refer to the report: UBS Global Real Estate Bubble Index 2019.

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