UBS Property Report: is London heading for a bubble?

There’s trouble brewing in the London property market – or is there? Economists at UBS have placed London at the top of their 2015 Global Real Estate Bubble Index on the basis that property prices are now divorced from local incomes. The report has sparked a frenzy in the UK media, with sensationalist headlines stoking fears that we are now in ‘bubble risk territory’.

The analogy is a peculiarly effective one. The idea of a bubble strikes fear into our hearts because it suggests a sudden pop precipitating total collapse. But, in the case of London, it is unlikely – and misleading. Stamp duty, tighter mortgage regulations and the looming spectre of the base rate rise are likely to keep the bubble risk in check by letting some air out of the market in a gradual, controlled way.

Most damaging of all to UBS’s forecast is the simple fact, reiterated by Savills in their quarterly report, that housebuilding in the UK is well below the levels required to meet current demand. Until this imbalance is corrected, a total collapse is impossible; and it certainly does not look like sorting itself out any time soon.

UBS Property Report findings under scrutiny

Of course, a bubble can never be proved until it bursts. UBS has identified ‘the risk of a substantial price correction should the fundamentals for real estate investment deteriorate’ in London. 12 of the 15 cities in the report were classed as overvalued, but it is their conclusions on London that have grabbed the headlines.

Their key benchmark for bubble risk is the price-to-income (PI) ratio, defined as ‘the number of years a skilled service worker needs to work to be able to buy a 60sqm dwelling near the city centre’. According to UBS, London’s PI ratio is currently 14 years.

Their findings are at odds with research released by the Greater London Authority (GLA) in February who found that, at 12.5 years, London’s PI ratio made it cheaper than Paris and on a par with New York. New York was one of the only cities that UBS considered fairly valued.

At the heart of the discrepancy lie the figures UBS chose to calculate the PI ratio. They used data showing that the average annual income of a skilled worker in London is £29,500; but the ONS, in December 2014, estimated that the figure was more like £34,500. Putting salaries 16.5% higher than UBS’s assumption pushes down the PI ratio significantly.

Perhaps more to the point is that indicators like this, whether you choose 14 or 12, obscure the diversity of London’s property market. Croydon’s PI ratio would of course be dramatically lower than Westminster’s. The city is bursting with micromarkets which will follow their own distinct trajectories over the next few years.

Is a property bubble on its way?

Let’s put quibbles about data to one side for a moment and assume that UBS are right: the London market is overvalued and we are heading for a bubble. Are house prices about to collapse?

The current market looks totally different to how it did in 2008. The loans which triggered mass defaulting no longer exist, and regulators have introduced stricter affordability checks. All borrowers are being stress-tested to make sure they could cope with an interest rate rise of 2%, when Mark Carney has suggested that any increase will most likely come in gradual 0.25% increments. There is certainly no sign of the credit issuing frenzy which has in the past triggered a bubble.

Stamp duty and mortgage regulations have also had a dampening effect. Price forecasts for London have been trimmed back of late, with the rest of the UK now expected to outperform the capital in terms of percentage growth.

Most significant of all is the simple principle of supply and demand. London’s population is rising, and there are not enough houses to go around. The level of new building has picked up in recent years, but is still well below government targets. Supply is scarce and demand is sky-high, and it is difficult to imagine anything correcting this imbalance any time soon.

Even if prices were to fall in the short term, the ensuing flood of opportunistic demand would push them back up. More likely is that we will see a slower rate of growth – but growth all the same.

Savills are of the view that the current conditions in the housing market are far from a ‘temporary phenomenon’, and we are inclined to agree. London’s property prices are not going to crash. You heard it here first.

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