Contrasting expectations

There’s an interesting UBS paper on global house prices. In bubble terms, London looks scary on price-income ratios but not so bad on price–rent ratios. I suspect that the problem with London’s income-price ratio is measuring buyers’ income. A lot of the central London buyers are not resident, don’t get taken into account in income-price ratios and tend to have very big incomes. UBS state that

London house prices, in real terms, are 6% above their previous 2007 peak despite nationwide prices having declined by 18%. The decoupling of the London real estate market from the rest of the UK is even more drastic considering that, in the same period, real average earnings fell by 7% both in London and UK-wide. Foreign demand and demand deriving from safe-haven seekers largely explain current valuations. Global geopolitical risk and the high property valuations in Asian cities have helped to propel London house prices to new heights. Domestic buyers too have contributed to the appreciation. The “help-to-buy” scheme, alluring yields on buy-to-let investments and ongoing population growth have stoked demand. We advise caution as the UBS Global Real Estate Bubble Index, as well as the cross-sectional benchmarks, point to the risk of a substantial price correction should the fundamentals for real estate investment deteriorate.

London seems to have been immune from recent deterioration in the “fundamentals”. Maybe that’s why, in their latest Residential Property Focus, Savills are forecasting price growth of approximately 20% over the next five years with a bit of geographical variation. That’s 2-3% per annum on average  in real terms depending on your CPI inflation expectation. They’re definitely not forecasting a major correction. In contrast, UBS state that

Between 1985 and 2009, whenever the index exceeded 1.0, i.e. it entered the upper half of overvaluation territory, a real price correction of on average 30% began within three years 95% of the time. Investors in overvalued markets should not expect real price appreciation in the medium to long run.

With London awarded a score of 1.88 in their bubble index, their message is clear. Such a correction would be pretty disastrous for Savills.

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