The past few years have hopefully taught policymakers and the public that real estate bubbles go pop eventually and that the results can be damaging. UBS looks at the cities where it sees bubble risks.

London, Zurich and Hong Kong are among the six cities deepest in real estate bubbles and suffering from overvaluations fuelled by low bond yields and a growing disconnect between prices and wages, according to UBS’s report on 20 cities across the globe.

These cities are all located in states that have adopted a low interest rate policy despite their relatively robust real economy, according to the report. Vancouver tops the index in 2016. Besides London, Zurich and Hong Kong, as mentioned, bubble risk is also present in Stockholm, Sydney and Munich. There are also deviations from the long-term norms in San Francisco and Amsterdam. 

“A sharp increase in supply, higher interest rates or shifts in the international flow of capital could trigger a major price correction at any time,” the UBS head of global real estate, Claudio Saputelli, said.

The 50 per cent house price increase characterising the six cities marked "red", which include Stockholm and Munich, is disproportionate compared to the 15 per cent rise witnessed in other financial centres when compared to local economic growth and inflation rates, the study said.

London comes second on the index of real estate bubble risk, after Vancouver, while Hong Kong, Zurich and Singapore rank sixth, ninth and 14th respectively on the index. 

The report notes that all European cities were overvalued apart from Milan, due to the single currency policy of the eurozone. 

London is by far the most overvalued housing market in Europe with an index score of 2.06, which puts it deep in “bubble territory”, which is from 1.5 upwards. 

High stamp duty on growth area luxury products and the newly established stamp duty on buy-to-let have had a limited cooling effect on the London market.

The contrast between higher prices and relatively stagant wage growth is a key concern, the bank said.

However, although a decline in the sterling exchange rate after the June Brexit vote might tempt foreign buyers of UK property, UBS said a repeat of a luxury boom is unlikely in economically uncertain times.

The dynamics are different regionally, the report adds.

Save for Paris, London and Zurich, most European cities remain affordable looking at price-to-income ratios (the number of years a skilled service worker needs to work to be able to buy a 60 metre-squared flat near the city centre) for the average highly skilled person. 

London, Paris, Singapore, New York and Tokyo show price-to-income multiples exceeding 10, with Hong Kong sporting 18 years, followed by London at just over 15 years, and Paris and Singapore requiring 13- and 12-year stints respectively. In Hong Kong, however, even those who earn twice the average income would struggle to afford a 60 metre-squared property, not only due to the recent overheating the market has undergone but also to stagnating salaries in the city.
 
The lack of affordability explains low local demand, against growing supply, which should weigh further on the downward price curve which the housing market entered in mid-2015. 

Growth uncertainty in the region, low rental yields and high stamp duty are equally restraining international flow of capital in the market.

The negative trend in prices (UBS evaluates the correction at 10 per cent), although low compared to the sharp increase - a mere tripling - between 2003 and 2015, is affecting the rental market, which is down 8 per cent from last year.
 
Low affordability indicated by the PI ratio points to diminished long-term price appreciation prospects, while high PI multiples indicate a dangerous dependence on low interest rates, UBS said.