UBS recently published the 2023 edition of its Global Real Estate Bubble Index. While Tokyo and Hong Kong are usually considered the most overvalued cities, the real surprise is how frothy Europe is looking.
Europe's Overvalued Cities
According to the index, Europe has eight overvalued metros compared to just two in the United States. Zurich takes the top spot with a score of 1.71, followed by Munich at 1.35, and Frankfurt at 1.27. Surprisingly, the Big Apple appears to be a relative bargain at 0.47, and San Francisco even more so at 0.27.
Rotten Outlook for European Real Estate
No matter how you look at it, the outlook for European real estate, particularly in Germany, is grim.
While U.S. housing prices have remained relatively stable due to the prevalence of 30-year fixed-rate mortgages, Europe relies on a patchwork of shorter-term or adjustable-rate mortgages. This discrepancy is expected to lead to an increasing number of forced sales.
According to Pablo Espinosa Uriel, an investment strategist who studies housing markets at German financial giant Allianz, there is a growing consensus that prices will mainly fall in 2024.
To add to the concern, the European Central Bank has raised its prime rate from 0% to 4.5% in the past 15 months, while the Bank of England has rapidly increased its rate from zero in late 2021 to 5.25% at present.
The Changing Landscape of European Housing Markets
The housing markets in the United Kingdom and Germany are experiencing significant shifts, with potential implications for the rest of Europe. According to the World Economic Forum, the UK has the second-highest proportion of adjustable-rate mortgages in Europe, amounting to over 40%. Spain takes the lead in this category, as its housing prices have never fully recovered from previous crashes. Concerns arise as mortgage payments could double when these loans reset, putting financial strain on homeowners. David Aikman, a finance professor at King’s Business School in London, questions whether these circumstances can be sustained and wonders how it will all add up.
Regarding the UK, housing prices have already fallen by 25% in real terms since 2015, partially attributable to Brexit-related anxiety. However, uncertainties also loom over Germany's housing market. Despite being considered in a state of irrational exuberance until the European Central Bank (ECB) initiated rate hikes, Germany has now found itself leading in several undesirable categories. Allianz reports that price-to-rent ratios have soared to 1.6, compared to 1.35 in France, ranking it in the first place. Additionally, 15% of German households are spending more than 40% of their disposable income on housing, double the proportion of Spain and Italy.
Although Zurich and Geneva are witnessing stretched valuations, the Swiss National Bank's decision to maintain interest rates at 1.75% eases immediate concerns. In Germany, housing prices have already declined by 14% since their peak in March 2022, according to Allianz's calculations. This downward trend is expected to continue throughout Europe, as projections indicate a 5% to 10% drop by the end of 2024. However, even with these price adjustments, buyers remain reluctant due to current interest rates. Allianz estimates that prices may have to fall by approximately 15% to align with the reduced purchasing power caused by tighter monetary policies and inflation.
In addition to the impact on prices, higher interest rates are also constraining the supply of new housing, with Germany experiencing a 25% decline in construction permits during the first half of 2023 compared to the previous year. However, there is a silver lining in this challenging housing market. Experts believe that the current correction across European housing markets could pave the way for a sharp rebound if and when interest rates decrease again. Christian Holzhey, a real estate expert, predicts that once central banks begin to cut rates, we will witness a significant increase in prices.
While developments in Europe's housing markets are worth monitoring, it may also be worthwhile to consider alternative opportunities. For instance, the housing market in San Francisco could provide interesting insights and potential investment prospects.
Key Points:
- The UK has a high proportion of adjustable-rate mortgages (over 40%), second only to Spain.
- Housing prices in the UK have already fallen 25% in real terms since 2015.
- Rising interest rates in Germany have resulted in a decline in housing prices by 14% since March 2022.
- In Zurich and Geneva, stretched valuations are less immediately concerning due to the Swiss National Bank's interest rate policies.
- The rest of Europe is projected to experience a 5% to 10% drop in housing prices by the end of 2024.
- Higher interest rates are impacting the supply of new housing across Europe, including a 25% decline in construction permits in Germany.
- A potential rebound in European housing markets is predicted once interest rates decrease again.
- San Francisco's housing market presents alternative opportunities for consideration.
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