Research article

Taking the temperature

As concerns grow about affordability, we reveal which cities are overheated.

The weight of money that has pressed on many of the 12 world cities since quantitative easing took hold in 2009 has led economists and politicians to ask whether real estate bubbles have been created. Large numbers of residents in these cities have also become concerned, so political pressure is growing to curb what is seen by many to be a problem. But are the markets really as overheated as some commentators suggest?

Our analysis indicates that many concerns for the mainstream residential markets, in particular, are overdone and, although some of our world cities may look very expensive in relation to the countries in which they sit, this is not indicative that all of the markets are overheated.

Do rents reveal value?

In our last world city analysis, we started to look at this issue by examining the cities where residential rental growth was not keeping pace with capital growth. We assessed whether the resulting low yields looked sustainable by reference to the prevailing rate on government bonds.

We have updated this analysis again as we think it is a revealing measure of fundamental value (see fig. 7). But this time we have looked across the board at rents paid in commercial markets as well as residential (see fig. 8).




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Figure 7
Figure 8

By this measure, which takes the Savills Executive Unit (SEU) as its basis, Tokyo, New York and Paris look ‘safe’ or even good value to investors. Sydney, London and Singapore show little scope for further capital growth without further rental growth, but are not yet overheated. Meanwhile, Rio, Mumbai and Shanghai all look particularly vulnerable and may now be overheated.

While this evidence might be viewed with concern, especially 
in those ‘new world’ cities that 
are most affected, it is worth considering that it may be reasonable to see real estate as a safer, lower risk investment than 10-year government bonds in certain jurisdictions. In those locations where tenants might be viewed as less likely to default on their debt than governments, it would be perfectly reasonable to accept a lower yield on property than on bonds.

This is where ‘old world’ real estate, particularly prime markets in Anglophone countries with good legal title and transparent markets, have taken on a ‘safe haven, store of wealth’ status with many private buyers.

Capital affordability

One of the key metrics that is used by economists to measure the affordability of housing markets is the ratio of house prices to average incomes. We have increasing concerns as to the efficacy of this measure as average incomes are 
of decreasingly low relevance to capital values in cities where the majority of the population rent, only the wealthiest buy, mortgage lending (especially at high multiples) is rare and where affordability is determined by the amount of equity that is available to those buyers.

We have used city GDP per capita as a measure to proxy the amounts of equity (through stock investments, bonuses and IPO payouts, etc.) that are more likely 
to be available to buyers in each city. Together with the average house price value of our SEU in each location, we have identified how ‘hot’ each city market looks (see fig. 9).

Figure 9

Once again, Mumbai and Shanghai look vulnerable and Hong Kong more so than it did by the yield measure, but Rio looks 
far safer. London and Dubai residential prices look on the higher side of average but are still some way off the hottest cities.

This analysis becomes further nuanced when we consider that the pressure of global money on world city real estate markets emanates from the wealthiest in society rather than across the board. It would appear that the hottest markets are the prime, luxury ones most associated with ultra high net worth global investors.

We have conducted the same GDP per capita analysis for non-prime, or mainstream, residential property in each of our world cities and this shows a very different story (see fig. 10). Only Mumbai looks distinctly overheated, while Shanghai looks hot.

Figure 10

When it comes to the ordinary non-prime residential markets, London and Rio appear to be cool, while Dubai and Hong Kong look merely fully valued.

For investors in particular, there may be huge advantages in shifting focus from prime to secondary markets worldwide.

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