Hot in the city

GLOBALISATION has created a handful of metropolises that attract people, capital and ideas from all over the world, almost irrespective of how their national economy is doing. House prices in such places, unsurprisingly, outpace the national average. In our latest round-up of global housing, we find that prices have risen in 20 of the 26 countries we track over the past year, at an (unweighted) average pace of 5.1% after adjusting for inflation. Prices in pre-eminent cities in these countries, however, have risen by 8.3% on average.

In a survey conducted last year, fewer than one in nine residents of Amsterdam, Berlin, London, Paris, Stockholm and Zurich thought that it was easy to find reasonably-priced housing. In these cities, house prices have risen at an average pace of 6.5% a year over the past three years (again, unweighted), compared with a national average rise of just 3.2%. The value of homes in four cities on the Pacific—San Francisco, Vancouver, Sydney and Shanghai—has increased by 12% a year over the past three years, twice the average national pace.

The supply of housing is rather inelastic, so in the short term house-price inflation is driven more by demand factors, such as the number of households, disposable income, interest rates and the yield available on other assets. In recent years all of these have helped to push house prices steadily upwards, especially in big cities.

In the conurbations in question, the number of households is rising fast as hordes of ambitious millennials pour in. Two in five of Zurich’s residents were born outside Switzerland; 44% are between the ages of 20 and 44. The boom towns also have tight labour markets and therefore relatively high income growth: the unemployment rate in San Francisco and Stockholm is around a percentage-point lower than the national averages. Some are havens for second homes and money seeking safety: foreigners snap up half of London’s princeliest dwellings, according to Savills, an estate agent. Finally, they provide a decent return: net yields in Vancouver were 11% in 2015, according to MSCI, a data provider, three percentage points above the average for Canadian housing.

Whenever the supply of a good is limited, there is potential for exuberance. San Francisco’s property market is intertwined with the technology sector: since 2008 there has been a 93% correlation between the monthly movements in the NASDAQ and house-price inflation in its metropolitan area. Since bottoming out in early 2012, prices in Silicon Valley have risen by 73%, compared with 31% in America as a whole.

To determine whether homes are fairly valued The Economist looks at the relationship between prices and disposable income (an indicator of affordability) and between prices and rents (a substitute for buying a home). If rising prices move these ratios above their long-run averages, then either incomes or rents are likely to rise, or house prices to fall.

Across America house prices, after falling by 25% from their peak between 2007 and 2012, are now at fair value compared with rents and incomes. In San Francisco, too, they are at fair value when compared with rents, but 45% overvalued relative to incomes. Thanks largely to their big cities, housing appears to be more than 40% overvalued in Australia, Britain and Canada, according to the average of our two measures. Between 2002 and 2012 the typical London home sold for seven times the city’s average annual salary. That figure has since risen to 12 times.

As property developers from Las Vegas to Limerick will attest, when supply does eventually respond to soaring demand, property prices fall. Restrictive planning laws curb new construction in the area around San Francisco Bay; the narrow peninsula that San Francisco itself occupies compounds the problem. London suffers from an even more severe planning regime. Yet housing starts are at a nine-year high in San Francisco. In London, too, builders are finding a way: construction began on 24,000 new homes in the capital in 2015, the highest rate for ten years.