According to UBS, the term “bubble” refers to a “substantial and sustained mispricing of an asset, the existence of which cannot be proved unless it bursts.” Typical signs of a bubble include “a decoupling of prices from local incomes and rents, and imbalances in the real economy, such as excessive lending and construction activity,” according to the report.
The UBS index score is a weighted average of five standardized city sub-indices: 1.) price-to-income (fundamental valuation); 2.) price-to-rent (fundamental valuation); 3.) change in mortgage-to-GDP ratio (economic distortion); 4.) change in construction-to-GDP ratio (economic distortion); and 5.) relative price-city-to-country indicator. The index uses the following risk-based classifications: depressed (score below –1.5), undervalued (–1.5 to –0.5), fair-valued (–0.5 to 0.5), overvalued (0.5 to 1.5), and bubble risk (above 1.5).
Toronto (score of 2.24) and Frankfurt (score of 2.21) top the list. UBS notes that real house price levels in Toronto have more than tripled in the last 25 years and property price growth in the city accelerated to its highest rate in five years, with house prices now 17 percent higher than a year ago. Despite some recent cooling, Frankfurt’s nominal housing prices are currently more than 60 percent above their levels five years ago and during this period, price growth has significantly outpaced income and rental growth in a major decoupling from fundamentals, according to the report.
