The London housing market faces a “substantial” correction according to a report which said properties in the capital are the most overvalued in the world.

Economists at UBS warned inflated prices are a bubble at risk of bursting with prices bearing no relation to incomes. The bank’s Global Real Estate Bubble Index blamed demand from foreign investors looking for safe havens for their money as the biggest cause of sky-high valuations. However, despite house prices rising 40 per cent on average since 2013 the economists said they should not expect decent returns in the medium to long run.

The Index said “global geopolitical risk and the high property valuations in Asian cities” also contributed to propelling London house prices to new heights.

It said: “Domestic buyers too have contributed to the appreciation. The help-to-buy scheme, alluring yields on buy-to-let investments and ongoing population growth have stoked demand.”

With sluggish wage growth the price increases have made London one of the most expensive cities in the world based on price-to-income and price-to-rent ratios, the UBS report said.

London also has the second highest price-to-income (PI), a calculation of the number of years a skilled service worker needs to work to be able to buy a 60 metre square flat near the city centre.

Its PI of 14 is behind only Hong Kong and has hit an all-time high. “The expense of buying a flat is comparable to renting it for 30 years,” the report said.

The most expensive cities in the world 2015 Show all 10 1 /10 The most expensive cities in the world 2015 The most expensive cities in the world 2015 1. Grand Cayman, Cayman Islands The largest island in the Cayman Islands group, Grand Cayman is the most expensive city in the world to live in David Rogers/Getty Images The most expensive cities in the world 2015 2. Zurich, Switzerland Switzerland's largest city, Zurich, takes the number two spot FABRICE COFFRINI/AFP/Getty Images The most expensive cities in the world 2015 3. London, United Kingdom The British capital of London is the third most expensive city in the world Chris Jackson/Getty Images The most expensive cities in the world 2015 4. Geneva, Switzerland One of three Swiss cities to appear in the top 10, Geneva is the world's third most expensive city Mike Hewitt/Getty Images The most expensive cities in the world 2015 5. New York City, USA The Big Apple is the fifth most expensive city in the world Afton Almaraz/Getty Images The most expensive cities in the world 2015 6. San Francisco, USA San Francisco, on the other side of the country, comes one place behind NYC Ezra Shaw/Getty Images The most expensive cities in the world 2015 7. Washington, DC, USA America's seat of power, Washington, DC, is the 7th most expensive city Brendan Hoffman/Getty Images The most expensive cities in the world 2015 8. Bern, Switzerland The Swiss capital is the 8th most expensive city in the world FABRICE COFFRINI/AFP/Getty Images The most expensive cities in the world 2015 9. Hong Kong The city-state of Hong Kong is the ninth most expensive city in the world PHILIPPE LOPEZ/AFP/Getty Images The most expensive cities in the world 2015 10. Singapore Another city-state, Singapore, edges in to the top 10 most expensive cities in the world ROSLAN RAHMAN/AFP/Getty Images

The Index looked at 15 cities around the world, including Hong Kong, Sydney, New York, San Francisco and Geneva, examining prices against the economic backdrop in each country.

London rated 1.88 on the bubble index. The report said that between 1985 and 2009, whenever the index exceeded 1.0 “a real price correction of on average 30 per cent began within three years 95 per cent of the time”.

It warned that a shift in investor sentiment or a major supply increase could trigger a decline it said, blaming lose monetary policy for preventing “normalisation of the market” and increasing a bubble risk. The report said housing prices were expected to fall by more than 10 per cent by the end of 2016.

Only New York and Boston were found to be fair-valued relative to their own history, while Chicago was undervalued.

UBS head of global real estate Claudio Saputelli said: “When inexpensive financing is combined with bullish expectations, real estate prices eventually uncouple from the real economy.

“We have seen this in the current cycle, particularly in the world’s leading financial centres, where housing prices are now, in many cases, fundamentally unjustified. The risk of a real estate bubble in these cities has risen sharply. While it is not always possible to prove conclusively the existence of a bubble, it remains essential to identify the signs of one early on.”

The Index comes just a day after the Land Registry said the average property price in London had almost hit £500,000 with the annual rate of inflation running at 9.6 per cent.

Price increases have made London one of the most expensive cities in the world (Getty)

Deutsche Bank also warned in an email to clients last week that a combination of rising interest rates, likelihood that the Bank of England will “rein in” the market and the increasing “politicisation of the housing issue” means price falls could be likely.

The cost of housing has been blamed as the biggest single driver of poverty in London and industry experts have said the government’s forthcoming and controversial Housing Bill, which will extend the right-to-buy programme to housing association tenants and force councils to sell off its most expensive council homes, will make things worse.

Both Zac Goldsmith and Sadiq Khan, the Conservative and Labour London Mayor candidates respectively, have placed housing at the centre of their campaigns.