The German housing market is gradually heating up

The strong surge in housing prices continued in Q1 2016. The prices for owner-occupied homes rose on the year by 4.7 percent, the growth rate in multi-family dwellings was even more pronounced, at 8.0 percent. In the big cities, price increases cooled in the interim but have since picked up again, with owner-occupied flats becoming some 9 percent more expensive.  Neither the fact that prices have already rocketed nor the tangible expansion in residential construction were able to dampen the price hike. Four factors have driven this: Firstly, the basic economic conditions for the housing market are better than at most points in the past. Secondly, the interest rate slide results in lower mortgage payments, despite the increase in house prices.  Thirdly, rental returns that can be achieved in the housing market remain a much-sought alternative to the bond market. And fourthly, housing supply is still tight, as, despite the significant pick-up in construction activity, the completion figures do not suffice to cover the annual housing requirement.

High demand for housing is reflected in a vibrant loan business. The outstanding volume of mortgage loans is growing by about 3.5 percent p.a., i.e. considerably more strongly than in the past. Nevertheless, thanks to comparatively high increases in incomes, private households’ relative debt levels have remained at a moderate level of about 85 percent of disposable income. Private households’ relatively low debt levels and steady income trends are prompting banks to become increasingly a little less cautious. The increasing competition and the attempt by some banks to bag market share by offering relatively aggressive terms has led to an increase in loan values in recent months.  Structurally speaking, this is a somewhat ungratifying trend for the banking sector. Moreover, there is a growing trend to build houses while ignoring needs. Demand remains higher than the number of newly-built homes, but supply is rising in a price segment where there is little demand. Demand is increasing primarily in the lower price segment, while homes are primarily being built in the medium-to-high price segment. In other words, over time an unbalanced market will evolve although all in all there will still be an insufficient number of houses completed.

Low interest rates, the good economic environment, ongoing short supply of houses, and the persistent “dearth of investment targets” will probably push prices up further. However, headwind is increasing, because the appeal of buying property falls as prices rise, supply gets successively larger, and the impact of declining interest rates is likely to ebb.  And loans approvals may be dampened by the Mortgage Credit Directive that came into force in March. Should prices start to fall, various factors will lessen the danger. Good employment figures and fixed-interest loans signed at favourable terms reduce the risk of loan defaults. However, one should not ignore the fact that some buyers have taken on large debts. It is therefore only sensible that the financial regulators monitor the housing and loans market carefully and the government creates the parameters for introducing macroprudential instruments before the end of the year.

That said, this also shows what factors pose the real threats to the German property market. If the growth momentum in Germany wanes and impacts unfavourably on jobs, this could clearly put pressure on property prices. Because then private households’ income levels would develop less favourably and the current strong willingness to buy houses would dwindle accordingly. Another problem could arise with follow-up financing for current loans. If in coming years the ECB returns central bank interest rates to a normal corridor, the strain on households would rise accordingly. If the currently low credit interest rates were not used for correspondingly higher redemptions, for many households the follow-up financing may prove to no longer be viable. This could as a whole place a tangible strain on the German housing market.

In summary, we are thus seeing the first signs that the German housing market is heading into structural over-heating. However, this is just the beginning and the trend could take a while before it becomes a real cause for concern. As long as interest rates remain attractive, the economy would need to cool noticeably to trigger a correction in property prices. In other words, we are in the process of creating an over-heated German property market. Should this continue, it will be hard to avoid a sharp correction, although a few years may pass before this occurs. However, developments should already be watched carefully and if necessary the regulators should intervene.  Irrespective of this, in large cities it already bears considering whether any price level is justified for an apartment. In some cases, I would have my doubts.

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