Germany: Exaggerated prices becoming far more numerous in the housing market

Sentiment in both the German housing market and the construction industry is buoyant overall. Unlike the situation a few years ago, when the property market had to hunt hard for buyers, in large parts it is now decidedly a seller’s market. Thanks to low interest rates at present loan instalment payments are usually not higher than the comparable rent. The strong willingness to buy is also fuelled by good labour market conditions and rising levels of disposable income. Moreover, the strong demand among prospective owner-occupiers is buttressed by investor interest, as the return on rents remains significantly higher than the yield on bonds. For this reason, the flats and houses on offer are swiftly absorbed by the market, and usually at high prices. At the same time, construction companies’ capacities are largely fully utilised, meaning they are hard-pressed to keep up and complete the requisite number of dwellings; the gap between building approvals and flats that are actually built is therefore growing.

However, this is not the case everywhere. For the booming property market in many large cities often contrasts with a miserable state of affairs in rural regions that lie beyond the commuter belt: a housing shortage and rapidly rising prices on the one side, vacancies and a lack of buyers on the other. This imbalance dims the joy at the good demand in the property market. Were there to have been a regional balance to developments, then the price hike for housing that set in as of 2010 and has currently accelerated to six percent a year would have been justified in the wake of many years of stagnation. In actual fact, however, the difference in price trends is immense. In the mid-1990s, an existing owner-occupied flat in Munich would have been about 60 percent more expensive than in Chemnitz. Today, such a flat in the Bavarian state capital costs more than six times the one in Chemnitz.

Thus, the nationwide rise in the price of houses and flats of around 30 percent in 10 years has arisen primarily because the growing number of cities where there is considerably more price momentum is taking the market upward. This reveals a glance at the trend for the 80 large German cities. Prices for existing flats in five cities have over that period at least doubled. These are Hamburg and Munich (both of which are well above the million inhabitants mark) and three considerably smaller cities, namely Ingolstadt, Kassel and Regensburg. That said, in 30 other large cities prices have become appreciably more expensive with hikes of between 50 and 100 percent.

While the German housing market as a whole is therefore not excessively expensive, the valuation ratios measured in terms of income and rent trends have left fundamentally healthy terrain in an increasing number of large cities. In the seven largest German cities, for example, it takes two additional sets of annual income to buy a new-build apartment compared to the average over the preceding 20 years. And instead of the sum of 26 years’ rent, the median purchase price today corresponds to over 30. Below the line, new-build and existing flats in the seven metropolises are already over-valued by about a quarter; in Munich, the figure is actually north of 50 percent. By contrast, the average over-valuation in the other large cities is short of ten percent and thus more modest, above all because the sub-prime property locations serve to depress the averages.

So is there cause for concern? Yes there is, because high over-valuations in the cities concerned can lead to painful price corrections, for example if the valuation ratios drop back to the average level of the past two decades. This does not seem to be on the cards at present, as overall conditions (high demand and short supply) means rising prices are much more probable than falling ones. However, the imbalance in the supply/demand ratios will no doubt gradually be eliminated, and the tailwind provided by falling interest rates is no doubt a thing of the past. Instead, demand will presumably be squeezed by interest rates and inflation levels edging up again. By comparison, the supply side will grow thanks to the surge in house building.

That said, there is a good chance that the German property boom will flatten without a crash: Private households as a whole are only encumbered by moderate debt. Approvals for property loans tend to be conservative. And the interest rate turnaround is likely to be flat, while economic prospects remain sound. Moreover, in many places the need for housing is so large given the far too low volume of completions in the past that there is no need to fear a swift glut in supply. Not to forget that the financial watchdog was able to prepare itself for the task: the necessary legal steps have already been initiated to activate a dampening brake on loans if necessary. Nevertheless, a correction may be sharper, and that would also weaken macroeconomic trends and the financial system. This would specifically be the case if the level of interest were to rise more briskly. For this reason, careful attention should continue to be paid to the situation.

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