German property market: The strong price surge in 2016 weakened in the fourth quarter

The property price index that has just been released for Q4 2016 by the Association of German Pfandbriefbanken (Verband deutscher Pfandbriefbanken) proves in black and white what had already started to become clear in the course of the year: With an increase of exactly 6 percent, last year posted the strongest price rise for owner-occupied homes since the index was first launched in 2003. The upturn was slightly weaker for prices in detached and semi-detached houses, at 5.8 percent, while that for owner-occupied flats was a little greater at 6.5 percent. The pronounced increase not only shows that the price trend picked up pace quite significantly, in the wake of an increase of 4.5 percent in 2015 and of a good 3 percent in each of the four prior years. But also that, buttressed by a low rate of inflation of not even half a percent, the real price of properties in 2016 climbed at almost the same speed.

The prices for rented multi-family dwellings grew even more strongly, costing on average 7.1 percent more last year than in 2015. Unlike owner-occupied homes, the prices of such property, which many investors favour as an alternative investment to bonds, have been surging at that fast rate since as long ago as 2014. By contrast, the rise in the price of commercial properties quickened markedly in 2016 and kept pace with that of owner-occupied homes.

The reasons for the surge in property market prices are well known. One key demand driver is the ongoing low interest rates, which firstly ensure that financing terms are favourable and secondly make it harder to invest funds. Furthermore, the economy is performing soundly, doing very well in 2016 with economic output climbing 1.9 percent, the strongest rise since 2011. And the robust jobs market also played a positive role: By ensuring rising private households’ income levels, it has enhanced their financial scope and leads to an enduring demand for commercial premises to cater to the additional jobs. Another price driver is the shortage of residential properties, which contrasts with not only a pronounced wish to buy homes, but also a strong need for residential properties among the population, which is growing fast specifically in the cities.

The factors driving prices look on balance to have now peaked. While conditions for demand for property remain favourable, they are no longer improving. This is especially true of the cycle of lowering interest rates, which has come to a stop. To date, falling interest rates have meant that the rising property prices have hardly, if at all, raised the financial burden on the buyers. By contrast, buyers will in future have to be more careful doing their sums as they will need to see whether they can afford a particular property. Moreover, the supply side is improving on the back of the rising number of new builds completed, although these to date only cover about two thirds of the actual requirement.

A slight taste of the shape of this shift in the dynamics of the property market can be gleaned from the price data for the fourth quarter. Because unlike the pronounced increase in the price of homes in the year as a whole, in Q4 prices only rose modestly on the prior quarter. On a quarterly basis, the prices for owner-occupied homes grew only one percent and thus far slower than they did in the preceding three quarters. The prices for multi-family dwellings actually almost stagnated, up 0.3 percent. Only prices for commercial properties continued to surge.

Essentially, this dwindling in the overall strong price momentum is to be welcomed. It dampens the danger that the existing local price exaggerations could trigger a nationwide property bubble. While we expect the current year to again see the price rise slowing, we do not expect it to brake sharply: On average for the year, we believe prices will rise in 2017 between 4 and 6 percent. A more pronounced deceleration is less probable given the still favourable property market conditions. The same also applies as regards the pace picking up again in light of the above-mentioned shift in the relation of supply and demand.

To this extent, the slower price rise in the fourth quarter should not be read as a general weakness in demand. However, it can be understood as an indicator that there is no guarantee of an enduring upturn in the German property market, especially as the number of risks will no doubt increase. These include greater political risks, such as growing protectionism following the pro-Brexit and pro-Trump votes. The pending elections in the Netherlands, France and Germany have the potential to trigger economic risks and boost uncertainty. Both are toxic for demand for property, the purchase of which differs from other goods in terms of economic impact and long-term thrust. Even if the German property market has hitherto benefited as a safe haven from foreign crises, one cannot rely on this always being the case. And the market is by no means immune to price corrections.

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