German housing market: is a major turnaround imminent

Sentiment in the German real estate sector couldn’t be better, concrete gold is selling in Germany “like hotcakes.” And this is not only the case for apartments and houses. Demand for office space, shopping and specialist store centres, logistics warehouses as well as hotels and micro-apartments is at least as great. As a result, prices are high and rising across the board while rental returns have fallen to unprecedented lows. When such a boom changes from an initial phase of exaggeration into a full-blown property bubble, then danger looms for the economy and the financial system. But things have not got to this stage yet. This, at least, is the outcome of the market analyses recently published by the Bundesbank and the “Council of Real Estate Experts” (“Rat der Immobilienweisen”), the former in its Monthly Report and the latter in its annual Spring Report for the real estate sector.

However, a few words of warning to sharpen awareness of the risks of the overheating that already exists in the property market cannot do any harm. In particular, the Spring Report attracted a lot of attention and met with a broad response in the press: it emphasised not only the excessively high price increases of around 30 per cent for dwellings in the big cities, but also predicted – as already in the previous year’s report – that housing prices could come down by almost one quarter to one third in Berlin, Munich and Stuttgart over the next four years. One reason for this is the declining number of younger people entering the market because they can no longer afford current housing prices in these cities and are consequently moving to cheaper towns. This is exacerbated by the growing supply of housing as new home building picks up momentum, as well as by the steep increase in prices since 2009.

Whether housing prices really come down to such an extent remains to be seen. Even if they do, such a decline would be bearable: on the one hand, it would reduce present property overvaluations and, on the other hand, at 7 per cent of the population only a small part of the market as a whole would be affected. In addition, such a development would presumably be of a temporary nature. In virtually all countries, young people are attracted to the big cities, which are growing everywhere and in which housing, apart from some setbacks, is becoming ever more expensive. These urban agglomerations apparently offer newcomers opportunities that offset the high housing prices. In Germany this probably also applies – but not only – to cities such as Berlin or Munich, in which many foreign buyers are also very interested.

However, regardless of the fact that prices may possibly come down in a few big cities and that housing prices will continue to rise for the time being in what is currently a favourable economic environment, one should not overlook the fact that conditions in the property market are likely to deteriorate over the longer term. A market correction is also possible. The main reasons are: first, the tailwind from falling interest rates is over, indeed higher interest costs are likely again. Second, the already very mature expansionary economic cycle is likely to come to an end sooner or later. And third, the supply of new housing is growing: new home completions have already almost doubled compared to 2009, up to around 300,000 dwellings at the moment and still rising. But it is hard to forecast how the property market will develop in concrete terms in the next few years. Besides the development of the factors mentioned above, the extent of immigration as well as political measures such as child housing allowances, subsidies for social housing or accelerated depreciation are also of importance. Preferences as to where and how we want to live also have a major influence: in a house, an apartment, in a metropolis, a large city, a small town, near a town, in the suburbs or in the country after all? What is important is to be prepared for a slump in the property market. As in the past, moderate credit growth and continued strict lending standards continue to make a major contribution here.

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