German housing market: Record price increases in 2018

Anyone who has bought a house or apartment in recent years can expect to see a respectable growth in the value of their property. According to price data recently published by the Association of German Mortgage Banks (Verband deutscher Pfandbriefbanken), the price of owner-occupied residential property rose by a record 7.7% in 2018 alone (annual average across Germany). After deducting inflation, real value growth pans out at almost 6%. As the situation was pretty much the same in previous years due to the meanwhile low inflation, the cumulative real value growth over five years adds up to more than 20%. If the property is located in one of the seven largest German cities, the nominal price increase in 2018 was even two percentage points higher. However, inflation has appreciably decelerated in the course of the year and was unable to keep up with the nationwide growth pace in the third and fourth quarters of 2018. Even so, the accumulated value growth over five years in these big cities, adjusted for inflation, chalks up an enormous gain of more than 50%. Given the high purchase prices in this sector, this translates into a six-digit asset growth in euro terms, even for smaller apartments.

The owners’ good mood might well be clouded over due to the evident difficulties in readily realising the real estate value increases, unlike with financial investments. The question concerning further developments on the real estate market could also prove a source of concern. Are we about to see a price correction that could wipe out the profits? After all, the conditions underlying the real estate market have deteriorated. For one thing, prices are already relatively high. In some large cities, properties are already overvalued. This is revealed in the deterioration between the ratio of price and rent, for example. For another, aggregate economic growth has decelerated and economic forecasts have been revised down noticeably.

However, arguments supporting a steady demand for real estate and rising prices are more numerous. The robust labour market, for example, is laying the foundation for further growth in employment and strong income growth. In addition, buying apartments is often the cheaper alternative given the equally sharp increase in rents. This effect is intensified by the low mortgage rates which in January 2019 fell to their lowest level since 2016. At the moment, standard mortgages with a ten-year fixed interest rate can be had at a nominal interest rate of around 1%. Not even investors have been put off all that much by the high real estate prices because alternative investments seem even less attractive to them.

A further reason that diminishes the likelihood of a price slump and raises the likelihood of higher prices is the shortage of housing. New construction has failed to meet demand for housing for years, and the current gap in demand on the housing market is widening. The completion rate of currently around 300,000 apartments is not expected to rise in the near future to the necessary construction volume estimated to lie at 400,000 units. Even if sufficient building land were available, the construction industry that is working to full capacity would hardly be able to build more apartments.

The bottom line is that a deceleration in price momentum will be the likeliest scenario for the housing market. Over a short term horizon, price developments are likely to decelerate more in the already hugely expensive cities than in regions signalling good affordability. Prospective buyers would also do well to keep an eye on the more distant future and ask themselves what impact our ageing and probably shrinking population could have on a location’s demand for housing. If, despite all of this, prices were to fall more sharply, the generally moderate debt level of private households should at least dampen the risk resulting from this.

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