German house prices are accelerating!

After almost four years of strong house price rises, Germany’s housing market remains very strong. In a country where the housing market has historically been extraordinarily stable, this is a significant shift. The reasons? Strong economic growth, 1.1 million refugees, high work-related immigration, record-low unemployment, weak construction supply and low interest rates.

The German hedonic price index rose by 7.29% (4.89% inflation-adjusted) during the year to end-Q3 2018 (hedonic indices attempt to compare like-for-like exactly, so are the best measure of house price trends), based on Europace figures. Quarter-on-quarter, the index increased 2.27% (1.54% inflation-adjusted) during the latest quarter.

During the year to Q3 2018:

• Apartment prices rose by 7.55% (5.15% inflation-adjusted), up from y-o-y rises of 3.89% in Q2 2018, 5.82% in Q1 2018, 6.18% in Q4 2017, and 7.4% in Q3 2017.
• New home prices rose by 5.9% (3.53% inflation-adjusted), after y-o-y rises of 5.25% in Q2 2018, 5.92% in Q1 2018, 3.38% in Q4 2017, and 5.28% in Q3 2017.
• Existing home prices rose by 8.65% (6.23% inflation-adjusted), after a y-o-y rises of 8.94% in Q2 2018, 6.06% in Q1 2018, 4.69% in Q4 2017, and 6.1% in Q3 2017.

The German housing market was one of the few that avoided a slump in the wake of the 2008-2009 global financial crisis.

Extremely low interest rates and bond yields have encouraged persistently growing demand, despite the fact that most German mortgage borrowers borrow on long-term interest rates, which are higher than “tracker” rates.

Residential property transaction volumes in Germany surged by 19% to €8.8 billion (US$10 billion) in the first half of 2018 as compared to the same period last year, according to Savills.

Low construction activity is another reason for the continued increase in house prices. Housing supply is not keeping up with demand. In 2017, dwelling permits dropped 7.3% y-o-y to 347,882 while dwelling completions increased by just 2.6% y-o-y to 284,800 units, according to the German Federal Statistical Office (Destatis). During the first eight months of 2018, the number of dwelling permits issued rose slightly by 1.9% to 234,400 compared to the same period last year.

Recently, the migration crisis and strong economic growth have added to the pressure.

Despite the price rises, Deutsche Bundesbank, Germany’s central bank, has ruled out the existence of a full-blown property bubble - at least not yet.

“The good news is that there is currently no real estate bubble that threatens financial stability in Germany,” said Bundesbank’s chief banking supervisor Andreas Dombret. “But the traffic light is clearly on yellow.”

This view is supported by Michael Voigtlaender of Cologne Institute of Economic Research. “Rising prices on their own aren’t enough to create a bubble - you have to look at the fundamentals,” said Voiglaender. “We have a stable mortgage market with steady equity ratios, and fairly moderate levels of home construction.”

“Market crashes are typically caused by too much construction, and the opposite is true in many German cities,” Voigtlaender added.

Germany’s economy expanded by 2.5% in 2017, the strongest rate in five years, according to the International Monetary Fund (IMF). Then in Q2 2018, the economy grew by 1.8% y-o-y and 0.5% q-o-q – marking the country’s sixteenth consecutive quarter of growth – the longest period of uninterrupted growth since the reunification. Both the IMF and the European Commission expects the German economy to expand by 1.9% this year and in 2019.

Local house price variations

In North-East Germany:

• Berlin had the strongest y-o-y apartment price rises in the region in Q3 2018, rising by 12.82% to a median price of €3,906 (US$4,446) per square metre (sq. m.). The median price of one- and two-family houses rose by 12.26% y-o-y to €2,543 (US$2,895) per sq. m.
• In Hannover apartment prices rose by 8.67% to a median price of €2,357 (US$2,683) per sq. m. during the year to Q3 2018. Likewise, the median price of one- and two-family houses increased 6.66% to €2,018 (US$2,297) per sq. m.
• In Dresden, median apartment prices soared by 11.24% to €2,489 (US$2,833) per sq. m. during the year to Q3 2018, while one- and two-family houses increased 7.89% to €2,349 (US$2,674) per sq. m.
• In Hamburg, median apartment prices increased 11.34% y-o-y to €3,985 (US$4,536) per sq. m. in Q3 2018. One- and two-family houses rose by 6.55% to €2,640 (US$3,005) per sq. m.

In West Germany:

• Dusseldorf had the highest apartment price increase in the region, rising by 8.7% to €2,625 (US$2,988) per sq. m. during the year to Q2 2018. Prices of one- and two-family houses also rose by 4.02% to €2,409 (US$2,742) per sq. m.
• In Cologne, median apartment prices rose by 4.19% y-o-y to €2,857 (US$3,252) per sq. m. in Q2 2018. One- and two-family houses had a price increase of 5.86% y-o-y to €2,349 (US$2,674) per sq. m.
• In Dortmund, median apartment prices rose by a meager 0.53% to €1,515 (US$1,725) per sq. m. during the year to Q2 2018 while the median price of one- and two-family houses increased 1.95% to €2,042 (US$2,324) per sq. m.

In South Germany:

• Munich had the strongest y-o-y apartment price hike in South Germany in Q2 2018, increasing by 11.24% to €6,361 (US$7,241) per sq. m. Prices of one- and two-family houses rose by 10.08% to €4,771 (US$5,431) per sq. m. over the same period.
• In Frankfurt, apartment prices rose by 6.71% to €3,317 (US$3,776) per sq. m. during the year to Q2 2018. One- and two-family houses had a y-o-y price increase of 5.71% to €2,579 (US$2,936) per sq. m.
• In Stuttgart, apartment prices rose by 10.69% y-o-y to a median price of €3,261 (US$3,712) per sq. m. in Q2 2018, while the median price of one- and two-family houses rose by 7.54% to €2,992 (US$3,406) per sq. m.

All figures from Dr. Klein’s trend indicator of property prices (DTI).

Berlin

Germany’s capital, Berlin, is the seventh most populous urban area in the European Union. The city’s residential sector has been boosted by its young population and growing reputation as a European creative and media hub. It hosts several renowned universities, orchestras, museums, entertainment venues and other creative industries. For several years, Berlin has recorded a high population growth of about 40,000 to 60,000 annually, mainly due to inward migration. In 2017, Berlin had a population of around 3.7 million. It ranked 13th out of 231 cities included in the Mercer 2018 Quality of Living Index.

Berlin is currently facing a severe housing shortage. While there were around 12,800 housing completions in 2017 (up almost 20% from a year earlier), current annual requirements are for more than 20,000 residential units. If the excess demand of about 70,000 units over the past few years is added, it is estimated that Berlin needs around 194,000 new units by 2030.

"Berlin’s economy, which is exceptionally dynamic compared to other German cities, will continue to drive high population growth, suggesting that demand will continue to grow in the residential market," said JLL.

Hamburg

Hamburg is "Germany’s Gateway to the World", and its port is Europe’s third largest. It is Germany’s second largest city, and the eighth largest in the European Union. It is a major tourist destination, and its Speicherstadt was declared a World Heritage Site by UNESCO in July 2015.

The city has flourishing small and medium-sized enterprises, as well as its international trade and business services sectors. Hamburg’s population growth exceeds 5% between 2013 and 2017.

But like Berlin, construction activity in Hamburg is well below demand. In 2016 and 2017, housing completions averaged 7,000 units annually, less than half of the estimated annual requirements for 15,000 homes, according to JLL. Hamburg Senate recently set a new-build target of 10,000 homes per annum.

Munich

Munich is Germany’s third largest city and is home to many major universities, museums, and architectural attractions. It is a traffic hub and is one of Germany’s fastest growing cities. It ranked highest (overall: 3rd out of 231 cities) among major German cities in Mercer’s 2018 Quality of Life Index.

In 2017, housing completions in Munich reached 8,000 units, the highest level in more than a decade. However, the Federal Institute for Research on Building, Urban Affairs and Spatial Development (BBSR) estimates demand for residential development was almost 10,000 units in 2017, and about 15,000 to 20,000 units should be built annually to absorb the excess demand from previous years.

Construction activity in Munich has shifted increasingly from the city centre and downtown neighbourhoods towards the outskirts and less densely developed districts in the past few years, according to JLL. Despite the city government’s efforts to solve the housing shortage, the problem is expected to linger amidst robust population and economic growth.

“Considering the forecasts for further population and economic growth, and given the demand backlog from recent years, the problem of excess demand is unlikely to diminish over the coming years,” said JLL.

Cologne

Cologne, Germany’s fourth largest city, hosts more than thirty museums and hundreds of galleries.

Housing completions in Cologne amounted to 2,140 units in 2017, slightly up from the previous year but sharply down from almost 4,000 new homes in 2015 and from BSSR’s requirement of about 4,500 new homes annually. However due to its growing need for houses, on top of the high demand backlog from previous years, the City of Cologne plans to build about 6,000 new homes annually starting 2019.

Major developments over the next few years include the Clouth site in Nippes, the Sürther Feld in Rodenkirchen and the Deutz AG site in Mülheim.

Frankfurt

Frankfurt is the fifth largest city in Germany. It is Germany’s financial centre and is known for its major trade fairs such as Messe Frankfurt, one of the largest in the world; Frankfurt Motor Show, the largest motor show in the world; and Frankfurth Book Fair, also the largest in the world. It ranked 7th in the Mercer 2018 Quality of Living Index.

The city’s population - which has climbed to more than 730,000 in 2017 - is forecast to reach over 800,000 by 2027. Population growth is focused on the large new-build districts such as Riedberg in the north (peripheral districts) and the Eu ropaviertel (City Centre I). Housing completions averaged around 3,500 annually over the past five years. However, well below current demand for almost 6,000 units annually, amidst strong population growth.

Stuttgart

Stuttgart is Germany’s sixth largest city, and is known as the Cradle of the Automobile. It ranked 28th in Mercer’s 2018 Quality of Living Index.

Stuttgart’s housing stock increased by just 2.4% units annually from 2013 to 2017, while the number of households grew by 4.3% per year, according to JLL.

There were about 2,130 housing completions in Stuttgart in 2017, almost unchanged from the previous two years but still below the BSSR’s requirement of about 3,200 new units in 2017.

Publicly owned housing companies and cooperatives, were the city’s biggest net investors, followed by professional asset and fund managers.

Düsseldorf

Düsseldorf, Germany’s seventh largest city has a population of 600,000. From 2013 to 2017, the city’s population growth was around 7% while the number of households increased by almost 8%. It ranked 6th in Mercer’s 2018 Quality of Living Index.

Like other German cities, housing supply in Düsseldorf is not keeping up with demand. There were just over 1,000 housing units completed in the city in 2017, a substantial decline from about 2,000 completions in the previous year and far lower than the annual requirement of 4,500 units.

Too few homes being built to meet demand

Residential property transaction volumes in Germany surged by 19% to €8.8 billion (US$10 billion) in the first half of 2018 as compared to the same period last year, according to Savills. There were about 74,630 units traded during H1 2018. Foreign investors, particularly from Israel, France, and the UK, represent about a quarter of direct residential property investments in Germany.

In 2017, dwelling permits dropped 7.3% y-o-y to 347,882 while dwelling completions increased 2.6% y-o-y to 284,800 units, according to Destatis. This is insufficient, due to a rising urban population and surge of migrants. In the medium term, the country needs to build around 400,000 flats annually to prevent housing shortages in cities, according to HDB President Thomas Bauer.

After the mid-1990s there was a substantial drop in housing completions, in part caused by policy changes such as a rise in VAT from 3% to 19% in 2007, and the abolition of owner purchase subsidies. From an annual average of 476,000 permits from 1992 to 1999, dwelling permits fell substantially to an average of 222,000 permits every year from 2001 to 2015.

Germany had a total dwelling stock of 41.97 million units in 2017, up by 0.6% from a year earlier, according to Destatis.

During the first eight months of 2018, the number of dwelling permits issued rose slightly by 1.9% to 234,400 compared to the same period last year.

The influx of refugees

The influx of refugees in recent years has exacerbated Germany’s acute housing shortage. Germany took in around 1.1 million asylum seekers in 2015 and another 280,000 refugees in 2016. In September 2017, Chancellor Angela Merkel agreed to cap the number of refugees Germany accepts at 200,000 annually.

Although more than 800,000 new apartment units were completed from 2015 to 2017, this number is insufficient. To house the refugees the German authorities have turned to public buildings, including former schools and sports centres, as well as a concert hall in Thuringia and a former barracks in Brandenburg, according to Financial Times (FT). But even these are not enough. Aside from tight housing supply, another problem is that refugees tend to locate themselves in big cities, such as Berlin, where the housing supply is even tighter. They compete for housing units with locals and migrants (mainly from other parts of Europe) who are in the country to work, resulting in a further surge in house prices.

German states spent about €21.7 billion on refugee housing, healthcare, language lessons, and other integration programmes in 2016 and another €21.3 billion in 2017. The country is expected to spend around €78 billion on migration-related programmes through 2022.

Moderate rental yields in Germany

Germany’s rental yields are poor to moderate, partly because of recent price rises, but more importantly because investment in housing (including buy-to-let) used to be heavily subsidized by tax-breaks. Many Germans live in rented accommodation, while 51.8% of Germany’s total households own their homes, according to Eurostat.

Rental yields according to Global Property Guide research, June 2017:

• In Munich a 120 sq. m. apartment can rent for around €2,250 a month, earning a yield of 3.5%.
• In Berlin a 120 sq. m. apartment can rent for around €1,500 a month, earning a yield of 3.5%
• In Frankfurt, a 120 sq. m. apartment can rent for around €1,700 a month, earning a yield of 3.7%.

Rent rises are broadly keeping pace with price rises. Rents for existing contracts rose by 103.8% from 1990 to 2017, while rents for new contracts rose by 65.4%. On the other hand, the average price of apartments rose by 98.1%, while the price of terraced houses rose by 81.4%, according to BulwienGesa.

Germany’s conservative mortgage market

Despite strong demand, Germany’s mortgage market saw little growth in the past 18 years. The mortgage market was equivalent to 40.5% of the country’s GDP in 2017 - an unusually low level for a developed economy, a huge plunge from 82% of GDP in 1998. As of Q2 2018, outstanding housing loans amounted to €1,357.5 billion (US$1,545.3 billion), up by 4.6% from a year earlier, according to the Deutsche Bundesbank.

Germans’ conservative borrowing is often attributed to the hyperinflation experienced in the 1920s, says Deutsche Bank real estate economist Jochen Moebert. However, the changes in tax incentives are likely to be a better explanation of the general decline in the mortgage loans to GDP ratio.

Housing loan interest rates remain stable

Germany homebuyers mostly borrow loans at a fixed rate. During the period 2003 to 2017, an average of around 70% of the new loans approved had an initial rate of fixation (IRF) of 5 years or more. In fact, in 2017, the share of loans with IRF of 5 years or more increased to 79.8% of total loans, from the previous year’s 78.6% and 64.4% in 2009. In contrast, loans with IRF of up to one year have never exceeded 20% of new loans approved.

Loans with interest-rate fixation of up to one year have declined to a record 1.4% of total loans approved in 2017, from the previous year’s 12% share of total loans and from 18.7% in 2004. This interest rate profile gives considerable stability to the German housing market, which tends not to suffer from the sudden lurches in rates, or in the value of houses.

An important explanation for Germany’s interest-rate stability is the loan sources of Germany’s banks, which borrow long, and so are keen to lend long-term.

Housing loan interest rates in Germany have fallen sharply from late-2008 to 2015, following ECB rate cuts. Since March 2016 the ECB base rate has been at 0%. The ECB also reduced its deposit rate to -0.40% and its lending rate by to 0.25%. In addition, the ECB increased its monthly asset purchases to €80 billion (US$ 89.71 billion) from €60 billion (US$ 67.28 billion), from April 2016 until March 2017. The result has been a significant reduction in interest rates.

However in recent years, interest rates have been largely stable. Housing loan rates in August 2018 were (Deutsche Bundesbank):

• IRF up to 1 year: 2.13%, slightly up from 2.05% a year earlier
• IRF 1-5 years: 1.7%, down from 1.89% a year earlier
• IRF 5-10 years: 1.71%, slightly up from the previous year’s 1.67%
• IRF over 10 years: 1.97%, almost unchanged from the previous year’s 1.98%

German economy remains strong

Germany’s economy expanded by 2.5% in 2017, the strongest rate in five years, according to the International Monetary Fund (IMF). Then in Q2 2018, the German economy grew by 1.8% y-o-y, up from a growth of 1.5% in the previous quarter, thanks to strong domestic demand despite global trade tensions, according to Destatis. Quarter-on-quarter, the economy grew by 0.5% in Q2 2018 – marking the sixteenth consecutive quarter of growth in Europe’s biggest economy – the longest period of uninterrupted growth since the reunification.

Both the IMF and the European Commission expects the German economy to expand by 1.9% this year and in 2019.

In 2017, Germany posted a budget surplus of €36.6 billion, its fourth consecutive year of surpluses and the highest level since reunification. The surplus was equivalent to about 1.1% of the country’s GDP last year. Then in the first half of 2018, Germany achieved another record budget surplus amounting to €48.1 billion.

Unemployment remains low. Germany’s unemployment rate was 3.4% in September 2018, down from 3.6% a year earlier and far below the entire euro area’s unemployment rate of 6.7%, according to Eurostat.

Germany’s annual inflation rate was 2.4% in October 2018, up from 2.2% in September 2018 and the fastest pace since February 2012, according to the Destatis. Overall inflation rate is expected at 1.7% this year, unchanged from a year earlier but sharply up from an annual average of 0.4% from 2014 to 2016, according to the European Commission.