German house prices are accelerating!

After three 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 6.24% (4.4% inflation-adjusted) during the year to end-Q3 2017 (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 0.9% (0.4% inflation-adjusted) during the latest quarter.

During the year to Q3 2017:

• Apartment prices rose by 7.4% (5.54% inflation-adjusted), after y-o-y rises of 8.65% in Q2 2017, 7.47% in Q1 2017, 8.66% in Q4 2016, and 9.35% in Q3 2016.
• New home prices rose by 5.28% (3.45% inflation-adjusted), after y-o-y rises of 11.44% in Q2 2017, 11.13% in Q1 2017, 12.33% in Q4 2016, and 10.24% in Q3 2016.
• Existing home prices rose by 6.1% (4.26% inflation-adjusted), after a y-o-y decline of 1.03% in Q2 2017, and annual rises of 3.71% in Q1 2017, 9.49% in Q4 2016, and 4.63% in Q3 2016.

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

German house price changes:

• In 2009, the price index fell by 1.9% y-o-y (-2.7% inflation-adjusted).
• In 2010, prices bounced back, rising by 3.6% y-o-y (2.2% inflation-adjusted).
• In 2011, house prices rose by 4.7% y-o-y (2.7% inflation-adjusted).
• In 2012, house prices rose by 4.6% y-o-y (2.5% inflation-adjusted).
• In 2013, house prices rose by 3.2% y-o-y (1.8% inflation-adjusted).
• In 2014, house prices rose by 3.7% y-o-y (3.5% inflation-adjusted).
• In 2015, house prices rose by 5.6% y-o-y (5.3% inflation-adjusted).
• In 2016, house prices surged by 10.2% y-o-y (8.4% inflation-adjusted).

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.

The quantitative easing programme pursued by the European Central Bank, worth about US$65 billion per month, is fuelling fears of housing price bubbles in several eurozone countries - with Germany and Norway most at risk, according to a report by Moody's Analytics (other researchers come to different conclusions). The QE programme lowers bank interest rates to zero, encouraging demand for homes. German homes could be overvalued by between 15% and 30% the German Federal Bank has warned.

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

But while Bundesbank has recognized the possibility that German house prices might be overvalued, it 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."

To ensure the health of the banking sector and the real estate market, the German government implemented the Mortgage Credit Directive (MCD) in March 2016, which requires banks to apply stringent rules to borrowers intending to acquire residential properties in Germany. Aside from the property's value, this new legislation requires banks to examine borrowers' creditworthiness, making it more difficult for borrowers to obtain mortgage loans.

During the year to Q3 2017:

In North-East Germany:

• Berlin had the strongest y-o-y apartment price hike in the region in Q3 2017, rising by 18.63% to a median price of €3,593 (US$4,191) per square metre (sq. m.). The median price of one- and two-family houses rose by 10.1% y-o-y to €2,321 (US$2,707) per sq. m.
• In Hanover apartment prices soared by 14.41% to a median price of €2,257 (US$2,633) per sq. m. Likewise, the median price of one- and two-family houses increased 11.7% to €2,007 (US$2,341) per sq. m.
• In Dresden, median apartment prices rose by 8.31% to €2,182 (US$2,545) per sq. m., while one- and two-family houses increased by 4.31% to €2,113 (US$2,465) per sq. m.
• In Hamburg, median apartment prices increased by 8.19% y-o-y to €3,669 (US$4,280) per sq. m. One- and two-family houses rose by 10.34% to €2,529 (US$2,950) per sq. m.

In West Germany:

• In Dusseldorf, median apartment prices rose by 8.8% y-o-y to a median price of €2,483 (US$2,896) per sq. m. in Q2 2017 while the median price of one- and two-family houses soared 17.2% to €2,330 (US$2,718) per sq. m.
• In Cologne, median apartment prices rose by 10.63% y-o-y to €2,671 (US$3,116) per sq. m. One- and two-family houses had a price increase of 12.02% y-o-y to €2,240 (US$2,613) per sq. m.
• Dortmund had the highest apartment price increase in the region, rising by 15.82% to €1,434 (US$1,673) per sq. m. during the year to Q2 2017. Prices of one- and two-family houses also rose by 11.22% to €2,058 (US$ 2,401) per sq. m.

In South Germany:

• Frankfurt had the strongest y-o-y apartment price hike in South Germany in Q2 2017, increasing by 21.87% to €3,167 (US$3,694) per sq. m. Prices of one- and two-family houses rose by 14.62% to €2,500 (US$ 2,916) per sq. m. over the same period.
• In Munich, apartment prices rose by 8.92% to €5,839 (US$6,811) per sq. m. during the year to Q2 2017. One- and two-family houses had a y-o-y price increase of 21.56% to €4,233 (US$4,938) per sq. m.
• In Stuttgart, apartment prices rose by 14.02% to a median price of €2,813 (US$3,281) per sq. m., while the median price of one- and two-family houses rose by 14.11% to €2,747 (US$3,204) 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. In 2016, Berlin recorded a population growth of over 60,000, up from an annual average of 45,000 from 2011 to 2015 and the strongest growth since Reunification. By end-2016, Berlin had a population of almost 3.7 million.

Berlin is currently facing a severe housing shortage. While there were almost 11,000 housing completions in 2016, it was still not enough to meet current annual requirements for more than 20,000 residential units. If the excess demand over the past few years is added, the housing shortage reaches 80,000 units.

"Berlin's economy, which is exceptionallydynamic compared to other German cities, will continue todrive high population growth, suggesting that demand willcontinue 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.

But like Berlin, construction activity in Hamburg is well below demand. In 2016, housing completions totaled 7,050 units, 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 (4/230) among major German cities in Mercer's 2017 Quality of Life Index.

From 2011 to 2016, housing completions in Munich averaged 6,700 units per year. However, the Federal Institute for Research on Building, Urban Affairs and Spatial Development (BBSR) estimates demand for residential development was around 10,500 units in 2016, 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. In 2016, for instance, Pasing and Aubing, located west of Munich, accounted for a large number of new apartment completions. Moreover, Freiham, currently the largest development zone in Munich, is located on the city outskirts. About 8,000 new apartments are expected to be built in Freiham.

Cologne

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

Housing completions in Cologne amounted to 2,117 units in 2016, sharply down from almost 4,000 new homes in 2015 and from BSSR's requirement of 3,900 new homes annually. However due to its growing need for houses, 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 Mercer2017 Quality of Living Index.

The city's population - which has climbed to around 730,000 in 2016 - 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 reached around 3,500 new homes in 2016, a record high for over 20 years. However, well below current demand for about 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 24th in Mercer's 2017 Quality of Living Index.

Stuttgart's housing stock increased by just 2% units annually from 2012 to 2016, while the number of households grew by 5% per year, according to JLL.

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. It ranked 6th in Mercer's 2017 Quality of Living Index.

Like other German cities, housing supply in Düsseldorf is not keeping up with demand. There were about 2,000 housing completions in the city in 2016, a substantial increase from just 979 units the previous year, still not sufficient to meet the annual requirement of 4,500 units.

"While the number of households has grown by 3% since 2012, the housing supply in Düsseldorf has risen by just 1.1% and therefore only a third of the additional demand could be supplied with new housing," said JLL. Düsseldorf has also a very low vacancy rate of just 1.4%.

Too few homes being built to meet demand

Residential property transaction volumes in Germany surged by 27% to €9.5 billion in the first nine months of 2017 as compared to the same period last year, according to Savills. Foreign investors, particularly from Israel, France, and the UK, represent about a quarter of direct residential property investments in Germany, according to JLL.

In 2016, dwelling permits rose by 19.8% y-o-y to 375,388 while dwelling completions increased 12.1% y-o-y to 277,691 units, according to the German Federal Statistical Office (Destatis). This remains 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 housing stock of 40.31 million units in 2016, up by 0.6% from a year earlier, according to Destatis.

The influx of refugees

The influx of refugees during the past two 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.

Although around 525,000 new apartment units were completed in 2015 and 2016, 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.

In 2016 alone, German states spent more than €20 billion on refugee housing, healthcare, language lessons, and other integration programmes.

In September 2017, Merkel agreed to cap the number of refugees Germany accepts at 200,000 annually - a move widely interpreted as caused by vote losses to the far right Alternative für Deutschland (AfD). During the September elections, Merkel's conservative Christian Union (CDU/CSU) got only 33% of the vote, sharply down from the 41% of vote it received in the 2013 elections.

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,  September 2017.

• In Munich a 120 sq. m. apartment can rent for around €2,250 a month, earning a yield of 2.9%.
• In Berlin a 120 sq. m. apartment can rent for around €1,500 a month, earning a yield of 3.0%
• 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 88.9% from 1990 to 2016, while rents for new contracts rose by 54.6%. On the other hand, the average price of owner-occupied houses rose by 79.4%, while the price of terraced houses rose by 67.7%, according to BulwienGesa.

Germany's conservative mortgage market

Despite strong demand, Germany's mortgage market saw little growth in the past 17 years. The mortgage market was equivalent to 40.6% of the country's GDP in 2016 - an unusually low level for a developed economy, a huge plunge from 82% of GDP in 1998. As of Q2 2017, outstanding housing loans amounted to €1,297.8 billion (US$1,513.8 billion), up by 4% 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 gradually increasing

Germany homebuyers mostly borrow loans at a fixed rate. During the period 2003 to 2016, an average of around 69% of the new loans approved had an initial rate of fixation (IRF) of 5 years or more. In fact, in 2016, the share of loans with IRF of 5 years or more increased to 78.6% of total loans, from the previous year's 77.7% 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 were only 12% of total loans approved in 2016, down from the previous year's 12.4% 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.

Interest rates tend to be stable. Even the dramatic ECB key interest rate cuts, from 4.25% to 1% between September 2008 and May 2009, only caused interest rates on 5-year+ fixed rate loans to fall from 5.17% to 4.37%.

Yet housing loan interest rates have fallen sharply over the years since the ECB began implementing its 0.75% base rate in July 2012. 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. Housing loan rates in September 2017 were (Deutsche Bundesbank):

• IRF up to 1 year: 2.04%, slightly up from 2.01% a year earlier
• IRF 1-5 years: 1.71%, slightly down from 1.75% a year earlier
• IRF 5-10 years: 1.71%, up from the previous year's 1.48%
• IRF over 10 years: 1.96%, up from the previous year's 1.66%

German economy remainsstrong

Germany's economy expanded by 1.9% in 2016, the strongest rate in five years, propelled by strongprivate consumption and state spending. The German economy slowed sharply in Q2 2017, with real GDP growth rate of just 0.8%, down from the previous quarter's 3.2% growth and the lowest growth since Q1 2013, according to the Destatis .

Despite this, the outlook for the Europe's biggest economy remains positive, with the IMF recently raising its growth forecast to 2% this year and to 1.8% in 2018. The European Commission is even more optimistic, projecting the German economy to expand by 2.2% this year and by another 2.1% next year, "driven by domestic demand and supported by robust world trade and a firming recovery in the euro area."

In 2016, Germany posted a budget surplus of €23.7 billion, its third consecutive year of surpluses and the highest level since reunification. The country also registered a current account surplus of about 8.4% of GDP last year.

"These figures show that Germany is doing well," said Deputy Finance Minister Jens Spahn. "We invest more than ever - and still have surpluses."

Unemployment remains low. Germany's unemployment rate was 3.6% in September 2017 - far below the entire euro area's unemployment rate of 7.5%.

Germany's annual inflation rate was 1.8% in September 2017, up from 0.7% in the previous year, according to the Destatis . From an annual average of 0.4% from 2014 to 2016, Germany's inflation rate is expected to accelerate to 1.7% this year, according to the European Commission .