Economic Research
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Economic Insight
German Real Estate Monitor
Residential property prises are rising strongly in German cities. We consider which house price indices are worth looking at and which indicators may warn of possible overheating of the market. The property market should continue to revive in the next few years, above all due to low interest rates. Even though a property bubble is less likely in Germany than it was in Spain or Ireland, the ECB’s long-standing expansionary monetary policy, maintained for the sake of the peripheral countries, poses significant long-term risks.
Analyst:
Ulrike Rondorf
For important disclosure information, please see https://research.commerzbank.com/portal/en/site/equity/disclaimer_1/index.jsf
Residential property prices are rising significantly in German towns and cities. According to the Bundesbank, prices of apartments in Germany’s seven largest cities rose by 11% in 2012. In Berlin, prices of apartments have gone up by 39% in total since 2003. In Germany as a whole, house prices are currently rising by between 3% and 5% compared with the previous year, depending on the data source. We have compared the different price indices for residential properties and we explain the advantages and disadvantages of these in the following (Chart 1):
- House price index of the Federal Statistical Office (Destatis): So far Germany does not have an official house price index. However, the Federal Statistical Office (Statistische Bundesamt) has now developed a price index as part of a pilot project initiated by Eurostat. This is based on data from 460 committees of experts from nine federal states and covers the period from 2000 to Q1 2012. From mid-year onwards, the index is expected to be published regularly, on a quarterly basis, and will cover almost 95% of German communities. Calculations will take into account all transactions, regardless of intended use, where the land and building are sold together. These cover newly built and existing properties. When aggregating the data into an index, the prices are adjusted for different quality characteristics such as size and location (hedonic price index).
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| CHART 1: Different indicators – one direction Price indices for residential properties Source: Destatis, Europace AG, VDP, Commerzbank Research |
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| CHART 2: Different indicators – one direction Destatis house price index, up to Q1 2012, thereafter own estimates based on data from Europace Source: Destatis, Commerzbank Research |
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| CHART 3: No bubble Level of house prices compared with rentals, long-term average = 100, 2011 Source: OECD, Commerzbank Research |
- VDP index: The index of the Association of German Pfandbrief Banks (VDP) uses data entered by member institutions in a transaction database on the basis of loan agreements. This includes information about the purchase price, size and other characteristics affecting the value of the property. The methodology used to produce the residential property index is similar to that of the Federal Statistical Office. The index has been available since 2003 and is published quarterly about six weeks before the end of the quarter, which has given it a clear advantage over the house price index of the Federal Statistical Office. Disadvantages are the somewhat shorter time series and the smaller sample: The 40 members of the VDP – nearly all major banks in Germany – have a 40% share of mortgage portfolios. This is a good sample, but the entered transactions are likely to be concentrated on urban areas.
- Europace house price index (EPX): This house price index is calculated monthly based on transaction data of the online financial marketplace of Europace AG. Just under 15% of the private real estate financing arranged in Germany is handled via this transaction platform for private property financing, building society products and deferred payment credit. This index also aggregates the prices of sold houses and apartments, adjusting them for various characteristics such as location, size and last modernisation. For the convertion into a national index only the transactions in 10 top regions are taken into account, as insufficient data becomes available each month in other regions. Besides the more limited regional coverage, a disadvantage of this index is that it has only been available since October 2005. The greatest advantage of the EPX is that it calculates price movements monthly rather than quarterly.
- BulwienGesa property index: This index is based on data collected by surveyors from BulwienGesa AG. In the category of residential property prices, it tracks the market segments of owner-occupied apartments, terraced houses and self-build plots in 125 German cities. The calculation of the price index differs from the other three indices in that it does not adjust the prices of very different properties with statistical methods; instead it only covers the prices of typical properties in the different segments, e.g. new owner-occupied apartment with medium to good location and a size of approx. 70 m². The great advantage of the BulwienGesa index is that time series are available from as far back as 1975. However, the survey is only carried out yearly, so that current momentum is not recorded in real time. Also, the methodology used here has the disadvantage that only certain segments of the property market – essentially new buildings – are covered.
On balance, the residential property price index of the Federal Statistical Office (Destatis) is likely to prevail, above all in view of the almost complete market coverage. However, since the quarterly index value will probably go on being published only at the end of the following quarter, the EPX index will also continue to attract attention. After all, its monthly values give a good, timely indication of how residential property prices are developing. Despite of the different data platforms, it has shown a very similar house price trend to the Destatis index in recent years (Chart 1). The VDP index, on the other hand, is likely to become less important in view of its great similarity to the Destatis index. This is probably also true for the BulwienGesa index: Due to the focus on newly build property it has increased much stronger in recent years than the other indices. It is therefore only partially suitable to assess the trend in the German residential property market.
According to the Destatis index, prices of residential properties rose by 3.5% in 2011, having merely stagnated from 2000 to the beginning of 2010. Based on the EPX index, we estimate that
prices rose by 2.5% last year (Chart 2).
No bubble – yet (?)
Prices have risen by only about 8% overall since 2009. This suggests that no bubble has developed in the German real estate market so far. In Spain, for example, prices rose by more than 130% between 2000 and 2007. But what are the grounds for believing that the market is not becoming overheated? We would look in particular at the following indicators:
- Relation to income: So far, house prices have moved in line with fundamental data, as disposable incomes have also risen significantly in recent years. Incomes of German private households were on average approximately 8% higher in 2012 than in 2009. According to the OECD, the ratio of house prices to incomes in Germany is 20% below the long-term average (in Spain it is still 35% above), so that properties in Germany are still affordable on average.
- Relation to rentals: Buying a property in Germany is still cheap compared with renting (Chart 3). The picture may be different in large towns and cities, but these shifts between urban and rural areas are taking place in other countries too.
- Debt: Lending to the private sector is currently rising only very slowly (Chart 4). Admittedly, we expect mortgage lending growth to increase in the coming years. However, there is no cause for concern as long as debt does not increase significantly relative to disposable income. At around 45% of disposable income, the volume of outstanding mortgage loans is well below the peak of 100% reached in Ireland, for example, at the height of the crisis (Chart 5).
Experience from other countries such as Ireland, Spain, and the USA shows that rising property prices lead to very optimistic expectations regarding future price increases. This appears to justify low capital ratios, which can lead to a self-reinforcing upward trend in household debt. It is only then that property market trends potentially threaten the banking sector and the economy as a whole. When debt reaches a high level, private households cannot cope with a price correction. The risk of excessive household debt is significantly lower in Germany than in other countries, as very strict capital requirements are traditionally applied in Germany. According to VDP, the capital ratio for house purchases in Germany currently averages 29%, which is even higher than in 2009 (26%).
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| CHART 4: Demand for credit is only picking up slowly Lending to the private sector (consumers and businesses), year-onyear change in percent, mortgages and consumer loans for purchasing residential property Source: OECD, Commerzbank Research |
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| CHART 5: Debt remains low Mortgage loans as a percentage of disposable income Source: ECB, Eurostat, Commerzbank Research |
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| CHART 6: Germany is strongly regulated OECD indicator of real estate market regulation, scale 0-6, 0 = barely regulated, 6 = strongly regulated Source: OECD, Commerzbank Research |
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| CHART 7: Construction: revival yes – boom no Residential construction orders, building investments, real and seasonally adjusted, index 2005=100 Source: Destatis, Commerzbank Research |
We do not think that affordability indices, which take into account the monthly costs of property financing, are a good way of estimating potential risks in the property market. As these indicators depend very much on current interest rates, high affordability of properties may only indicate that rates of default are likely to be low and prices are well supported in the short term. But in the long term, low interest rates – which allow a larger section of the population to buy property – are the best foundation for an overheating of the property market.
Sustainable recovery
Low financing costs in Germany are the main reason why German property prices are likely to go on rising in the coming years. In the fourth quarter, German consumers paid only 2.7% interest on average for a mortgage with a fixed-interest-rate for five to ten years (which is the most common type of mortgage in Germany. Furthermore, low interest rates have also reduced income from alternative investments, thereby cutting the opportunity costs of a house purchase. Since the ECB will not increase its key interest rate before 2015, rates are unlikely to rise much in the foreseeable future. We expect residential property prices to continue growing steadily at around 3% per year.
Besides interest rates, significant growth in real wages should also support price uplift for houses and apartments in the next few years. After years of wage restraint, initially there will be higher wage growth, due in particular to the buoyant economy. Additionally, a structural trend reversal is emerging towards greater labour market regulation, e.g. restrictions to the use of temporary contracts have recently been adopted. This trend provides further tailwind to wage growth. On the other hand, a high level of tenant protection compared with other countries has a dampening effect on the property market. This puts off institutional investors in particular from seeking large exposure to German residential property (Chart 6). Furthermore, panic buying prompted by fear of a severe economic crisis is likely to recede, now that the sovereign debt crisis has abated.
No construction boom like in Spain
Besides these factors, prices naturally also depend on the trend of supply. If higher demand were to lead to more new building, this would weaken price growth. The last few years have seen a slight pickup in the construction sector (Chart 7). Orders in the German construction industry have broken the downward trend which lasted for many years. Orders for residential building in 2012 were 7.5% up on 2011 and as much as 33% higher than in the first quarter of 2010. Building investment rose by 6% in 2011, the strongest rise since 1994. However, it fell again slightly last year. It is worth bearing in mind that building investments are significantly hindered by the fact that commercial and public-sector investments (which after all account for 30% and 14%) are not growing as strongly.
What next? We expect the revival of residential construction to continue. Looking at replacement demand, we find that building permits and, to an even greater extent, subsequent completions are still below the estimated minimum replacement demand of 250,000 units per year. Nevertheless, we consider a construction boom with high single-digit or even double-digit growth in building investment – like that seen in Spain and the USA – to be unlikely. On the one hand, there is little building land available in the sought-after cities. On the other hand, adverse demographic trends prevent the expansion of residential areas on the fringes of towns and cities or in rural regions. Therefore, particularly in urban areas, prices will continue to be supported by lack of supply.
Analyst:
Ulrike Rondorf
For important disclosure information, please see https://research.commerzbank.com/portal/en/site/equity/disclaimer_1/index.jsf
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