From the standpoint of investors, German real estate markets were completely unattractive for many years. In fact, they were treated as “no-go areas.”
Prices hardly went up for more than 10 years, even in metropolitan regions. At the same time, annual returns on rental properties were generally below interest rates even on safe government bonds, sometimes falling below 3 percent. In addition, German laws were clearly pro-tenant, at least from the standpoint of investors.
While most European real estate markets experienced a historic boom in the decade before the start of the financial crisis, which eventually led to a bubble, the property market in the continent’s largest economy was downright dreary. Many investors felt that Germany was “fully developed.”
From a macroeconomic perspective, going from a rental apartment to buying property can reduce the mobility of the workforce.
But then came the turnaround, with institutional and private buyers alike literally pouncing on German properties. Prices and rents have increased by 4 percent a year across the country since 2009, and by much more in some larger cities and neighborhoods.
More recently, property prices have increased at a faster rate than rents. But even if that means investors will have to wait longer before rent income makes their purchase worthwhile, the boom continues unabated. After all, in contrast to 10 years ago, returns on rent are now significantly higher than interest rates on government bonds, especially in good downtown locations.
The turnaround in the German real estate market is breathtaking. But it also raises many questions, in terms of both economics and sociology.
How credible and sustainable is this upturn? Can we expect to see similar price excesses like the ones in Spain, Ireland and the United States before 2007? Excesses that plunged entire economies into depression and brought the global financial system to the brink of disaster? What does the trend to buy property mean in a society that demands growing mobility from its workforce? And a society, or at least parts of it, that increasingly emphasizes a sharing economy rather than an ownership economy?
There are many reasons for the newfound enthusiasm for German real estate. Some go back many years.
As impressive as the upturn is in terms of its magnitude, the fact is rents in German cities had to go up. Housing had become more scarce, thanks to the stronger German economy. The most important reason for the high demand for real estate in Germany is a positive rise in disposable income for the average household. In addition, unemployment has gone down dramatically in recent years, so that suddenly full employment seems possible once again.
But absolute income growth alone does not sufficiently explain the dynamics of the rental market. Another equally important factor is Germany’s relative income development in comparison to other European countries. The prospects of well-paying jobs attracted hundreds of thousands of people from Southern and Eastern Europe to Germany. Since 2009, the country has seen net immigration of 1.5 million people. Most immigrants go where the jobs are, which usually means that they look for housing in cities.
One factor is also that young families are increasingly interested in living in downtown areas. The family model, predominant for decades, of the single earner who accepts long commuting times so that they can live with their family in the suburbs is no longer the reality. Not only do more women want to work today, but more and more men want a better balance between work and family life. Short commutes have become more valuable. The fact that rents and real estate prices in cities had stagnated for years only reinforced this trend toward a new urbanization.
The problem is that price and rent stagnation prior to 2009 had crippled the housing economy. Very little new housing was built, even in metropolitan areas. In the year before the big real estate turnaround, about 40 percent fewer properties were placed on the market in German cities than in 2000.
Another factor: The historically low interest rates that have prevailed since the outbreak of the financial crisis narrowed many investors’ options. At a time when safe federal bonds were even yielding negative returns, depending on their maturities, investing in real estate seemed to be the latest silver bullet.
But could this development become dangerous once again? Those with years of experience in the German housing market are likely to be shocked by the prices being charged today. The significant decline in returns on rent, in light of the high purchase prices, should also serve as a warning signal, especially in prime locations in major cities, including Munich, Hamburg and Düsseldorf, as well as a few university towns such as Freiburg in the south-west.
But the German real estate market is still a long way from the kinds of excesses that were seen in Spain or Ireland before 2008. Prices are rising at a much lower rate in Germany today than in Spain or Ireland a decade ago. In other words, while caution should be exercised, panic is not in order.
The fact that private and institutional investors are diverting money from typically low-risk types of investment, such as government bonds, into housing markets, is a welcome development rather than a threatening one. Studies show that relatively slow wealth building in Germany, compared to many other western countries, is partly attributable to the fact that Germans have and continue to tie up too much capital in low-risk and low-return investments.
Besides, real estate helps to reduce the overall investment risk in a mixed portfolio, partly because real estate markets do not move in sync with stock and bond markets. If this shift means that less capital flows into foreign stocks or other securities and more into domestic construction projects, this also has a positive impact on the economy as a whole. That’s because construction activity is more likely to have a positive effect on the German economy than buying a U.S. mortgage-backed security.
However, investors shouldn’t forget that real estate markets are volatile and therefore not risk-free. Many investors associate real estate with a low-risk investment, but this is not always the case, as investors have learned the hard way in United States, Spain and Ireland in 2008.
Germany is no exception: The massive declines in value in eastern Germany after the country’s reunification also showed that investments in real estate can prove to be a losing proposition.
Investing in Germany can come at a high price. Houses and condominiums are not mobile, and purchasing them comes with high transaction costs and usually requires outside financing.
All of this can become dangerous, especially for private investors and for properties in prime locations and university cities.
Two additional, temporary factors have influenced real estate markets in university towns: the reduction of time students spend in primary and secondary school before attending university from 13 to 12 years and the recent switch in Germany from universal conscription to an all-volunteer military. Both measures are creating additional demand for housing in university towns, but only in the short term.
There is another factor that will change the nature of the boom over time. The influx of immigrants will not permanently offset Germany’s low birth rates.
The demographic challenge of a declining population doesn’t just pose an economic risk for Germany, but it also brings the need to make housing more suitable for older residents. This age-related conversion of a million housing units will likely require an investment program that will cost billions. Of course, private investors will need to pay for part of this program, and they will also incur substantial costs.
The re-urbanization was not just a social phenomenon, but was also the result of the existence of more affordable housing in cities.
The boom in the market for residential real estate has some other unique advantages and drawbacks. One of the advantages is that when more young people invest in their own property, they can support their personal pension plan in two ways: They are saving a larger portion of their income and, at the same time, are able to devote a larger share of their remaining savings to higher-risk and higher-return investments.
From a macroeconomic perspective, however, there are pitfalls. The high transactions costs in Germany mean that going from a rental apartment to buying property can reduce the mobility of the workforce. Although this may strengthen neighborhoods, the limited mobility of workers poses a threat to labor markets that should not be underestimated – partly because employers are often forced to add a mobility premium to salaries.
In addition, if an employee loses his job in a city where unemployment is rising, the value of his property will decline. Investing indirectly in real estate, such as through a real estate fund, is an attractive alternative for those who are averse to such risks. It makes it possible to increase the real estate allocation of ones portfolio without the investor having put all their eggs in one basket.
But such pitfalls are nevertheless why private investors should consider that they are not only increasing their yield potential in the short term by investing and living in a property; they also pay a price for it in the form of higher risk. Far from all market players in Germany are aware of this risk.
Still, the boom in real estate markets has aroused national and local housing policy from a deep sleep that has lasted for years. Aggressive measures are needed to meet the demand by increasing the amount of affordable housing in the short term, especially in urban centers. Many cities still have plenty of “additional agglomeration potential,” meaning that they can continue to grow upward and outward.
Joint planning ventures between cities and their surrounding communities make sense, because they help prevent housing markets from ending at arbitrarily drawn city boundaries. For this reason, planning processes should involve all the relevant players.
Such incentives are also necessary for another reason: The re-urbanization of recent years was not just a social phenomenon stemming from lifestyle changes, but was also the result of the existence of more affordable housing in cities. This reason for re-urbanization has lost some of its significance as a result of the current boom in the housing market.
The boom is now causing some families, who would rather have stayed in cities, to move to the periphery as a second-best alternative. This is already recognizable in the fact that, while apartment prices rose in the first phase of the housing market upturn, now prices of single-family and multi-family homes are also going up.
For other households, the boom means cutting back on living space to afford their location of choice, so that per capita use of space will probably increase at a slower rate than in the past.
At the same time, construction activity is increasing in many cities. Although the number of housing completions in most cities was significantly higher in 2013 – up 20 percent from the 2009 level – it was still significantly lower than the value for 2000.
Strengthening this dynamic by increasing the amount of land approved for construction should be the central mission of local and national housing policy. But increased new housing construction is also needed, to reduce tensions in a few rental markets.
Many cities and the German government have taken a different tact: Newly-introduced rent controls and other measures to protect urban areas are aimed at limiting the pace of rent increases and preventing cities from losing their character. However, rent control and other protections don’t necessarily create additional supply. They also reduce a city’s ability to change. In fact, some of the measures aimed at protecting the character of urban centers have been introduced in cities that are still relatively young.
In any case, there is no denying that government interventionism carries the risk of weakening market mechanisms, so that important signals and valuable information about future shortages are lost. Even before rent control legislation went into effect, the Paris-based OECD found that the German rental housing market is one of the most heavily regulated markets of its kind in Europe.
This raises the question of whether the very extensive government housing policy interventions were appropriate, in light of the fact that the current tensions in many rental markets are regional and temporary in nature. Instead, local authorities who want to make more housing available should focus on expanding supply. The reduced costs that governments want will follow.
The author is professor for real estate business in Regensburg and heads the IREBS Academy for Real Estate. To contact him: firstname.lastname@example.org