Two years ago I was in London talking to a senior manager from one of the big U.S. banks about investing in German real estate.
I explained that we could generate around 10 percent returns with little risk.
His reply was “Germany is old news, why put money in German real estate, when I can buy an emerging market stock index and make more than 10 percent a year without any work?”
I replied that Germany, on a risk-adjusted basis, seemed to me like a much safer bet than Thailand or Malaysia. He politely smiled at me and said he was not interested.
This summer the Shanghai Shenzen Composite Index and the Hang Seng (the Hong Kong stock market) indexes all fell back to 2011 levels and the IBOVESPA Brazilian stock market index is now worth 40 percent less than in 2011 in the face of political turmoil and the political inability to deal with a slowing economy; the real’s devaluation follows hand in hand.
The Thai and Malaysian markets have given up most of the gains of the last two and a half years and Russia, hit by well thought-out sanctions as a result of its military escapades, has falling stock markets and a currency in free fall.
Emerging markets proved to be less resilient and riskier than people though, probably because most are not as stable politically and economically as the ‘Old World’ and things change a lot quicker than in Europe or North America.
If we take into consideration currency devaluations and actual inflation, the losses are even greater than the stock market losses would indicate. The euphoria came to a sudden end on the realization that speculation and expectations, rather than fundamentals, were responsible for driving up stock prices.
Key German cities have not been particularly good at managing the supply of new housing.
In the face of widespread disaster, Germany has been holding up well. The DAX fell back to 2014 levels, but proportionally it was much less affected than other markets, since Germany is still seen as a haven for safety rather than outperformance.
German residential real estate is doing quite well and delivering stable returns on solid fundamentals, with annual increases of 5-10 percent even during these crisis years.
Why is this the case? Is this growth also based on speculation?
Real estate is often strongly correlated to a country’s wealth creation and to influxes of capital. Germany is experiencing both. Predictions that its export-led economy could suffer under this year’s slow-down, especially in China, have proven to be unfounded. Only a small part of the Chinese population is invested and therefore affected by its stock market losses. In fact, Chinese consumers keep spending and want German products.
The German residential real estate sector is particularly resilient because of two factors: low supply of new product and strong immigration.
Key German cities have not been particularly good at managing the supply of new housing: Munich and Hamburg have very little new accommodation on the market, and Berlin, which has plenty of available land for construction, is experiencing a poorly managed surge in construction, mostly unaided by the authorities.
Germany suffers from a structural lack of accommodation due to the low construction levels of the last decade. Construction was held back by low real estate prices. Why build a new building when you can buy an existing one at half the cost?
One can still buy a residential building at or below €2,000/sqm in Berlin, the German capital, where prices are finally growing fast but rent still represents around 20-30 percent of disposable income, roughly half of what tenants in other major European cities are paying for rent.
German real estate is still eminently affordable. As rents have started increasing and Germans and foreign investors started buying more apartments, apartment prices have also increased and with it, developer’s interest in new projects. The pace has only just started to pick up though.
Germany has also become the second-most popular migration destination after the United States. In 2013, Germany experienced a net immigration of approximately 430,000 people. Last year, before the refugee crisis broke out, this number grew to 550,000 people, of which Berlin took in more than 45,000, or 1.3 percent of its population.
In 2015 Germany is expected to welcome at least 1 million refugees, on top of its ‘normal’ immigration, and the number could well end up being higher amid confusing asylum laws and constant pressure on its borders. Refugees also end up living in Germany for a long period of time before they are processed, and accepted or rejected for asylum.
We have all the ingredients for an emerging housing crisis: If you couple the slow pace of new construction with a strong net immigration and a generous asylum policy, Germany is likely to face a serious accommodation crunch over the next five to seven years as the construction industry struggles to catch-up with the shortages.
Building houses takes time, especially in Germany, with its strict construction laws and environmental restrictions, which make it expensive. As a result, supply cannot change overnight. While Germany does not lack high-end residential space, which has been the focus of building over the last decade, it certainly has a chronic shortage of low- to medium-end accommodation.
What really needs changing is the policy approach to development. Local government in Berlin for example, instead of focusing on dealing seriously with the accommodation shortage, is more interested in making headlines about ‘protecting’ tenants against rent increases. The German government sold hundreds of thousands of apartments to investors in Berlin over the last decade and is busy trying to put rent controls in place to placate angry tenants. Does this actually help to boost the housing supply and address the problem? Or does this only help local politicians get re-elected?
Germany needs a serious, nationwide policy to encourage construction of low- and middle-income housing, which is left to the private sector – which is at the whims of local politicians more influenced by neighborhood protests than by housing shortages.
Admittedly, an emergency law facilitating building permits for housing asylum seekers has just been passed, but this in itself won’t solve the housing crisis.
The high minimum wage of €8.50 per hour recently set by the government could also be a problem since it will make it harder for unskilled immigrants to find jobs. The current and projected housing shortage will, in turn, make it difficult to accommodate them.
If Germany wants to host millions of new citizens without turning into a large campsite, it may need to relax its labor and housing policies to make it easier to hire people and accommodate them.
A nation with negative population growth and tight environmental and social protection laws has opted, probably correctly, to open its borders to address a long-term shortage of young and productive citizens.
But what was a politically astute move could backfire unless Germany quickly relaxes some of its restrictions to avoid a crisis that increases social tensions.
If I look at this dynamic from an investment point of view, I see a good opportunity: Emerging markets are struggling, and there is a flight to safety that will refocus investor’s attention on Germany.
Germany is still the richest country in Europe and is suffering from a housing shortage and just opened its doors to hundreds of thousands of people. This will result in a widening of the supply-demand gap for housing.
Foreign investors should be seen as a source of much needed funds to finance the construction of more housing. If the government plays its cards right, it could get a lot of help from foreign investors, who should be very interested in Germany because the value of its existing accommodation stock is rising and coming under pressure as governments begin to create incentives for building more housing.
The German government has a choice: It can either make it easier and attractive for investors to finance construction, or it will need to do so itself. Whatever course it chooses, it will need to do so quickly because the need is acute.
That U.S. bank manager today probably regrets he didn’t invest in Germany after all.
To contact the author: firstname.lastname@example.org