German Housing Market — State of Irrational Enthusiasm?

The topic of a possible property bubble in Germany has been very popular for almost a decade. The prices in the biggest urban regions keep growing at an unsustainable rate for the long-term residents.

The ongoing debate made me reconsider publishing some of my research on this topic. The results, though not the most actual, are still of great importance. They show that not much has changed in the market dynamics over the past two years.

This is the conclusion of my Bachelor Thesis (2017) at the OTH Regensburg.

“This thesis studied the recent and relevant to the German housing market reports, publications and analyses, as well as the publicly available data to find missing or disregarded indicators for an unsustainable housing price development.

Housing prices in Germany have surged since 2010. The growth can neither be explained by the development of rents, nor by the income growth which has been moderate. Major cities and towns experience the strongest price disengagement from the two factors. Housing is becoming less affordable and buyers accept longer lasting commitments to pay the house prices. Because prices are no more justified by the current levels of rents and income, expected capital gains from property appreciation seem to be the main price driver, along with expected rent growths — two rather speculative motives. These expectations are based on a sustained and high demand.

Unlike in other countries where credit has fuelled the bubble episodes, German lending practices have been sound in recent years. High requirements for liquidity of up to 30 percent at the time of purchase, of which 20 percent are the minimal down payment, create high barriers and transaction costs. In the recent quarters, some banks have reported that the lending criteria have been lowered and more banks expect this to happen in the short-term. This would constitute to a stronger bubble formation. Also, certain levels of risk arise from a possible interest rate increase by the ECB.

The reduced affordability can be observed in the lower rate of homeownership. More people decide to rent rather than to buy, even though mortgage liabilities of an average household have decreased. If the interest rate payments as a share of the disposable income are much lower than in 2003, an expected result would be more people buying homes. But since the homeownership rate declines it may be a sign for an unsustainable price growth.

Based on a web search query analysis, it could be established that the general interest to buy, sell, and rent out has grown significantly. Using this as a proxy, it may be inferred that the transaction volume in the housing market increases. Unfortunately, there is no recent official and real data on transactions available to be entirely sure of the trend. Establishing a data source for transactions would be helpful for regulators to monitor the market closer in the future.

The construction, though low if viewed historically, has picked up since around 2009; completions increased by over 70 percent and permits have more than doubled in the same time. Calls for a drastic increase in construction activity must be considered very carefully. The lag between permits and completions can be anywhere between one and four years, as seen historically. Hence, developers and investors must be careful to not overestimate and overshoot the future demand.

The predicted urbanisation and net migration add to the demand in urban areas. Some of the demand may be explained by the historically low interest rates on government bonds, and the investors who seek a more secure investment opportunities than the equity market but still expect reasonable returns. Foreign investment fuels the prices as well. It must be noted that German home price development lags behind the economic growth. Thus, it can be stated that the current price development is partially the result of the economic growth of the previous years, and because the German economy is in a good shape and expected to grow at least in the mid-term there is a high chance of the price dynamics to continue for quite some time. Additionally, the Euro as a single currency for the Eurozone facilitates foreign investment and Germany has only limited capacity to counteract this trend.

My findings suggest that the price growth in the German housing market is mainly based on the optimistic expectations about the future. Although my conclusion is that there are already reasons to believe that a housing bubble is building up in Germany at the moment, my results do not establish definite evidence. The compiled evidence neither suggests that the prices are near climax, nor that a strong price correction may not occur. An unforeseen negative shock to the economy my trigger such a reaction.

It seems that the indicators support the general sentiment of a new era in German housing market — a phase of a new higher price levels with room for growth — leaving the historical patterns behind. As Schiller has pointed out, this is the exact thinking that facilitates irrational behaviour of market participants, and that we must be wary of. A more quantitative approach would help identifying the scope of the phenomenon.

This thesis highlights the necessity of an ongoing and real-time multi-factor quantitative analysis of the German housing market. Unfortunately, this market is under-researched and data availability is limited. Interesting for future research would be examining the scope and effects of foreign capital inflows into the German housing market.”

In retrospective, we see that the German academia underestimated the effects of urbanisation and slow construction. This can be seen as the public outcry for more housing development becomes stronger.

Ich studiere Startups & Innovationsmanagement. Dabei fallen mir Sachen auf, die ich gerne mit der Welt teilen möchte. <digital generalist & european citizen>

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