German house prices ‘decoupling’ from rental levels, says DIW

Economists in Germany have been quick to justify the rising level of German residential prices across the nation over the past two years, citing catch-up effects, safe haven status, low interest rates, and rural urban demographic shifts to underpin the fundamental causes of the upward movement in prices. Now, however, the German Institute of Economic Research (DIW Deutsche Institut für Wirtschaftsforschung) has issued a nervous study suggesting that rental levels and purchase prices were drifting dangerously apart from each other, which could soon bring residential property prices into bubble territory.

The DIW study highlights how particularly in Berlin, Hamburg, Munich and Dresden the price differential between buying and renting has soared, so that buyers are now paying about 25 years worth of rent to buy a property, as against a more traditional 19 years. The study uses data for 25 cities from leading online real estate portal Immobiliensocut24

At the heart of the problem, say the DIW researchers, is the expansionary monetary policy of the European Central Bank. Low interest rates and a fearful economic climate are leading investors to put their money into tangible assets, such as bricks and mortar. Large internal migration into the larger cities since the year 2008 has lead to a diminishing supply of available property which is pushing up prices.

The DIW study points out that apartment prices have now risen by 6.5% annually over the past five years, while rents have risen on average by only 1.8%. However, in many cities, such as Berlin, Frankfurt, Augsburg, Hamburg, Munich and Nuremberg apartment prices have risen by more than 10%, while in less dynamic regions such as the Ruhr valley prices have barely moved. In the former cities, prices are expected to rise again this year by a further 10%.

Between 2007 and 2010 rents were rising faster than prices, but since 2010 the trend has been reversed with prices now soaring past rent increases, says the DIW study.

The Bad Homburg-based rating agency Feri has also issued a similar cautioning study recently, carried out amongst professional investors. These institutionals are also betting that the residential sector is the segment most likely to show further price appreciation over the coming years. 38% of those surveyed expect prices in the sector to rise further over the next three years, while on 16% expect retail real estate to rise, and less than 10% expect the same for office properties. Of those surveyed by Feri 26% plan to increase their exposure to residential.

Feri stop short of calling the market a bubble – so far.  “Local excessive price rises are always possible and can turn into yield traps”, they say in their study, citing the already very high entry prices in large cities such as Munich, Düsseldorf or Hamburg which are not yet matched by parallel rent increases. Rents would have to rise at levels that may be hard to achieve for the overall investment to be profitable, they warn. They also warn of excessive exuberance in university towns such as Munster, Oldenburg, Freiburg or Darmstadt, which have seen house prices rising at rates that will be hard to justify from student-affordable rents.

Meanwhile, down the road in Frankfurt, the conservative guardian of Germany’s sound money policies – the Bundesbank – is sounding increasingly shrill in its statements on Germany’s housing market. While remaining sanguine about fundamental factors, such as growing numbers of households despite declining population, and rationed building space in the cities, the Bundesbank is increasingly pointing to the wide discrepancy between the cities and more rural areas. There they see the danger of investor-led factors driving up prices, in addition to normal consumer demand, at rates that are faster than the ability of rents to increase.

However, even here the cautious Bundesbankers are so far just warning of their concern at the possible emergence of a house price bubble, and hinting at their readiness to intervene should the situation accelerate – possibly by setting higher equity requirements or tightening credit approval standards where necessary, it said.

Presenting its Financial Stability Report 2012 recently, in which - unusually - the bank devotes a complete separate chapter to its concerns about the German housing market, Andreas Dombret, a member of the bank’s executive board, warned that “The experiences of other countries show that precisely such an environment of low interest rates and high liquidity can encourage exaggerations on the real estate markets. This could clearly happen in the larger German cities, which would seriously endanger the financial stability of the country.”

The level of credit financing is still the key focus of the Bundesbank’s attention, which it says remained moderate at a growth rate of 1.2% last year, although it does see rising demand for housing credit, and with it, increasing risk.

In a recent research note, Helaba in Frankfurt’s Stefan Mitropoulos pinpointed Germans’ aversion to inflation, currently poor investment alternatives and the historically low financing interest rates as “the ingredients for a flight on the part of German investors into ‘concrete gold.’”

He too justifies the house price rises on the basis of low supply and high demand in the cities, adding the proviso, “the main risk is not that prices are too high but that they are going to continue to rise. As a result, if the robust increase in prices for German residential real estate continues, an overheating in certain markets cannot be ruled out over the medium term.”

The big danger is that economic recovery in Germany and the rest of Europe could herald the return to much higher interest rates. “Many households currently taking advantage of 3& interest rates to take out large loans on housing property could have trouble refinancing in ten or fifteen years once the interest rate level has normalised”, he said, in reference to the 7.7% rates seen during the post-reunification property boom in the 1990s.  “It took the industry a decade to recover from that,” he said.