Building costs, inflation, refugees help underpin residential market stability

The Europace House Price Index, an index we track closely here at REFIRE as it follows actual prices achieved in the market rather than advertised or wished-for prices, has flagged a downturn in the price trend for new-build housing in its July reading, the first time this has occurred since it started collecting data for its monthly index in 2005.

The Index shows prices for new condominiums (private apartments) fell by 0.86% to 228.65 index points in July. Over the past twelve months, prices had still put on growth of 7.93%. Prices for existing properties (Bestandsimmobilien) fell the most in July, falling by 0.69%, second only to condominiums. The gain over the past twelve months was still 8.03% for prices of existing houses. The overall Europace index decreased by 0.60% compared to the previous month, In contrast to a 9.19% price rise last year.

Another index which we track here at REFIRE is the Aengevelt AWI Residential Index, which takes the measure of the market mood for residential property twice a year. Its current summer reading reflects worsening market sentiment. After the low in the Corona summer of 2020 (index value 49.2 points), the AWI Index had risen strongly again in the winter survey of 2021/2022 to 74.1 points. This was followed by another sharp drop of 18.1 points to 56 points in the current 2022 summer survey.

The poorer outlook affects residential across the board. In so-called 'good' locations, the AWI dropped by 18.8 points to currently 58 (winter 2021/2022: 76.8). 'Mid-range' locations saw the biggest drop, down 20.9 points to 57.1 (winter 2021/2022: 78), while 'basic' locations, i.e. simple housing, saw the lowest current score, down 13.6 points to 53.7 (winter 2021/2022: 67.3).

Another index which REFIRE tracks closely is the VdP-Immobilienpreisindex, which stems from the research department of the Verband deutscher Pfandbriefbanken (Association of Pfandbrief-issuing Banks), and is likewise based on prices from actual concluded transactions. Small differences in its results from the Europace Index are to be expected because of the wider pool of financing sources that Europace taps into for its statistics. Still, the VdP index is based on a quarterly evaluation of real estate transaction data from more than 700 credit institutions carried out by VdP Research.

The VdP Index sees property prices across Germany having risen by 8.4% year-on-year compared with Q2 in 2021, pushing the index to a new high of 194.8 points (base year 2010 - 100 points).

The strongest growth was again recorded by residential properties, which rose in price by 10.1% across Germany. Prices for commercial properties rose by 1.9% compared to the same quarter of the previous year. Office property prices were responsible for the increase there, rising by 4.1% in the same period. For retail property prices, the negative trend continued with a minus of 3.5% compared to the same period last year.

However, as VdP CEO Jens Tolckmitt said: "In the second quarter of this year, the real estate market in Germany again proved robust and continued to show price increases, some of them significant, compared to the previous year. This applies to both the residential and the office property market. However, it is to be expected that the negative economic factors, such as the subdued growth prospects, inflation or the noticeable rise in interest rates, will also be reflected in the index results with a time lag." In other words, the bad news lies ahead.

Looking ahead, Tolckmitt expects prices to weaken. However, with demand for residential property in particular continuing to outstrip supply, a collapse in prices is unlikely. The orientation of prices in future is likely to revert to a healthier relationship with the level of achievable rents, rather than as a function of the extremely favourable financing conditions which pertained over the last several years.

While the market is bracing itself for a slowdown or even a reversal of prices, certainly in some regions, Deutsche Bank Research, which issued a gloomy prognosis for the housing market only a few months ago, recently produced a new analysis in which it partly retreats from its confident earlier prediction of the end of the real estate boom in Germany.

Recognising that there has been a "shock of uncertainty in the real estate sector", real estate analyst Jochen Möbert of Deutsche Bank Research now prefers to view the current market as "more of a breather than the definitive end of the price cycle." He justifies this by pointing to the huge cost increases in construction, up at least 17% year-on-year, and the scrapping of the KfW energy subsidies by the government at the beginning of the year - all of which has led to an abrupt decline in building activity, reducing supply, and potentially driving up prices.

Deutsche Bank has also markedly revised its forecast upwards of the number of expected refugees from Ukraine, from the initial assumption of around a million to an estimated influx now in 2022 and 2023 of up to 1.6 million. Immigration from other countries is likely, too, to be higher than expected. "This influx massively exacerbates the housing shortage, and we now calculate the fundamental supply shortage will now not be reduced before 2025, and not in 2023, as we had previously projected," said the bank.

Another factor the bank is reconsidering is inflation. If inflation remains structurally high, which there are good reason to assume might be the case for a while, then the burden on existing borrowers tends to fall, assuming their incomes rise in line with inflation. This compensation for inflation, either through rising wages or higher achievable rents, can realistically lead sellers to push through higher resale prices, particularly where housing shortages persist. So even if there were a temporary dip in prices, the bank researchers say, the sharp housing shortage and still negative real interest rates should act to push prices back up again.