Residential prices still rising despite growing fears of "end of cycle"

Despite growing signs of uncertainty and even outright pessimism in Germany's residential housing market, the prices of apartments and houses continues to rise, as shown by new figures for the first quarter from the VdP, the Association of Pfandbrief-issuing banks.

The VdP's own property price index hit a new high of 190.8 points, (base year 2010 = 100 points) with its figures showing that across both residential and commercial property, prices for real estate in Q1 rose 8.8% year-on-year, ahead of last quarter's rate of increase of 8.4%. Residential property prices rose by 10.7%.

In the quarter, commercial real estate prices increased for the second quarter in a row, by 1.8%. This was driven by office prices, up 3.9% in the quarter, while prices for retail properties fell 3.2% over the same period last year.

The VdP's members include nearly all the most important German mortgage finance providers. The index is based on a quarterly evaluation of real estate transaction data from more than 700 credit institutions carried out by VDP. The association's CEO, Jens Tolckmitt, commented: "The real estate market in Germany continues to be on the upswing - even though the pandemic is still not over and Russia's war of aggression on Ukraine has caused a highly disturbing exogenous shock."

Whether this will continue after second- and third-round effects from the Ukraine war kick in,remains to be seen, said Tolckmitt.

At its annual press conference in April, the VdP President, Louis Hagen, forecast further increases in property prices over the coming years, albeit with slowing momentum. Rising interest rate and the associated lower affordability of residential property would act to dampen demand. A weaker economy would also have a negative effect on the commercial propery market, while the residential market would hold up well unless there was a huge increase in unemployment, he said.

The mood among investors for commercial real estate does indeed appear to be darkening by the day, judging by several leading indices. For example, RICS' Commercial Property Sentiment Index for German commercial property slipped into negative territory in the first quarter after still rising marginally in Q4 last year.

RICS Deutschland's CEO, Susanne Eickermann-Riepe, presenting the RICS survey, said: ""While individual countries are seeing significant growth momentum, investor sentiment in Germany is falling,"

According to the RICS survey, Germany continues to be assessed as expensive (55%) and very expensive (28%) as a real estate investment location. This puts Germany in third place after Luxembourg and Austria in the global comparison of countries that consider their location to be expensive. It was followed by Switzerland and Israel.

Among those calling an end to the upward price spiral of German residential are the research analysts at Deutsche Bank, who see a price correction coming in 2024 - but not a crash. They're not expecting to see anything close to a repeat of the market reversals seen elsewhere after 2008.

Jochen Möbert, head of Deutsche Bank Research, said even nominally falling prices in some regions were possible even now. But looking ahead, he said: "We think an end of the cycle is very likely in the course of the decade. The average of our various approaches still results in 2024 as the end of the cycle, despite all the uncertainty."

"After the price peak has been reached, there is not necessarily a threat of a massive correction, although in our base scenario, we do expect to see an isolated end of the cycle", he said.

For the year 2024 to 2026, this would mean a nominal price decline of 2%, although with the now evident higher inflation rates, that price decline could be even smaller. If one assumes a further increase of 7% per year for the years 2022 and 2023, this would mean that despite the correction phase, house prices in 2030 would still be cumulatively 24% higher than in 2021, the researchers calculate.

The Deutsche Bank analysis was largely completed before the Russian invasion of Ukraine, which is likely further to distort the figures and add new elements of demand. And the bank's valuation model implies undervaluation for many cities only in the case of low risk premiums and strong price growth. "The lower influx and dynamically growing new construction in the pandemic years has eliminated the fundamental supply shortage in many cities," the analysts argue. "The current refugee movement due to the war in Ukraine is likely to revive the shortages only briefly."

The real estate industry expects a short-term demand of hundreds of thousands of apartment in Germany for war refugees from Ukraine. An analysis presented recently by the leading lobbying association Zentraler Immobilien-Ausschuss (ZIA), the number of refugees from the war-torn country is likely to be at least 310,000 in the best-case scenario, meaning the need for 120,000 additional apartments.

In its medium-outlook scenario, Germany would have to prepare for about 810,000 refugees and a need for 310,000 apartment units, as calculated by research institute Empirica for the ZIA. In the maximum case, there would be up to 1.29 million people from Ukraine and 500,000 additional apartment units needed.

German apartment prices have been moving up the ranks compared with their European peers over the past few years, further adding to fears - not least by Germany's Bundesbank - of overvaluation by up to 40%, as we've reported previously in REFIRE.

Even still, the Deutsche Bank researchers concede that certain German cities are likely to see the boom continuing for a while yet. "Our projections suggest an end to the fundamental supply shortage in Bremen, Düsseldorf, Hamburg and Nuremberg," said Möbert. Bottlenecks in the major cities of Berlin, Hanover, Cologne, and Stuttgart are likely to persist for some years, while "The cycle in Berlin and Leipzig could last particularly long."

In Munich, too, traditionally Germany's most expensive big city, housing is still in short supply, but the high valuations there are likely to herald the end of the cycle. By contrast, In Heidelberg, the supply surplus could soon turn into shortages again. Still, "Despite these differences, an end of cycle in one metropolis could have a signal effect for all," Möbert warned.