Study on German house price inflation – Capital Economics

A recent report from Capital Economics asks, "Should we be concerned about German house prices" – an issue that has been occupying a lot of minds since the market started rising ten years ago, and has hardly paused for breath since.

The report addresses all the issues that keep us awake here at REFIRE in assessing the state of the residential and commercial property markets in Germany. It concludes that the strength of German house price inflation is largely a response to increased urbanisation and a shift towards home ownership in the country, and with mortgage lending growth remaining moderate, it sees little risk to the Germany economy.

The Capital Economics researchers point to the Bundesbank's recent argument that German house prices are overvalued by 15% to 30%, but say that the Bundesbank's house price model based on previous relationships with macroeconomic fundamentals and the determinants of demand for housing – whether buying or renting – may have changed.

The Bundesbank's data show a rise in rents of just 8% between 2010 and 2016, compared to 26% for house prices. However, these data on rents relate to all existing rents, and a more valid comparison is between house prices and the growth in new rents. According to market researcher BulwinGesa, from 2010 to 2016 these new rents rose by 29% - a much more meaningful figure.

In any event, whichever way rents are judged, the relative rise in house prices to rents pales in comparison to the increases seen in other countries ahead of house price crashes. In Spain, for example, house prices doubled compared to rents between 2000 and 2007.

Another strong argument is that German house price inflation is not being accompanied by a rapid build-up of debt. In fact, house price inflation has outpaced mortgage lending growth since 2010, with household debt actually falling relative to GDP as a result of strong economic growth in the period. There is also little sign of a sharp supply response that might hit prices. While Germany publishes few figures on actual housing starts or completions (as against the number of new permits issued), the national accounts do show that residential construction investment is still fairly low at 5.9% of GDP, compared to 7% in the early 2000's.

One explanation for strong German house price inflation is the increase in concentration of the population in the bigger cities. The latest data show that the populations of the four largest cities rose by an average of 4.5% from 2010 to 2015, compared to 2.5% for Germany as a whole. Hence the greater demand for housing in the main cities, where regulations limit building and construction costs are high.

Additionally, Germans are slowly but surely favouring home ownership over renting. Record low interest rates mean it's often cheaper to buy than to rent, while lowering the opportunity cost of keeping savings in bank accounts. And by using existing savings to buy property, it helps to explain why house price inflation is outpacing credit growth.