The European Central Bank in Frankfurt am Main
For the first time since July 2022 the European Central Bank at its most recent sitting did NOT raise its key interest rate, which will now remain unchanged at 4.5%. The deposit rate, which banks receive for parked funds, remains at 4.0%, the highest level since the establishment of the monetary union in 1999. The decision to leave rates unchanged after ten successive rate increases did not come as a surprise and had been widely expected in many quarters, particularly in the light of recent lower inflation rates in the Eurozone and increasing turbulence on the capital markets. Many observers now expect borrowing rates to close in on the 5% mark, particularly for long-term financing with high loan-to-value ratios, after having crept up from 4.0% to their current 4.5% over the past six months.
Building interest rates themselves are at a 12-year high in Germany, as data from the consumer platform Biallo show, which closely tracks bank lending activities. Despite the fact that current rates are not particularly high by historic standards, the speed at which both building costs and interest rates have risen over the past eighteen months has had disastrous consequences for the German real estate industry.
As we report throughout this issue of REFIRE, almost no segment of the industry has remained untouched from these developments. With commercial property prices - particularly offices - still in freefall, and developer insolvencies being announced on almost a weekly basis, there is plenty of scope for things to get even worse from here.
Within the ECB, several of the bank's more hawkish rate-setters are still thought to be eyeing a further rate rise in December, despite the more conciliatory tones surrounding the latest non-increase on October 26th. While consumer price inflation has been falling, wage growth has been surging across the eurozone, with Dutch unions having hammered out a deal for pay increase of at least 10% for their members. Inflation in the services sector of the eurozone, which includes labour, was 5.5% in August. The ECB forecasts certainly don't envisage consumer price growth falling to anywhere close to its 2% target any time before end-2025. There are of course many uncertainties that could easily put that projection in jeopardy. The message "Higher for Longer" is being sent out loud and clear from the ECB.
The good news is that there appears to be some consensus building among market players that in the residential sector, at least, we may be approaching something like a bottom-building, after falls of up to 20% for sellers looking to exit, compared to prices prevailing early last year. The latest figures from the Federal Statistics Office put the fall in house prices at 9.9% at the end of the second quarter versus the same period last year. This certainly does seem credible to us at REFIRE, although the market is so differentiated that generalising is difficult - with the factor of future energetic refurbishment liabilities playing an increasingly important role.
In REFIRE's view, demand for housing is so strong in Germany that a housing collapse much beyond current price levels is improbable, although there will certainly be regions and urban markets that could continue their downward trend. With big developers pulling back from building projects, it's becoming increasingly clear how the building shortfall looms over the markets, with hundreds of thousands of dwellings definitely not going to be there over the coming years to help plug the supply gap.
Felix Pakleppa, CEO, Central Association for the German Construction Industry (ZDB)
The latest official data shows that new orders in residential construction throughout Germany fell by 3.3% in nominal terms and 6.5% in real terms in August compared to the same month last year. Construction orders overall rose in August by 10.8% but this was almost exclusively due to civil engineering, municipal public transport and energy infrastructure orders. Felix Pakleppa, CEO of the Central Association for the German Construction Industry (ZDB), urged the government to immediately set about implementing the 14 key points agreed at their latest summit at end-September to fire up new housing construction, otherwise the sector faces imminent collapse.
The overall sentiment in the residential construction sector has also officially reached a record low, as measured by the business climate index of the Munich-based Ifo-Institute. In September, the index for the residential construction sector was at its lowest level since the survey began in 1991, at minus 54.8 points. The number of companies in the sector complaining about a lack of orders has tripled in the past twelve months and stood at 46.6% in September. 21.4% of firms reported cancelled construction projects.
In their analysis, the Ifo researchers say the mixture of constantly rising order cancellation figures, soaring financing costs and ever-new geopolitical risks give little hope for an end to the crisis in construction in the near future. It remains to be seen whether the bottom has yet been reached, they gloomily conclude. Ifo's head of surveys Klaus Wohlrabe commented that even if politics could provide some form of impulse with various aid packages, even that would not compensate for the negative headwinds the industry is facing.
ifo
Dr. Klaus Wohlrabe, Head of Surveys, ifo Institute
Wohlrabe said it was not at all clear whether housebuilders would be able to survive the current crisis. So far waves of layoffs have been avoided, but with more insolvencies threatening, capacities would inevitably be reduced. These workers would be lacking when things did pick up again, he said, leading to further shortalls of skilled labour.
Certainly the mood at the recent Expo Real trade fair in Munich reflected the pessimism, with several prominent commentators suggesting that "half of all project developers were heading for bankruptcy". Many people REFIRE talked to referred to the decisions by big firms like Vonovia and LEG Immobilien to definitively cancel any immediate development plans for this year (and probably next), given that it makes no economic sense in the current interest rate climate, and with the current level of building material prices.
Building permits
The Federal Statistics Office has also recorded a hefty decline in the issuance of residential building permits, another key signal that augurs badly for future development activity.
From January to August 2023, 28.3% fewer dwellings were approved than in the same period last year. Building permits also slumped for single-family houses (-37.7%), two-family houses (-52.5%) and multi-family houses (-28%). Rising construction costs and poor financing conditions are making ever more building projects unprofitable in their originally-planned form.
And of course, just because the authorities have approved the construction of an apartment does not mean that it will actually be built. It is likely that at best 200,000 new apartment units will be completed in the current year - barely half of what the ruling government coalition has targeted. On current projections, there could well be a shortage of close on a million apartments by 2025 - with the potential for all sorts of civic unrest.
