Germany’s looming recession is hitting eastern cities hardest
By Sara Seddon Kilbinger, Senior Reporter, REFIRE
As Germany’s economic crisis deepens, the risk of tenants defaulting on their rent is rising, particularly in eastern German cities, according to a recent PREA study: "Germany in the stress test".
The study examines the resilience of housing markets against the backdrop of an emerging recession and how energy prices affect the rental income in specific districts. The question that landlords, investors and project developers are increasingly asking is: just how high is my rental default risk?
‘Around 29% of people in Germany have a monthly income after tax of €1,500 or less,’ Dr. Martin Kern, a senior data analyst at the PREA Group in Berlin, told REFIRE. ‘In eastern Germany, that’s even more – around one third of people earn €1,500 or less a month. These households just don’t have a huge buffer to spend €1,000 on energy costs. With German rental markets, the energy bill is typically sent from around April. People know that their energy bills have risen but they have no idea by how much, so they could still be facing a big energy bill, even if they cut down on heating during the winter. The risk now is that they won’t be able to pay their energy bill to their landlord.’
His colleague Yuri Ostashov, chief data scientist and partner at PREA agrees: ‘The increase in consumer prices hit people in Germany with varying degrees of severity. Households at the lower end of the income scale have, on average, a higher risk of rent default because they spend a higher share of their income on essential goods that can only be substituted to a certain extent.’
PREA has conducted a multi-dimensional study of the macroeconomic influences on rental income for all districts across Germany, focusing on the rent-relevant effects of the increased energy costs for households and industry. One thing is clear: poorer households, which tend not to have a financial buffer, are being hit the hardest because energy comprises a significant share of utility costs. The higher the share of low-income households per district, the smaller the buffer to bear the high utility costs, according to the study.
Berlin is Top 7 city at highest risk of default
Large cities in eastern Germany are particularly affected by very high rent default risks. This is due, among other things, to the larger rental market and the share of low-income households. Of the top 7 cities, Berlin is the only city with a very high risk of rent default. According to the study, the highest rental default risk is in Chemnitz, Leipzig and Rostock. Elsewhere, Düsseldorf, Cologne, Munich and Stuttgart have a moderate risk.
‘At the beginning of Russia’s war with Ukraine, energy prices surged, leading to high inflation rates in Germany, everything has become more expensive,’ Kern said. Germany’s inflation stood at 8.7% last month, according to the Federal Statistical Office, well above the ECB’s target of around 2%. The prices of energy products advanced sharply, especially for natural gas (46.6%), electricity (23.1%), and heating oil (16.1%). The CPI, harmonized to compared with other European countries, climbed 9.3% on the year, the fifth-highest level on record, and gained 1% month-on-month. ‘Supply chains have become broken, resulting in higher energy and food prices,’ Kern added.
Interestingly, regional temperatures and building fabric also play a role. In terms of heat consumption, above-average values have been recorded in eastern Bavaria and in the Volcanic Eifel (> 20,500 kWh), while large cities on the Rhine such as Freiburg im Breisgau (8,800 kWh), Düsseldorf (9,200 kWh) and Mannheim (9,400 kWh) have significantly lower heat consumption per household. The reasons for this are the higher average temperatures there as well as newer building stock and the denser urban development.
‘All three indicators are important for assessing in which districts and independent cities landlords are exposed to a higher or lower risk of having to forego part of their rental income,’ warned Ostaschov. ‘For this reason, we linked the three indicators multiplicatively and standardised them with the Germany-wide average.’ A value above 100 highlights an above-average letting risk across Germany.
What does this mean for landlords and tenants? Ultimately, Kern feels that the government will have to step in if there’s a spike in tenants this year who are unable to pay their energy bills: ‘It’s a bit harder in Germany to evict people. I would expect the government to step in to some extent and put a ban on evictions,’ he said. ‘Like in the pandemic, people were given more time to pay their rent debt. There will probably be some kind of government protection but, at the moment, there’s a lot of uncertainty for landlords.’
It’s not just rental losses that are worrying but also how increased energy costs could put a dampener on many regions and sectors across the country. Chemical and metal industries, coking and petroleum refining, and the manufacture of glass, ceramics, paper and cardboard are particularly affected, according to Ostaschov: ‘There are few options for these industries to continue saving energy: Either they will have to close individual plants or production lines or relocate part of their production abroad. Moreover, the situation will not improve in the medium term either. The energy price will remain above the pre-war level due to the increasing demand for LNG imports.’
Kern agrees: ‘This energy crisis is posing a threat to areas where there are energy intensive companies,’ he said. ‘It’s important to differentiate between global companies that have the funds to go somewhere else and medium sized companies that can’t resettle anywhere else. Even if they could, where would they go? The energy crisis is affecting the whole of Europe. The obvious choice would be the U.S. but you don’t resettle there if you don’t have business there.’
Multinationals targeting eastern Germany
Are we seeing a case of two stories unfolding in the region? U.S. companies are rolling out big expansion plans there. Tesla is building a 492,000 square metre Gigafactory Berlin-Brandenburg, marking its first production facility in Europe, representing more than €1 billion investment Tesla spokesperson Kathrin Schira says the 492,000-square-meter Gigafactory will be the ‘most advanced mass production facility for electric cars in the world’, capable of turning out 500,000 cars per year – mostly Tesla’s Model Y SUV to start with. As the facility nears completion, local officials hope it will create the foundation for a larger boom. Karl-Heinz Paqué, head of the liberal Naumann Foundation and former finance minister of Saxony-Anhalt has publicly said that ‘Tesla, Intel and Co. will be ‘the economic breakthrough for eastern Germany’, with German Chancellor Olaf Scholz (SPD) calling eastern Germany ‘one of the most attractive economic regions in Europe’.
Ultimately, research and training locations need to be strengthened, according to the PREA study. Take the example of Intel Corp: The U.S. multinational corporation and technology company announced last year that it will build a semiconductor plant in Magdeburg as part of an investment of up to €80 billion in Europe over the next decade. The initial outlay for the facility in Magdeburg, the capital of Saxony-Anhalt, is €17 billion. Production is due to commence at what Intel is calling “Silicon Junction” in 2027.
The federal government is supporting Intel's relocation with a subsidy of around €2.7 billion last year and Intel will receive a total of €6.8 billion from the federal government and the EU for its mega-factory to cover around 40% of the expected total costs. Subsidies obviously benefit the subsidised companies but to what extent the surrounding region will benefit – other than an increase in jobs – remains to be seen.
The industry association Silicon Saxony estimates that in Saxony alone about 100,000 workers will be needed in the microelectronics and communications industry in 2030 - 30,000 more than today. At the same time, around 5,000 industry specialists will retire by then. One head-hunter likens it to the Bundesliga: "The top talents change frequently".
Nonetheless, productivity has a corrective effect, leading to higher margins and thus a higher buffer to compensate for higher costs. Accordingly, the PREA study argues that in states with more productive companies, structural changes are less likely than in counties where productivity is rather low. As a result, PREA lists a comparatively low risk of recession for the independent automobile cities of Wolfsburg and Ingolstadt. The federal state of Rhineland-Palatinate is particularly hard hit by the energy crisis. In more than half of the districts, there is a high or very high risk of a structural increase in the unemployment rate due to the energy crisis and thus a high risk of vacancies.
Interest rate hikes putting dampener on multi-family yields
Inflation and interest rate hikes are putting a sizeable strain on the housing sector, according to the PREA study. In recent years, holding on to existing properties promised secure returns and attractive potential for value appreciation. However, following the hike in interest rates, the yield gap to bonds has shrunk to the extent that it is even negative compared to U.S. government bonds. ‘With less risk and more market liquidity, American government bonds currently achieve higher yields than residential real estate,’ Ostaschov said. ‘This means that residential real estate is no longer attractive for investors. For them to become interesting again, the yields for residential real estate must rise by about 250 basis points.’ This would be equivalent to a price correction of about 40%.
Project developers and property owners are also feeling the strain. Due to the often significant delay between construction and marketing, the higher exit prices calculated at the start can no longer be achieved, thereby eroding their margins. In addition, interest rate hikes are making it impossible for many people to buy a home. In contrast, owners of existing homes are benefiting. ‘Despite recent considerable devaluations of their real estate portfolios, the rental market in many German cities is likely to remain strained due to the declining supply of new buildings and the failed dreams of home ownership. At the same time, properties with good insulation are likely to be in particularly high demand due to the high energy costs,’ Ostaschov said.
In the short-term, there is no quick fix, Kern warns: ‘Energy prices will stay high in the medium term,’ he said. ‘Infrastructure needs time to adjust. By around 2025/2026, that should be in place, it should be easier to import this gas. There should be enough supply – not to mention an increase in solar energy – and energy prices will come down again. It will take time.’
