The German housing market in the low-interest-rate environment
Guest contribution in "Immobilien & Finanzierung" published January 2014.
Prices for new apartments in German large towns and cities rose by 25% between 2009 and 2012. In addition to the favourable economic situation, this development undoubtedly owes much to the, at present, very low interest rates, which make an investment in residential property appear more attractive than other asset classes. Moreover, buyers who are primarily seeking a home for self-use have been taking advantage of the cheap financing available.
Given the above, rising prices are first an indication that market forces are responding to growing demand in many regions. Property purchase prices and rents signal that residential properties are in short supply and provide incentives to increase the supply. However, we have learned from other countries that housing markets are fundamentally susceptible to exaggerations – particularly in an environment of low interest rates.
Our analysis does not at present suggest that this development in prices poses a threat to financial stability. But on the other hand, the current constellation must not be permitted to lure banks and households into building up risks which could jeopardise financial stability in the future. This makes it crucial for banks and other lenders to stick to conservative lending standards.
Price trend continues in 2013 – but varies from region to region
Given the different economic and demographic developments in the various regions, towns and cities, it is difficult to speak of a homogeneous German housing market. Thus, the regional pattern of price levels and the increases in prices for residential properties are highly disparate. At the top end of market developments we find newly built condominiums in large towns and cities that are especially attractive for investors. Here, prices soared by just over 25% between 2009 and 2012. Figures available to date for 2013 indicate that prices for new apartments in these large towns and cities have risen by around a further 9% this year.
The rise in prices for new apartments in the 125 medium-sized and large towns and cities between 2009 and 2012 was somewhat weaker, at around 18%. When one considers the development of prices in all administrative districts and urban municipalities, the increase is lower still at 11½%. And finally, taking an even wider perspective to include existing apartments as well as new and existing houses across all administrative districts and urban municipalities, prices are seen to have risen by only 8% between 2009 and 2012. By comparison, general consumer prices in Germany also advanced (by around 5¼%) in the same period. In the meantime, however, there are indications that the housing price increases are spreading from towns and cities to their surrounding areas.
No property bubble, but sub-markets are tense
Taking the market as a whole, prices for residential properties in Germany have probably deviated little from their fundamentally justified value. However, this assessment does not apply to individual sub-markets.
According to Bundesbank estimates, apartments in attractive large towns and cities may be overvalued by as much as 20% in terms of longer-term demographic and economic determinants. In these towns and cities, strong demand coincides with an, in some cases, tense supply situation. This is reflected in the fact that first-time rents are racing ahead of existing rents, which are less sensitive to short-term market dynamics.
There cannot at present be any talk of a property price bubble or a risk to financial stability, however. For that to be the case, a number of different, additional factors would have to coincide. For instance, besides rising prices, banks would also have to expand their lending significantly while at the same time relaxing their lending standards for housing loans. We do not see any developments of this kind in Germany to date: the volume of mortgage loans to retail borrowers has risen relatively steadily, yet only moderately, since 2010 – by around 2% per annum of late. In fact, lending standards have even been tightened again slightly. A major factor in this connection is that the lending standards for residential property loans in Germany are somewhat conservative in structural terms compared with other countries. Yet even if we cannot speak of a property bubble, we cannot rule out that buyers may suffer a loss, particularly in large towns and cities, in the event of a price correction.
Risk factors need to be monitored throughout the cycle
In order to gain a better grasp of current developments, we can use the different phases of the housing cycle as points of reference. The present upturn in the German housing marketwas preceded by a period of stagnation lasting one and a half decades. Nevertheless, risks may arise if price increases persist. Given the prolonged duration of housing cycles, the danger of self-sustaining processes and the dogged persistence of unhealthy developments once they have occurred, it is crucial that we keep a close eye on potential risk factors.
For instance, rising property prices and low interest rates must not be allowed to result in mortgages being granted with lower deposits. To prevent the risk of borrowers facing a greater financial burden when they roll over their mortgages, an adequate maturity and an appropriate repayment instalment need to be agreed for the first loan. In addition, the attractiveness of housing investments compared with other asset classes ought to be assessed on the basis of average ratios to be expected in the long term, not on the merits of the current special situation. A danger no doubt exists that the low interest rates might encourage investments which would not be made under normal circumstances. Once the interest rate level has returned to normal, over-optimistic yield calculations could quickly be put into perspective. Particularly the overvaluations that have been seen, to an extent, in large towns and cities as well as the downward trend in rental yields make investments susceptible to adverse changes in interest rates and prices.
With regard to safeguarding financial stability, it is crucial that we keep very close tabs on the situation to allow an early and appropriate response to destabilising developments. Besides developments in lending, useful indicators that a riskier market phase is looming are property valuation benchmarks such as the ratio of prices to rents or of prices to income. German banks are currently being asked to provide information which will offer even deeper insight into the financing of residential properties.
Judging by how the various indicators have developed up to now, the German housing market so far shows no signs of dynamics that could jeopardise stability. Above all, we are a long way from the credit-driven real estate booms seen in Ireland and Spain before the onset of the debt crisis. And finally, the ratio of household debt to disposable income in Germany has declined steadily in recent years, which points to improved debt sustainabilityon the whole.
Financial stability in relation to housing policy
A distinction has to be made between the financial stability perspective we are considering here and questions of general housing policy. Financial stability focuses squarely on the prevention of systemic risks. Traditionally, the remit of housing policy, on the other hand, is to ensure affordable housing, to ensure favourable supply and demand conditions and to promote home ownership. A clear division must therefore be maintained between the two.
Nevertheless, housing policy frameworks can play a part in the emergence of financial stability risks. For instance, in some countries the assumption by government entities of risks stemming from mortgage loans encouraged moral hazard. For this reason, finding a balance between aspects of financial stability and housing policy objectives is likely to be key to the German housing market developing healthily.
Outlook: market participants must take responsibility
Without doubt, the German housing market is in a phase of dynamic development, yet, it would be wrong to speak of a property price bubble or a risk to financial stability. Nonetheless, we recommend investors and banks take responsibility for how they handle the current special situation of low interest rates. For us at the Bundesbank, it is important that we maintain an awareness of the special features of the current situation and of the risks that could arise. We can learn from the experience of other countries. As far as financial stability is concerned, the notion that "this time, it's different" remains a fallacy most dangerous.
- These so-called grade A towns and cities include Berlin, Cologne, Düsseldorf, Frankfurt am Main, Hamburg, Munich and Stuttgart.
- See Deutsche Bundesbank (2013), The determinants and regional dependencies of house price increases since 2010, Monthly Report, October 2013, pp 13-29.
- See also Deutsche Bundesbank (2013), Housing market continues to grow dynamically, Financial Stability Review, November 2013, pp 63-68.
- See Deutsche Bundesbank (2013), Macroprudential oversight in Germany – framework, institutions and tools, Monthly Report, April 2013, pp 39-54.
- Supplemented by model-based assessment approaches.
- See Eekhoff, Johann (1993), Wohnungspolitik, Tübingen.