Exaggeration maybe, but no bubble!

September 2017 – For eight years now, the price of residential and commercial real estate has been rising sharply. But the market exaggerations in the major German cities alone is far from being a “bubble”. And even if in some places adjustments will soon need to be made, the panic is overblown. Real estate financiers are much better prepared for setbacks than before the financial crisis.

The national stability watchdog at the Deutsche Bundesbank back in February this year couched their warning in very moderate language. Their colleagues in the international monetary fund, in contrast, were less hesitant the following May. “In the face of a continuing rise in real estate prices, the trends on the market for mortgages need to be observed very closely”, said the economists from the IMF in a study for the Federal Government to take note. In the deliberately restrained jargon of economists, this equated to a very strong warning. The bankers from the German Federal Bank and the guardians of the international finance system are particularly concerned about the sustained rise in prices for residential real estate in the major German cities – and the fact that, in the opinion of the IMF, ever more German nationals would become overindebted due to the dream of owning their own home.

Up, up - and away? Residential and commercial real estate increase in price ...

The vdp index trend since 2008

Up, up - and away? Residential and commercial real estate increase in price ...

Source: vdpResearch

The warning level was “yellow”

Strong increase in price especially in the major cities

“Since 2010, the prices of German residential real estate rose by an average of 30 percent across Germany,” says Dr. Andreas Dombret, member of the board of the German Bundesbank. He is mainly concerned about the situation in the major conurbations. “In the Bundesbank's indicators for the 127 cities, the prices rose by almost 50 percent since 2010; in the seven major cities it was even more than 60 percent.” The warning light for Dombret was therefore “yellow”.

In addition to the residential sector, the office real estate business is also buzzing. According to vdpResearch, the market research company of the Association of German Pfandbrief Banks, the prices for office real estate across Germany in the second quarter of 2017 rose in comparison to the previous year's quarter by another 7.5 percent. In the centers of the seven big cities of Berlin, Düsseldorf, Frankfurt am main, Hamburg, Cologne, Munich and Stuttgart in particular, modern offices are now often a scare commodity.

Little fear of a bubble also for the commercial property market

Market participants, including construction companies, financiers and installers themselves see the situation as far more relaxed than the banker Dombret. There would be no “bubble” bursting on the German residential or commercial real estate market in the next two years, said the overwhelming majority of the around 800 real estate professionals most recently, who are regularly questioned by the economic research institute Cologne Institute for Economic Research (IW Köln) and Immobilienscout 24. “Only around four percent estimate the probability of a crash in the housing market to be high or somewhat high. 90 percent estimate the risks to be somewhat unlikely or very unlikely. A similar picture is emerging for the office market. The greatest risks in the market will be seen in retail space”, Professor Michael Vogtländer, real estate expert of IW Köln, says in summary of the results.

The real estate economy is not expecting a crash?

Question: How likely do you think it is that prices for real estate in the major cities are going to fall in the next two years by at least 20% in each of the market segments?

The real estate economy is not expecting a crash?

Source: Cologne Institute for Economic Research

But isn´t perhaps the person not seeing any danger on the horizon the overoptimistic one? On this point too, a study by IW Köln and Immobilienscout 24 gives the all clear. “A glance at the detailed issues discloses that the companies are in no way too optimistic – which would point towards speculative exaggerations – instead they very well do differentiate. For example, the number of companies which estimates further price rises has clearly gone back. Still in the previous quarter, this were over 70 percent, now it is only just under 52 percent,” explaines Vogtländer.

Increasing incomes, low interest rates

Exaggeration maybe, but no bubble: Neither for credit finance for residential nor for office real estate there is evidence of an unhealthy level. But it is precisely this that is a requirement for a real bubble. “We do not have any expansive foreign finance,” is the evaluation of Professor Tobias Just, real estate expert at the University of Regensburg.

The prerequisites for a real bubble are missing. No unsound extent of external finance

There is good reason for the IMF to question the increased mortgage debt for private households. Income for those in employment has in recent years seen a strong increase. “Unlike in 2008 in the USA or Spain, where major real estate bubbles burst, here we have a very healthy national economy, with rising income and a record level of employment”, says Peter Axmann, head of real estate clients at HSH Nordbank. In addition to this, the low interest rates in the Eurozone are speeding up real estate procurement by Germans.

„While the number of unemployed has dropped by 18 percent since 2009, the number of office staff has increased by a good ten percent.“

Peter Axmann, Head of Real Estate HSH Nordbank

The first-class condition of the German national economy by international comparisons, is also speeding up the commercial real estate market, foremost the office real estate business. “While the number of unemployed has dropped by 18 percent since 2009, the number of office staff has increased by a good ten percent”, reports Axmann.

The real estate market expert Axmann nevertheless is not ignoring many a possibly challenging trend: for instance of dropping returns. “In several German top cities, the top office returns are meanwhile getting close to the three percent. mark. According to Jones Lang LaSalle, in Berlin in the second quarter of 2017, this has even been achieved already”, reports the HSH Nordbank expert. He goes on to say, “If this trend continues, it won't be long before the first transactions can be observed with a two in front of the comma. The extremely low top returns also mean that the signs of excessively high prices on the market are on the increase.”

Vacant properties with virtually nil return

In cyclical markets such as the real estate business, price adjustments are the consequence of excessively high prices. But this would have nothing to do with a bubble bursting, clarifies Axmann. There is one argument in particular which convinces him of the robust condition of the German real estate market, “For a bubble, in addition to the low interest rates which we undoubtedly do have, it would also require new construction past needs. This was certainly the case well over a decade ago in the USA or Spain – but not in Germany today. We have virtually no vacant properties. No speculative buildings are being erected. All of the residential and office buildings which are now being erected in the major German cities are also being let.”

Construction site
Emptied real estate market

The German real estate market is currently simply sold out. “This is also demonstrated by the overall decreasing volumes of transactions which are not in decline because the investors consider the real estate too risky at the current price level. Rather, it is because available properties are becoming more and more scarce”, observes Peter Axmann. Not only the stock of real estate but also the project development market is affected, partly because of a steep rise in land prices.

Booming market

Commercial real estate transactions in Germany 2004 to 2016

Commercial real estate transactions in Germany 2004 to 2016

Source: HSH Nordbank Economics

When and to what extent an adjustment will take place on the market is anyone's guess. What tips the scales is the chief central banker Mario Draghi, Europe's man of the still cheap money. If the president of the ECB changesd the direction of interest rate, it will have long-term consequences for the real estate market. Nevertheless, the banks are well equipped for a setback in the market – far better than they were in 2008. “They learned their lessons from the financial crisis”, says HSH Nordbank expert Axmann, whose company has a proud real estate loan portfolio of 12.5 billion euros on its books at the end of 2016. “Our current loan portfolio can endure an increase in interest rates of several percentage points”, Axmann estimates. In the time before the financial crisis, the equity shares for real estate investments were frequently so low that the banks were already affected with minimal value adjustments. Now, the so-called loan-to-values which shows the loan value in relation to the market value, are on average below 70 percent for portfolio properties.

Up, up - and away? ... essentially related to the historically low interest rates

Trend of the 10-year German Federal Government Bond since 2012

Up, up - and away? ... essentially related to the historically low interest rates

Source: finanzen.net

It was also important that the banks have so far barely softened up their lending conditions despite strong pressure from the competition. According to the quarterly “bank lending survey” by the Deutsche Bundesbank, the German banks questioned had further tightened up their standards since 2011 with regard to lending for housing. A finding which will ultimately sound mild for a, by nature of his work, notoriously critical bank supervisor like Andreas Dombret.