Germany’s ironic mini-bubble

Published in Business Spectator (Melbourne), 7 February 2013

For decades, following German real estate prices was like watching paint dry. Well, actually it was even less exciting than that.

German house prices were a complete non-issue. For one simple reason: they never changed. Many other countries, most notably English-speaking ones, have seen their property markets rise strongly with big swings in either direction along the way. In pre-GFC Germany, on the other hand, you could buy houses for the same prices (adjusted for cost of living changes) you would have paid in the early 1970s.

There were good structural reasons why house prices in Germany were such a boring affair. Thanks to a flexible and price-responsive supply side (A housing market whodunit, February 10, 2011), there never was the kind of undersupply that characterises so many other housing markets around the world. Germany kept building enough to satisfy its housing demand.

At the same time, German banks were more conservative in their lending practices than, say, their British, American or Irish counterparts. Put simply, if you could not pay between 20 and 30 per cent of the house price upfront, you shouldn’t have wasted your time asking any bank for a mortgage.

In recent years, however, the hitherto boring German property market has become a bit more interesting. House prices have actually increased enough to make the Germans speak of a housing boom or even a bubble.

Mind you, everything is relative. What would be regarded as a stable market in other countries looks like frantic market activity in Germany.

According to real estate association IVD, last year German prices increased by 3.1 per cent for flats and 2.9 per cent for single-family homes. In fact, rents have only increased by 9.4 per cent over the past 20 years – and are thus lower in real terms than they were in 1992.

Not only that price rises have been modest; they have also triggered increased building activity. For the past three years, housing completions have gone up in Germany. The housing market obviously responds to price signals with increased investment. In 2012, a total of 245,000 new dwellings were approved – an increase of 7.4 per cent from the previous year. Indeed, according to the federal government’s housing research agency, there was only an extra demand for 193,000 units over the same period. Germany actually built more than enough to satisfy its housing demand.

Another factor cautions against assuming that there was anything bubbling German property: Mortgage finance in Germany barely increased. Typically, housing bubbles are fuelled by rapid increases in credit. However, for the past four years total mortgage lending in Germany has risen by little more than 1 per cent per year – hardly an indication of excessive lending.

Looking at Germany’s housing market, any international observer should conclude that it is far from overheating. It is only the Germans themselves who believe that they are experiencing a housing boom – if only because they have never actually seen one.

Of course, if you are used to a market that has been virtually flat for decades, then even small changes may appear like a big deal simply because they are so unusual.

There is, however, another explanation behind the new focus on the German real estate market. It has everything to do with the euro crisis and the European Central Bank’s reaction to it.

Traditionally, nothing in Germany is feared more than inflation (Germany’s understandable inflation paranoia, October 11). The trauma of two monetary reforms in one century is deep-seated and haunts the Germans more than any other nation. Consequently, the Germans are susceptible to anything that hints at future monetary instability. The euro crisis has therefore caused a reassessment of asset classes.

In this sense, house prices in Germany are rising for the same reason that Germany’s stock index DAX is on the way up. In times of crisis, and with fears of monetary debasement, the Germans tend to invest in assets that will be a store of value: gold, equities – and bricks and mortar.

A closely related factor in Germany’s moderately rising house prices are low interest rates. It has never been cheaper to finance your dream home than right now. Traditionally, and at a homeownership rate of just 46 per cent, Germany has never been a nation of owner-occupiers. However, for anyone considering fulfilling his dream of owning a house rather than continuing to rent, now is the time to do so. Apart from that, with low interest rates available to savers, there are no good reasons not to enter the property market. The alternatives to buying are simply not attractive anymore.

There is an irony in all of this. It was the bursting of property bubbles in Spain and Ireland that contributed to the euro crisis. And now it is the very same euro crisis that is sparking a miniature property bubble in Germany.

For anyone considering jumping onto the bandwagon and investing in German real estate, there are nevertheless good reasons to be careful. It may look like a bonsai bubble but it may not grow much bigger and it should not last long.

First, price increases are concentrated mainly in highly sought-after, inner city areas. It is most definitely not a uniform national increase in house prices. There are big regional variations. Second, long-term prospects for German housing should take into account that Germany’s population is destined to decline by about 20 per cent until the middle of the century for demographic reasons. And third, Germany’s economic growth has weakened over the past year which is likely to also have an impact on its future house market development.

The German housing market may currently show some unexpected signs of life. But in the long run, watching paint dry may still beat the excitement of following the development of its alleged housing bubble.