German property values have seen increases in recent years. There has been a flood of international investors swooping in to take advantage of high yields. Interest rates are at rock-bottom fuelling an investment flurry.
These factors combined with the implosion of the real estate bubble in the United States, Ireland and Spain has many investors fearing that Germany is setting itself up for a real estate bubble. Is that true? What do the facts really reveal?
What creates a housing bubble?
It is important to understand the factors which have lead to the recent housing crisis in other countries. This knowledge can then be compared to Germany. There are three main factors that cause a real estate bubble:
Factor #1: Price to Income Ratios Exceed the Affordability Index
An overvaluation exists when the cost of real estate (either property values or mortgage costs) relative to disposable income exceed long-term averages. When these ratios gets too high, households become increasingly dependent on rising property values to service their debt – invariably feeding an unsustainable cycle.
Factor #2: Irrational Consumer Expectations Drive Price Exaggerations
One very important factor is the failure to recognise mispricing. When investors blindly look at price appreciations and expect them to continue growing exponentially, the market is set to see unrestrained spending, high risk investments and little concern for accurate market values. This feeding frenzy drives up prices to unsustainable levels.
Factor #3: Loosening of Credit Underwriting Standards
As demand for properties increase, sellers begin to flood the market. Eventually the supply will exceed demand and/or property values will begin to exceed the affordability index. If let remain, the market will gradually rebalance itself. In a bubble, however, lenders begin to fan the flames by lowering lending requirements to pull in addition, though under qualified, buyers. As lending standards continue to fall, the investment risk dramatically increases and when the financially unstable bubble pops, few are left unaffected.
Is Germany heading for a Bubble?
“The German housing market does not currently have a price bubble, and there is little danger of a bubble developing in the future.” states Deutsche Bank in their September, 2012 report. Consider how Germany is dealing with the above mentioned factors:
Reason #1: Germany’s Housing Market is Undervalued
The German housing market, according to the OECD, is undervalued by 20%. Housing costs remain extremely inexpensive by international standards. An analysis of the past performance of the German real estate market indicates a return to normal values rather than inflated pricing. In fact, prices are only about 20% higher than they were at Germany’s reunification in 1990. This only amounts to appreciation of 0.9% per year. Additionally, over the past decade, disposable income has grown faster than residential property prices. Value increases are therefore simply adjusting for a lack of property appreciation over the past two decades.
Reason #2: Conservative Investors are Watching the Market
The fact that German property investors are concerned about a housing bubble is a good indicator that they will not fall for unrestrained investing that falsely drives up values. It should also be noted that value increases are largely attributed to portfolio rebalancing. Real estate yields are much higher than other current investment options. Even in cities with very low rental yields, they are still much higher than the yields on government bonds. The good news is that investors tend to weigh investment risks well making market over inflation unlikely.
Reason #3: Strict Lending Requirements Protect the Market
Lawmakers and regulators in Germany are particularly vigilant when it comes to monitoring the real estate market. In the event of an over acceleration of value, the credit supply could be reduced by setting more stringent loan-to-value ratios and regulators could also increase purchase or ownership costs to offset high investment returns.
What is the Condition of the German Real Estate Market?
The market is currently undervalued – not only in relation to many other countries, but also by historical standards. A lack of housing is currently fuelling an increased demand. As long as this demand remains unsatisfied, prices will gradually increase until the demand is balanced. This creates a secure and profitable investment opportunity without the risk of an impending decrease in values. By analysing past performance and focusing on the systems which are in place to monitor the market, there is no solid evidence to indicate that Germany is anywhere near a real estate bubble. Quite the opposite is in fact indicated, Germany’s property values are only now rising to meet the global market while balancing demand and affordability indices within its borders.