The Effect of the Eurozone on German Property Market

German property prices getting hotter

After a decade in the doldrums, whilst the rest of the developed world enjoyed a property boom, Germany property is now gaining heat and rises are being seen in many areas of the country. What is fuelling these increases and how sustainable are they? This report looks at the impact of the Eurozone economic policy, inflation expectations and current GDP growth as clues.

Well, it is no secret that the German exporting sector is providing a welcome engine to Eurozone economic growth, and has done for the last 2 years or so. German GDP rose 1.5% in the last 3 months, the fastest rate since re-unification and shows little signs of abatement. Its imports also reached an all-time high, up 3.1% to 79.4bn euros. Both imports and exports are the most since data started to be collected in 1950. The German economic boom is fuelling inflation, and prices are expected to keep rising because of Europe's one-size-fits-all monetary policy. The European Central Bank can't raise interest rates aggressively enough to curb German price pressures because that would hurt the weaker euro-zone economies.

The latest figures are of some concern, to a nation in fear of inflation which perhaps harks back to te hyper-inflation of the 1930s. Compared with the same month last year, consumer prices in Germany rose by 2.4 percent in April, the biggest increase since the outbreak of the financial crisis and the fall of Lehman Brothers. That means it is now the fourth month in a row where ECB has overshot its own 2% target for inflation.

Some pundits are now becoming pessimistic on inflation outlooks "We will have to get used to the fact that Germany will have inflation rates of between three and four percent in the coming years," says Clemens Fuest, an economist at Oxford University and a member of the Scientific Advisory Board of the German Finance Ministry. Olivier Blanchard, the chief economist at the International Monetary Fund [not the naughty one], has repeatedly told the Germans that they will have to come to terms with an annual inflation rate of around four percent.

The last time statisticians recorded inflation rates of four percent in Germany was 20 years ago, when the boundless enthusiasm surrounding German reunification drove up prices. Once again, an economic boom is fuelling inflation. Germany's economy is moving ahead at full steam. The country seems to have made up for nearly all the losses incurred during the financial crisis, and many companies are working close to capacity.

Germany's industrial sector is now growing at an annual rate of almost 15 percent, putting it in the same league as China. Soaring prices of natural resources are a big cause for inflationary concerns, but so is domestic demand. The ECB responded by cautiously raising its base lending rate in mid-April for the first time in nearly three years.

The ECB faces a dilemma. Its mandate is to pursue monetary policy for the entire euro zone, not just for one country, no matter how dominant that nation may be. The central bank must take into account the needs of all member countries -- and many of them, especially the peripheral southern nations like Greece, Portugal and Spain, are still mired in recession or struggling with stagnation.

There is no relief in sight for these stragglers -- quite the contrary. Figures released last week by Eurostat, the European Union's statistical office in Brussels, show that the 2010 Greek budget deficit was higher than expected at 10.5 percent of gross domestic product. At the same time, yields on Greek, Irish and Portuguese government bonds reached record highs last week -- a sign that investors expect these countries to undergo debt restructuring, despite all official statements to the contrary.

Out of consideration for Europe's most troubled economies, the ECB cannot raise the base lending rate nearly as much as would be necessary to contain price pressures in boom countries like Germany. If it did, their borrowing costs would rise even further, choking off what feeble growth the southern European countries are experiencing.

The Future for Interest Rates? Germany Needs 3% now!

If the Bundesbank were still in charge of monetary policy for Germany, as it was before the introduction of the euro, it would have long since raised interest rates far more aggressively. "In the current economic situation, a base lending rate in the vicinity of three percent would be entirely appropriate," says Joachim Scheide, chief economic analyst at the Kiel Institute for the World Economy.

"Interest rates will remain too low for us," says Deutsche Bank's chief economist Thomas Mayer. The consequences are inevitable: Germany's already strong recovery is being further fueled by cheap money from the ECB. Turning up the temperature like this can cause the economy to overheat.

"A real estate bubble could develop, just as it did a few years ago in Spain and Ireland, because the ECB's monetary policy is too expansionary for the economic situation in Germany," says Kai Konrad, chairman of the Scientific Advisory Board of the German Finance Ministry and a professor at the Max Planck Institute for Tax Law in Munich.

So the housing sector in Germany could be set for a boom, at odds with the rest of the Eurozone where falling prices are the norm.

For example, anyone currently looking to buy a new apartment in the heart of Hamburg is in for a shock. Over the past twelve months, real estate prices at prime locations such as the trendy Hafencity have risen by one-third to €5,899 per square meter ($814 per square foot), and in other urban areas they are even higher. Prices in low-priced regions such as Bremerhaven have also seen price rises of 24% last year. The rises are now uniform, but gathering pace.

The Next German Economic Miracle?

Observers are now debating whether Germany is to enter another period of the “economic miracle” that characterised the West Germany in the post-war years. And you can see why. In March of this year, German exports surged to their highest level since records began, on the back of a record-breaking 18.5% growth in 2010. Outstanding figures, for a developed country. But why does Germany enjoy all the success, when other nations are struggling?

It's quite simple really - Germany makes quality products that people in countries with growing economies want to buy. As China develops, so does its demand for the machinery which its factories need - and for the trappings of wealth which its new rich think they need, like flashy German cars.

But to explain this insatiable demand for “Made In Germany” one needs to look closer. One big difference is that Germany did not have a property bubble which then burst, leaving consumers and corporations and governments taking drastic action to pay off debt. Not only did the German property market avoid the property bubble between 1997 – 2007, German residents find it entirely acceptable to rent as opposed to buying. Germany has done a number of things to reform its labour markets in the past decade, and is now reaping the benefit. The country embraced labour market reforms, but in a measured way. It is now easier to hire and fire than it was a decade ago.

Companies have also taken full advantage of the reserve of workers in the east of the country, taking up the spare capacity in the labour force and as a result the unemployment rate, particularly in the east has fallen dramatically. For example, unemployment in Leipzig stood at over 20% in 2003, and now stands at 12,9% and falling 1 to 1.5% steadily each year. Volkswagen, Porsche and BMW, for example, have found it easy to move production to lower cost eastern sites around Leipzig. As have DHL, the global logistics company who now have their European hub in Leipzig, moving from Frankfurt.

Property Boom in Top German Cities

Germany is starting to experience what Ireland and Spain went through in the noughties. Current ECB policy has remained loose to help support Greece, Ireland, Spain, and others get back on their feet. All that money has to flow somewhere, and it's now heading into German property.

Examples of the boom (from Der Spiegel):

• Prices in top Hamburg district Hafencity up one-third in last 12 months

• Record sales in Hamburg, Munich, Düsseldorf and Berlin

• Land prices in previously depressed German northeast up 20-30% in last few months

Without easy access to Land Registry stats, it is more usual to look to portals to track property prices in Germany. The table below shows the start of the growth period, from 2009, and some unexpected cities made an entry:

The appearance of Bremerhaven at the top of the table is of interest, and shows that this smaller city, whilst still boasting above 10% yields [the only one on Western Germany], is on the up after years of declines.

Over the last 2 years, both property prices and rents having been rising across the country, but care should be taken to apply this across-the-board. Smaller cities, not just in the east but in the centre of the country also, have experienced declines in value. The biggest fallers, nearly all in the former west where the local economy has proven unsustainable are listed here:

Looking at the cities ProVenture operate within, in terms of apartment prices [we usually work with buyers of apartment houses] the following graphs show price development over the last year.

Leipzig

Whilst the picture is mixed across the city, the picture shows a developing capital value picture, with some regions experiencing above 20% price growth. Whilst the majority of our client buy apartment houses, the picture is not a direct relation to prices on the ground, but shows increasing demand in many places for single apartments, usually bought by owner-occupiers. The solid growth is due to year-on-year population growth for the last decade and tumbling unemployment, albeit from a high level:

coupled with tumbling vacancy rates for residential apartments across the city

So, still a city in development, but it is occuring in front of our eyes, as German economic growths gathers pace [more on Leipzig in the conclusion paragraphs]

Bremen

In the tipped-city of Bremen, we see a similar picture, with perhaps an even more widespread area of growth or high growth [red is above 20% in the last year]. There is a higher degree of sales completed on single apartments in this city, with owner-occupier rates higher, being in the former West of Germany.

Berlin [Neukoeln]

This part of the capital was very much “un-loved” when ProVenture first started operating in the city some 5 years ago. The area was characterised by social housing and higher than average unemployment. This was our main area of interest at the time [2006] and the picture shows some decent increases in many areas has been enjoyed in past years.

Berlin [Reinickendorf]

A large area to the north east of the city centre, Reinickendorf for years has been characterised by the airport Tegel and the industry set up which surrounds it. With the airport due to wind down operations in 2012 in favour of the new Berlin-Brandenburg International [Schoenefeld], the area is changing and finding increasing attractiveness to tenants, who find very good quality housing at some of the most affordable rates in the city, both for tenants and owner-occupiers. The area has seen some strong rises in the last year, with few postcodes experiencing decline. Overall, the gains were 5.6% in the last year.

Halle

A more “emerging” picture here with Halle. Some areas shown have good growth, above the 10% level shown by the orange region. But still larger swathes of prices stability or declines, particularly in the area around the main station. Care needs to be taken in the city, following the usual guides of vacancy rates, rental levels and the like.

Conclusion – Impact on Cities like Leipzig

The current monetary policy across the Eurozone is well-reported to be favouring Germany and its export economy positioned for solid growth in the medium term. Whilst the spectre of inflation cannot be ignored, the ECB seem more mindful than most central banks of the potential issues it can cause and are more posed to act, having moved interest rates already this year ahead of UK and USA.

Whilst the country did not participate to any great extent in the last housing bubble, the value of property and rent levels still are very low, and indeed have some inflation needs to catch up to norms, based on the country's GDP output. The regions of the country where owner-occupier levels are lower, typically the east but also cities like Bremerhaven, show greatest capacity to take advantage in this next part of the cycle. In parts of Berlin and Leipzig, housing costs for tenants amount to around 20% of take home pay, sometimes less. In the rest of the developed world it is between 35-45% in most cases.

The graph below shows rental levels for new build [yellow line] and existing stock [blue line] in the city of Leipzig, basically rent levels are flat for the last decade, untouched by inflation.

Whilst the city of Leipzig, like many other parts of Germany sees a dramatic rise in population

[Blue line shows actual population development, lower yellow line is that predicted in 2002, the higher line in 2007. Current forecast see Leipzig increasing to up to 545,000 by 2020]

Lots of capacity for rental level development without impacting on consumer purchasing power. And in many parts of the country still, the cars parked outside the apartments costs more than the apartments themselves. This real inequality of economic output per individual [highest in Europe after UK] versus house price [lowest in the developed world] is in many ways been long overdue a correction. Values are still coming off their lows in cities like Leipzig, and have a long way to climb to regain their levels 10 years ago. But they are starting to.

This graph shows transactions [yellow bars] and price per sqm [blue line] for investment property in Leipzig. Good time to buy?

"Germany is on the verge of a 'golden decade'," said Christian Schulz of Berenberg Bank.

Well, our clients who have invested with us these past 5 years would testify that they have been well-shielded during the global financial crises, and look forward to these predicted golden times with relish.