Towards a new bubble?

Yesterday’s Bundesbank report could bring international attention back to the German real estate market. Despite tentative signs of regional exaggerations, a text book bubble does not seem to be in the offing (yet).

Over the last years, there have been several indicators nicely illustrating the decoupling of the German economy from the rest of the Eurozone. Confidence indicators, unemployment rates and fiscal deficits have moved into different directions than in most other Eurozone countries. Another macro variable which has shown a totally different development is the housing market. While real estate prices have been dropping in many Eurozone countries, sometimes as the consequence of bursting bubbles, Germany has been experiencing a new real estate boom. Over the last years, prices at the national level have increased by an annual rate of around 3%.

However, national data mask vast regional differences. Prices in urban areas have spiked over the last years. Between 2009 and 2012, for example, apartment prices have increased by around 80% in Berlin. In other cities, prices increased by 15% to 30% during the same period. These developments have given rise to discussions about a possible bubble on the German real estate market. Yesterday, the Bundesbank weighed in and presented an analysis showing that prices in urban cities could be up to 10% higher than the level which can be explained by demographic and economic factors alone. In the attractive large cities, this possible overvaluation could be as high as 20%.

In our view, there are several factors behind the sharp increase in urban house prices: record low interest rates, migration from rural to urban areas and increased foreign appetite for German real estate. To a large extent, price increases are the result of a typical demand-and-supply dilemma. Demand for real estate in German cities is increasing sharply, while the supply remains hardly unchanged. This increased demand is also reflected by the fact that home ownership – which in Germany is traditionally much lower than in most European countries – has increased in recent years. At the same time, there are no reasons, yet, to call the latest developments the start of a typical bubble as experienced in other countries before. Mortgage growth has remained limited, loan-to-value ratios in Germany have been stable at around 80% and the large majority of Germans still prefer mortgages with fixed rather than variable rates. Signs of a debt-fuelled bubble are hard to find.

Even if the Bundesbank’s assessment of a fundamental overvaluation looks justified, prices – at least in urban areas – could in the short run still further increase on the back of low interest rates and limited supply.