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The German Housing Market – Fears and Challenges of an Emerging Housing Bubble

 5 min read / 

Housing bubbles have resurfaced as a worry for governments worldwide but especially in Europe, where eight countries (Austria, Belgium, Denmark, Finland, Luxembourg, the Netherlands, Sweden, and the United Kingdom) received warnings from the European Systemic Risk Board at the end of 2016.

Although Germany was not one of the countries deemed to be at risk, the chief banking supervisor of the country’s central bank (Bundesbank), Andreas Dombret, recently expressed his concerns that Germany may, in fact, be facing a similar challenge.

Fuelled by Cheap Money

Housing bubbles are characterised by three distinct but overlapping phenomena: a credit expansion, often fuelled by low-interest rates, which then creates a rush into real estate and a concomitant increase in prices.

Finally, with money plentiful, banks may lower their credit standards or cut back on due diligence, leading to even more money flowing into the real estate sector.

Two years ago, when warnings about a rising bubble in Germany emerged, only the increase in real property prices seemed to be a concern. This time around, however, soaring prices are just a part of the story (albeit admittedly an important one).

Sharp Rises in Property Prices

The Bundesbank index, which covers 127 cities in Germany, suggests that real estate prices have risen by almost 50% since 2010, with the increase accelerating over the past year from 4.5% to 6%. These increases can be partially explained by larger migration inflows and increased urbanisation, leading to a higher demand for housing.

Even though the construction sector is booming, there is still demand to be satisfied, as only around 53% of needed apartments have been built between 2011 and 2015. Despite this increase in demand, however, the Bundesbank notes that the observed price increases have outweighed any expected increase explained by the rising demand, leading to fears of a bubble.

Source: Bundesbank

A look at Germany’s credit boom in real estate makes these fears credible. The amount of real estate loans has been increasing in Germany since 2009, with low-interest rates a key driver. A mortgage at a fixed rate of only 0.94% over a period of ten years as offered by one of the major German lending banks opens the possibility of home ownership to a broad range of people.

Low-Interest Rates Driving Real Estate Boom

Since returns on savings and traditional retirement plans have ceased as a result of prolonged low interest rates, investing in a house has become an attractive alternative.

Moreover, increased demand for real estate properties not only raises prices for new construction, it also feeds through to higher valuations of the existing housing stock. As a result, real estate loans do not only surge in their amount, but also in their volume; additionally, household lending against the value of immovable assets also may increase.

While the credit boom is definitely underway in Germany, it is more difficult to draw a conclusion regarding bank credit standards. On the one hand, the results of the Bank Lending Survey suggest standards have been tighter since 2011, although this finding is attenuated by data limitations.

Quality Control Issues?

On the other hand, the profit margin of banks and financial institutions has been squeezed by low interest rates, and to compensate for this loss, increasingly riskier conditions for loans are being accepted. This process has been additionally fueled by inter-bank competition on the housing loans market. One consequence of this is a higher share of riskier long-term loans (as it can be seen in the Figure 2).

Source: Bundesbank

All of these factors have led the Bundesbank and the German Federal Financial Supervisory Authority to develop a stabilising plan in order to tackle overvaluation in the housing market. According to the IMF’s appeal for a policy toolkit of 2014, raising interest rates could be a powerful measure to cool down the market on the side of monetary policy.

ECB Constraints

However, Germany’s room for manoeuver is limited, as the European Central Bank (ECB) has been keeping inflation rates low in hope of accelerating growth. As a consequence, Berlin had to turn to alternative measures, such as allowing bank supervisors to raise capital requirements for financial institutions, increase risk-weights, and – should financial stability be under threat – introduce the default ratio to the banking system leading recurrently to higher capital requirements.

Conclusion

Dombret might, therefore, be right in raising the alarm even if there is no acute bubble in the housing market… yet. Indeed, the signs of an emerging bubble should not be underestimated, as the individual components of such a bubble are evident in the German housing market. However, ECB’s policies make the Bundesbank’s task considerably more difficult, and taking adequate steps to prevent the market from overheating in the face of loose money will be a daunting challenge.

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