Euro area property prices: Germany versus the rest
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Current Issues
Real estate
Euro area property prices:
June 29, 2012 Germany versus the rest
Author The euro area real estate price bubble burst with a delay of one to two years
Tom Mayer
+49 69 910-30800
after the US. Adjustment is far from complete and will weigh on economic
tom.mayer@db.com activity and banking sector health for years to come in most countries.
Jochen Möbert Adjustment is most advanced in Ireland, followed by Spain. Residential property
+49 69 910-31727 prices have hardly adjusted in France, Netherlands, and Belgium. Markets in
jochen.moebert@db.com Italy and Portugal seem to have escaped significant overvaluation.
Editor
Stefan Schneider
The exception to the general picture of overvalued markets is Germany, where
fundamental values remain at historical lows despite some price increases in
Deutsche Bank AG
DB Research
recent years. Given Germany’s status as a safe haven in Europe for investors
Frankfurt am Main and in view of Germany’s likely economic outperformance of other European
Germany countries we envisage further price gains in the German real estate market.
E-mail: marketing.dbr@db.com Prices are likely to rise fastest in cities with more than 500,000 inhabitants.
Fax: +49 69 910-31877
www.dbresearch.com
DB Research Management
Ralf Hoffmann | Bernhard Speyer
Euro area property prices: Germany versus the rest 2 | June 29, 2012 Current Issues
Euro area property prices: Germany versus the rest
Introduction
Interest rate declines to the low German level in the run-up to EMU and low
central bank rates during most of the first decade of EMU led to exorbitant
increases in real estate markets of many euro area countries. In some countries
of the euro area the residential property price bubbles burst with a delay of one
to two years after the US. Adjustment is far from complete and will weigh on
economic activity and banking sector health for years to come in most countries.
The exception is Germany, where fundamental values remain at historical lows
despite some price increases in recent years. Given Germany’s status as a safe
haven in Europe for investors and in view of Germany’s likely economic out-
performance of other European countries we envisage further price gains in the
German real estate market. Prices are likely to rise fastest in cities with more
than 500,000 inhabitants.
Unfinished correction
Since the outbreak of the financial crisis in 2007, many real estate markets are
correcting (chart 1). The drop in prices is largest in Ireland, where also the
earlier increase was most pronounced. Other notable declines occurred in Spain
and Greece, where prices had also surged to excessive levels before 2007. So
far there has been no visible correction in France, where prices had more than
doubled during the last decade. Prices have remained above their level of the
beginning of the new millennium in Italy and Portugal, but it is less clear in these
countries whether earlier increases were excessive. Note that in none of the
countries discussed have nominal prices returned to levels of the early 2000s,
suggesting that the price correction may not be over.
Unfinished price correction 1
Nominal house prices, 1994=100
600
500
400
300
200
100
0
94 96 98 00 02 04 06 08 10 12
FR IT ES GR IE PT DE
Sources: BIS, Deutsche Bank
The exception in the performance of real estate markets has been Germany.
There, restructuring at the company and general economy level left disposable
incomes and, as a result of this, real estate prices flat. Signs of an uptick in real
estate transaction volumes and prices have emerged only recently.
But how much further do we have to go?
The development of nominal prices alone is of course insufficient to spot
overvaluations and assess the size of the necessary correction. In Ireland, for
instance, the surge in real estate prices went along with a tripling of nominal
income per capita. Hence, at least part of the rise may have been supported by
fundamental factors. Therefore, we need to look at indices of affordability,
3 | June 29, 2012 Current IssuesEuro area property prices: Germany versus the rest
defined as real estate prices relative to disposable income or rents, to obtain a
better picture of the potential additional need for adjustment. By and large, the
two most common affordability indices, the price-to-income and price-to-rent
ratios, have developed fairly similarly, so we can focus on only one of them, the
price-to-income ratio.
Real estate prices are strongly affected by legal and regulatory issues such as
maximal loan-to-value ratios, rent control, tax deductibility of mortgage interest
payments, foreclosure procedures, etc. Fortunately, the impact of these factors
on prices is relatively stable as legal and regulatory frameworks change only
very slowly. Therefore, historical averages of affordability indices should be
good enough to determine the fair value for each market. For our assessment of
the necessary adjustment we take the difference between actual affordability
and its historical average.
Our indicators suggest that many euro area residential property markets are still
overvalued (chart 2). Although there has been considerable adjustment in
Spain, the market is still overvalued by roughly 25% on our metric. However,
following the past price correction, Spain fell from the top 3 overvalued
residential markets in the euro area. In Belgium, France and the Netherlands
houses are still less affordable than in Spain. Price-to-income ratios are
overvalued by roughly 40% in these countries and have broadly moved
sideways so far.
Houses not yet affordable 2
Affordability ratio of house prices to income, long-term average=100, index
160
140
120
100
80
60
1995 1997 1999 2001 2003 2005 2007 2009 2011
NL BE FR ES IT
Source: OECD
Against this backdrop, the adjustment in Ireland stands out (chart 3). The price-
to-income ratio dropped within four years by more than 50%. In Greece, house
prices grew only slightly faster than disposable income until 2007 and
affordability has corrected to the long-term average. However, prices are likely
to be dragged down by falling disposable incomes in the future. Germany is the
only country where affordability is clearly below its long-term average and may
rise on the back of higher incomes. Thus, the German market seems to offer
good fundamental value on top of its status as a safe haven in the euro crisis.
4 | June 29, 2012 Current IssuesEuro area property prices: Germany versus the rest
Germany and the periphery 3
Affordability ratio of house prices to income, long-term average=100, index
160
140
120
100
80
60
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
GR IE DE
Source: OECD
Could markets undershoot their long-term averages?
Several peripheral euro area countries are in a severe recession. In such an
environment house prices may not level off at the long-term average. There is
the risk that affordability indices undershoot. Historical data shows that several
markets were undervalued for a couple of years (chart 4). The data since the
mid-seventies suggest that affordability indices have a minimum threshold at
around 80 during the cycle. This level could mark the downside of the
adjustment discussed above. Based on this metric, only Germany seems to
offer fairly safe value.
A long-term view of affordability 4
Ratio of house prices to income, long-term average=100, index
140
120
100
80
60
77 81 85 89 93 97
DE ES IE IT NL
Sources: OECD, BIS, Deutsche Bank
How long will the adjustment take?
Without negative exogenous shocks and assuming a continuation of the smooth
and slow adjustment process from 2008 to 2012, we would expect the Spanish
market to have adjusted back to the long-term average of affordability by 2016
and to the downside level of an 80% price-income ratio by 2020. As mentioned
above, in Greece and Ireland affordability indices are already below their long-
term average. If prices continued to decline as in the previous years the Irish
downside would be reached within 1 ½ years and the Greek within four years.
5 | June 29, 2012 Current IssuesEuro area property prices: Germany versus the rest
Adjustment paths 5
Affordability ratio of house prices to income, long-term average=100, index
160
140
120
100
80
2000 2004 2008 2012 2016 2020
GR IE ES
Sources: OECD, Deutsche Bank
Adjustment scenarios 6
Years to adjust Long-term average (baseline) 80% of long-term average (downside)
ES 4 8
GR 0 4
IE 0 1
Source: Deutsche Bank
It is very difficult to forecast the developments in the strongly overvalued
Belgian, French and Dutch markets. Historically, in Europe only every second
boom ended in a bust. If legal and regulatory changes, which have contributed
to the high price levels, are maintained, price-income ratios may not have to fall
to past averages.
A closer look at Germany
The macroeconomic environment is clearly supportive for rising real estate
prices in Germany. Despite the deep global recession in 2008/9, Germany has
experienced average annual real economic growth of 2% since 2005 compared
to less than 1% between 2000 and 2005. The economy and residential property
prices developed quite similarly. Nominal house prices declined by around 10%
between 2000 and 2005 and then stagnated until 2009, before rising at 2 to 3%
p.a. in the last couple of years. Condo apartment prices rose by around 4%,
considerably faster than the inflation rate of 2.3% in 2011. By international
comparison, house prices in Germany have therefore performed in an anti-
cyclical way and have been less volatile. Low mortgage rates and the flight to
safe havens are likely to continue to support German house prices in the near
future.
The recent increase in residential prices went hand in hand with a rise in
disposable income, so the price-to-income ratio remained flat. The German
economy is forecast to grow by 0.8% this year and by 1% in 2013. Assuming
that affordability were to go back to its long-term average until 2020, house
prices could grow 3 pp above the growth rate of disposable income. For
example, if the average growth rate of disposable income were 2%, then house
prices could increase by 5% p.a. to produce an affordability index of 100 in 2020
(charts 7-8).
6 | June 29, 2012 Current IssuesEuro area property prices: Germany versus the rest
German scenarios: Affordability 7
Ratio of house prices to income, long-term average=100, index
100
90
80
70
99 03 07 11 15 19
prices +1%, income +2% p.a. prices +3%, income +2% p.a.
prices +5%, income +2% p.a.
Sources: OECD, BIS, Deutsche Bank Research
German scenarios: Prices 8
House prices 2005=100, index
170
160
150
140
130
120
110
100
99 03 07 11 15 19
prices +1%, income +2% p.a. prices +3%, income +2% p.a.
prices +5%, income +2% p.a.
Sources: BIS, Deutsche Bank Research
Is there a risk of overvaluation?
In its Monthly Report, the Bundesbank recently analysed the development of
residential property prices. Some formulations in the report, such as “bold
increases in prices”, were read as expressing fears of the Bundesbank that price
increases could further accelerate. However, irrespective of ECB policy,
excessive price movements could be checked. Thus, bank regulators could
tighten mortgage standards and legislators could raise property taxes or stamp
duties. However, prices could still spin out of control if foreign investors crowded
into the German market because of fear of a break-up of the euro area, or if
domestic investors allocated more funds to real estate. German households
hold financial assets worth EUR 4,900 bn and own dwellings worth
EUR 3,600 bn, leaving considerable room for portfolio shifts into real estate.
All real estate markets are local
From 2009 to 2011, German residential property prices surged in large cities
and rose robustly elsewhere (chart 9). Prices stagnated or declined only in some
structurally weak regions, in particular some small cities in east Germany. The
strongest boosts took place in large cities with more than 500,000 inhabitants,
where prices of single-family homes and condominiums increased by more than
7%.
7 | June 29, 2012 Current IssuesEuro area property prices: Germany versus the rest
Price growth from 2009 to 2011 9
Inhabitants (in thousands) Single-family home (%) Existing condos (%)
Above 500 7.5 7.9
200 to 500 3.5 5.6
100 to 200 3.8 5.4
Below 100 4.0 3.7
Germany (average) 4.2 5.9
West 3.9 6.3
Sources: BulwienGesa, Deutsche Bank
Conclusions
Our review of price and affordability measures in euro area residential real
estate markets has shown that adjustment from past overvaluation is far from
complete in most markets and will weigh on economic activity and banking
sector health for years to come in most countries. The exception is Germany,
where fundamental values remain at historical lows despite some price
increases in recent years. Given Germany’s status as a safe haven in Europe
for investors and in view of Germany’s likely economic outperformance of other
European countries we envisage further price gains in the German real estate
market. Prices are likely to rise fastest in cities with more than 500,000
inhabitants.
Thomas Mayer (+49 69 910-30800, tom.mayer@db.com)
Jochen Möbert (+49 69 910-31727, jochen.moebert@db.com)
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