Outlook on the German housing market in 2017: Prices and rents in Berlin, Düsseldorf, Frankfurt, Hamburg and Munich

Germany Monitor

Original in German: January 10, 2017

Munich remains the most dynamic German city when it comes to property, with its fast-rising population and historically low vacancy rate likely to lead to further price increases for many years to come. Further price rises are also expected in Berlin, although the main factors at play here are the very buoyant labour market and the fact that prices and rents are still relatively low for a European capital city. Of the German cities that were analysed for this report, Frankfurt has shown the lowest increase in prices in the current cycle. However, we are now seeing a Brexit effect, which is driving up prices for family homes in particular. In Hamburg sluggish rent growth and a high level of construction activity are the most striking trends, which could make the city more sensitive to interest rate movements than other urban centres. The situation is similar in Düsseldorf, where the vacancy rate in the current cycle is relatively high for a large German city. For every city analysed here and for the overall German housing market we anticipate further price increases in the coming years. All the macroeconomic conditions that might signal an end to the cycle - such as a turnaround in interest rate policy, a massive expansion of supply and/or a slowdown in migration to Germany - are not yet fulfilled and it is likely to be several years before they materialise. Consequently, we expect rents and property prices in the major German cities and across the country to continue to rise sharply in 2017.

Marketable vacancy rates

in % of the housing stock

2015 Marketable vacancy rates

in % of the housing stock

31.2

0.9

2

0.6

1 0.3

Berlin

Hamburg

Munich

0

0

2010 2011 2012 2013 2014 2015

Hamburg Berlin West-DE (ex Berlin)

Source: Empirica

Source: Empirica

Completions 1

No. of dwellings in '000

German housing market in 2017 - outlook for

700

600

500

400

300

200

100

0

Berlin, Düsseldorf, Frankfurt, Hamburg and

Munich

- In the current property cycle from 2009 to 2016, prices have risen by 63% in the A cities and by more than 40% in the B and C cities. The number of completed homes is likely to exceed 300,000 for the first time in 2017.

However, with an estimated requirement for at least 350,000 new homes,

this would cause the gap between supply and demand to widen further still.

90 95 00 05 10 15

A-city B-city C-city

D-city DE

Sources: riwis, National Statistical Office, Deutsche Bank Research

2016 apartment prices, existing 2

% yoy

12

9

6

3

0

This high level of demand will continue to put upward pressure on prices in

the German housing market.

• Between 2011 and 2016, nearly 45,000 new homes were completed in Munich for approximately 90,000 people. Over the same period, the city's population rose by 200,000 to reach 1.55 million. It is therefore estimated that an additional 55,000 or so homes are needed simply to accommodate the new arrivals. What's more, the vacancy rate tends to hover around the zero mark and Munich, Germany's most expensive city, has seen property prices more than double in the current cycle, with further increases expected in the coming years.

• In 2016, prices for existing housing stock in Berlin rose by 13% year on year, a particularly sharp increase and a stronger rise than all other German cities. Property prices in Berlin are now twice as high as they were in 2005 and have reached the level of some of the major cities in western Germany. A shortage of dwellings and a lack of land for development are often cited as the main factors driving the price increases. But demand is also adding

B D F HH M

Sources: riwis, Deutsche Bank Research

2009-2016 apartment prices, existing 3

% yoy 120

90

60

30

0

to the momentum, with high job growth and ever lower unemployment rates

likely to put further upward pressure on prices in 2017.

• Frankfurt's population stood at 724,500 at the end of 2015, an increase of 12% on 2005, and its healthy economy meant that the number of people in employment grew at a similarly strong rate. The resulting high demand for housing could not be met by the scarce supply, which was also the case in other cities. Consequently, property prices in Frankfurt increased by 'only' 40% from 2009 to 2016. The comparatively high baseline level and subdued job growth in the financial services industry due to the financial crisis and euro crisis were the probable reasons why price increases in Frankfurt have been relatively muted. Because of impetus from the Brexit vote, however, prices surged in 2016, particularly for family homes.

• In Hamburg, prices for existing housing stock have gone up by around 70%

B D F HH M

Sources: riwis, Deutsche Bank Research

2016 prices of single-family houses 4

% yoy

12

9

6

3

0

B D F HH M

Sources: riwis, Deutsche Bank Research

since 2009. Price momentum in the city's rental market is sluggish,

however. From 2012 to 2016, rent growth did not even reach half the level of the other major cities. The relatively high level of construction activity is probably a key factor in this and means the gap between supply and demand is likely to be narrower than in Berlin and Munich. All this suggests that low interest rates are the main reason why property prices are increasing in Hamburg. Consequently, Hamburg may have a relatively high sensitivity to any future normalisation of interest rates. Any normalisation of interest rates is probably still several years away, however, which leads us to expect further price increases in the interim.

- In Düsseldorf, the population has risen by 'only' 5% since 2009. Other drivers of demand have also been less buoyant than in other major cities. Consequently, the price of housing has tended to increase in line with or below the average. Düsseldorf's property market could be even more sensitive to interest rates than Hamburg, although price increases are also anticipated here over the coming years.

Population 5

in m 83

82

81

80

2009 2016

Source: National Statistical Office

2009-2016 house and

apartment prices 6

% 60

40

20

Single-family houses

Terraced houses new

Terraced houses existing

Apartments new

Apartments existing

0

Sources: riwis, Deutsche Bank Research

Munich: Housing market 7

No. of dwellings 15000

10000

5000

0

90 94 98 02 06 10 14

Completions Permits

Sources: riwis, National Statistical Office, Deutsche Bank Research

2015 Empirica vacancies:

City rankings: Lowest rates 8

in % of the housing stock 0.6

0.4

0.2

0.0

Source: CBRE-Empirica

Price pressure in the German housing market likely to remain high

Because of economic migration and the influx of refugees, Germany's population has now risen to 83 million, which is almost three million more than at the start of the current property cycle in 2009. A large amount of the influx was distributed across the B and C category of cities (half a million people) and the A cities (also half a million). The resultant demand is coming up against extremely inelastic supply, which has created a nationwide shortage of up to 1 million homes. This surplus demand caused prices in the A cities to surge by 63% between 2009 and 2016, with prices in B and C cities going up by 45% over the same period. Because of the deficit in supply, which could now lead to a relaxation of building regulations and environmental constraints, the number of new homes completed is set to reach 300,000 for the first time in 2017.

However, at least 350,000 new homes are required according to estimates by the German government, so this would not prevent a further widening of the gap between supply and demand. A rise in capital market interest rates of around 30 basis points since October 2016 means that demand-related pressure on prices is also likely to remain high. Consequently, prices look set to rise again in 2017. Although some analysts were talking about a property bubble early on in the current cycle, overvaluations - relative to historical price ratios at the national level (income to property prices) - will only come about when these further price increases take effect. However, because it will take a number of years for the excess demand to be satisfied, we believe that the risk of a bubble forming remains high. Germany's major cities are therefore likely to remain the focus of attention, which is why we are analysing the five major housing markets (Berlin, Düsseldorf, Frankfurt, Hamburg and Munich) in this report.

Munich's vacancy rate at a record low

According to the city's own statistics, 36,000 new homes were completed in Munich between 2011 and 2015. Factoring in estimates for 2016 puts the figure up to almost 45,000, which is equivalent to 7,500 homes a year. This means that new housing has been provided for around 90,000 people. Over the past six years, however, the city's population has gone up by around 200,000 (based on the 2011 census) to reach 1.55 million in 2016. It is therefore estimated that at least 55,000 homes are needed in Munich simply to accommodate the new arrivals. Munich's extremely buoyant job market is also likely to have further boosted demand for housing. The number of people in employment in the city rose by 3% in 2016 and job growth for the cycle as a whole was, at nearly 18%, particularly high compared with other cities. Equally notable are the low average unemployment rates for 2016, with overall unemployment at 4.6%, unemployment among foreign nationals at 8.0%, and youth unemployment at 3.1%. In line with the shortages that already existed, the Empirica research consultancy puts the vacancy rate for the end of 2015 at 0.2% (2011: 0.6%).

The vacancy rate is since likely to have fallen further, adding to the upward pressure on prices. By international comparison, prices in Munich, Germany's most expensive city, are certainly nothing out of the ordinary. According to data portal Numbeo, the price per square metre for property outside the city centre is, at EUR 5,340, the 14th most expensive in Europe (London, Paris, Stockholm, Luxembourg and a number of Swiss cities are more expensive). In 2015, the City of Munich's property market report put the price per square metre for buying property in the city at EUR 6,300, for rental of existing stock at EUR 14.50 and for new build rents at around EUR 16.60. Given the current rate of new development, an end to rent and price increases seems unlikely in the short term. The significant upward pressure on prices could even persist into the medium and long term. According to the City of Munich's latest planning forecast, which was published in May 2015, the population will increase to more

2016 Munich: Unemployment rates 9

% 9

6

3

0

Total Foreign Youth

Sources: Federal Labour Office, Deutsche Bank Research

Berlin housing market10

No. of dwellings 33000

22000

11000

0

90 95 00 05 10 15

Completions Permits

Sources: riwis, National Statistical Office, Deutsche Bank Research

Permits-to-completions ratio11

ratio 2

1

0

B D F HH M

Sources: riwis, Deutsche Bank Research

2009-2016 employment growth12

% 25

20

15

10

5

0

B D F HH M

Sources: Federal Labour Office, Deutsche Bank Research

than 1.7 million by 2030, which would equate to 150,000 new residents and demand for 75,000 new homes. Factoring in today's shortage of at least 55,000 homes, that would mean that 130,000 homes would have to be completed by 2030. The current completion rate is only 7,500 homes per year, however, so there would continue to be a shortage of homes right through to the end of the next decade. If the projections pan out as expected, Munich, more than any other city, will be forced to rethink its current urban development policies. The city can at least point to the fact that it previously succeeded in realigning its urban development strategy in the 1960s under Mayor Hans-Jochen Vogel.

Back then the building of new urban districts and the suburban and underground train systems made a big difference to the quality of life in Munich - and came in spite of the high population growth at the time. Similar large-scale projects are probably now needed in order to maintain this quality of life and prevent a continuation of inflated prices.

Rents and property prices in Berlin on a sharp upward trend

In Berlin, according to property data portal RIWIS, prices for existing townhouse stock went up by 4% year on year in 2016, while prices for detached family houses rose by 5.75%. These strong growth rates were comparable with other cities; however, the overall level of house prices in Berlin remains quite low. The difference in prices is particularly pronounced when compared with Munich. You can buy three houses in Berlin for the price of one detached family house in Munich, and the price ratio is the same for townhouses. However, property prices for existing stock have almost doubled since 2005 and are reaching the level of certain major cities in western Germany. According to Numbeo, the price per square metre for property outside the city centre stood at EUR 2,800 at the end of 2016. Property prices increased by 13% year on year in 2016, a particularly sharp increase that was higher than in all other major German cities. In Berlin, too, the rapid acceleration in prices is being caused by an acute shortage of homes, with a lack of development land often cited as one of the main reasons for the deficit. According to the latest Berlin property market barometer, there is a particular shortage of affordable housing in the lower price segment. There is no likelihood of a quick remedy, as the number of building permits and housing completions are increasingly diverging. For example, 82,500 permits were issued between 2009 and 2015, but only 44,000 homes were completed. In no other major German city is there a greater disparity between approved property developments and completions, with 1.9 permits issued for every completed development in Berlin compared with 1.4 in Hamburg and Düsseldorf and 1.3 in Frankfurt and Munich. At the same time, the city's population has risen by approximately 150,000 and the number of households by around 75,000. Despite the boom cycle which has persisted since 2009, demand for housing is still rising at a faster rate than supply. This demand is in part due to the strong Berlin labour market, with job growth of 4% in 2016 and more than 20% since 2009 - both impressive statistics.

Consequently, Berlin's unemployment rate has been on a downward trajectory for a number of years and in 2016 fell to below 10% - its lowest level for a quarter of a century. The sharp fall in the number of people receiving housing benefit (down by 21% year on year) provides further evidence of the broader health of the labour market. The proportion of all households receiving housing benefit now stands at 0.9%, which is below the national average of 1.1%.

Economic growth in Berlin is likely to remain strong in the future and the city expects its population to go up by more than 250,000 by 2030. The continually rising demand for housing that this causes will probably come up against further inelastic supply for a number of years to come. For Berlin, in particular, with its very low home ownership rate (2011 census: 15.6%; other major cities: over 20%; Germany as a whole: 45.9%), there are therefore strong incentives for