Trends and insights of the residential market in Germany
FUNDAMENTALS REMAIN POSITIVE
In more than two years of the Corona pandemic, with repeated lockdowns and great uncertainties regarding economic recovery, residential investment markets have remarkably proven their resilience. Almost €51 billion was invested in larger residential portfolios (30 units or more) in 2021, clearly a fabulous record. Measured in terms of turnover, investor interest is perhaps greater than ever before. The decisive question, however, is whether the momentum of the past two years is sustainable and able to endure into the medium term.
The fundamental data continues to bode well for the housing markets. Although the number of construction completions has gradually increased over the years, this has not led to any sustainable relief effects so far. At the federal level, the market-active vacancy rate fell below the required fluctuation reserve of 3% for the first time in 2016. It now amounts to a good 2.8%. Although there was a slight increase of around 8,000 units from 2019 to 2020, it would be premature to speak of an emerging reversal of the trend here. Rather, migration slowed by the Corona pandemic is making itself felt. The influx from abroad is likely to gain momentum again in the future.
INSTITUTIONS INCREASINGLY COMPETING WITH PRIVATE INVESTORS
Excess demand for housing continues to dominate the market. In addition to very stable cash flows, there are also opportunities for future medium- and long-term appreciation. However, it must be considered that the situation in individual markets and regions is nuanced as a result of past conditions and market developments. For example, the development of prices and rents in A-cities and those which attract younger inhabitants, already favoured by investors, is already significantly more advanced than in smaller towns and communities in surrounding metropolitan areas.
Another trend that will have a significant impact on future price development is the increasing interest of private investors in residential property. This is reinforced by rising inflation. Private investors are increasingly looking for safe investment opportunities that still offer attractive interest rates. Since the spread between prime yields in new builds and 10-year federal bonds is around 250 basis points, residential real estate is still an attractive proposition despite an already marked rise in prices. This is all the more true if seeking an inflation-hedged investment, such as residential investments. The spread versus inflation-hedged federal bonds has recently widened again and is now over 400 basis points.
Demand for residential investments is continuing to grow and is increasing competition, not least between private and institutional buyers. Against this background, there is much to suggest that prices, especially in sought-after locations, will continue to rise.
FOCUS ON OUTLYING COMMUNITIES AS AN ALTERNATIVE
For many investors, the potential offered by the wider metropolitan hinterland could be an obvious alternative to further yield compression in the A-cities. The close socio-economic links mean that these outlying settlements are under the direct influence of the A-cities and likewise benefit from their positive fundamentals. In addition, the housing shortage in core cities is increasingly driving people to move to the surrounding areas. Pressure on housing in the metropolises eventually catches up to the surrounding areas after a short interval. So, like the A-cities, the housing markets of the periphery offer stability and security to investors.
Comparing the relationship between the development of apartment purchase prices and rents in A-cities and their surrounding municipalities, it becomes apparent that decoupling of prices is not only far advanced in the metropolises. Purchase prices in the top 7 cities, for example, have risen a good 1.4 times as much as rents since 2014. In those municipalities within a 30-kilometre radius of the A-cities, decoupling has begun with a two-year lag, but it is now already 1.3 times higher.
Even though peripheries have experienced a significant price increase in recent years, there is still a crucial difference to the top 7 cities, namely price categories, and indirectly, the potential for value appreciation. Analysis of the cost burden (measured against disposable household net income) for an average private household renting a 70 m² new-build flat shows that in 2021 the average burden for the A-cities was 32.5%. Of course, these are average values, but the evaluation shows that potential for rent increases is limited across the board.
The situation is significantly different in surrounding municipalities. The cost burden amounts to a good 23%, so a considerably greater rent increase potential can be expected here.
In addition, although price increases of apartments in relation to rents is also considerable in the surrounding areas, this cannot be transferred one-to-one to investment properties. In contrast to metropolitan areas, the majority of listings for sale in surrounding areas are aimed at owner-occupiers, meaning that apartments are usually of a high standard and are not intended for rental. A comparison based on supply data therefore slightly overestimates the relative price increase. Consequently, yield compression for investment properties probably took place much more slowly in the surrounding municipalities.
BUILDING LAND NOT ONLY IN DEMAND IN A-CITIES
Project developers in particular have recognised growing demand outside the major metropolises and is reflected not least in the development of investments in residential building land.
In 2021, a good €1.4 billion was invested in land for larger construction projects outside the top 7 locations. It is noteworthy that a large proportion of recorded transactions are located outside the B-cities, proving once again that the focus of new developments is not only on tried and tested locations.
Nevertheless, A-cities are also disproportionately represented with a turnover of around €1.3 billion. The glaring product shortage in the portfolio segment is particularly noticeable, resulting in a desperate search for new developments.
CONSTRUCTION PRICES RISE SHARPLY
Another factor that is likely to have a clear impact on the development of yields in the coming months is the rise in construction costs. In the fourth quarter of 2021, costs rose by a whopping 11.6% compared to the same quarter of the previous year, which is the highest increase by far in the period under review since 2014. In view of the very high workload of construction companies, as well as further increases in material costs, it can be assumed that this trend will continue unabated in 2022.
In order to be able to continue building and cover costs, it is already foreseeable that purchase prices for new construction projects will have to increase once again. Whether this price increase can be passed on directly to end users everywhere seems questionable, especially in light of the analysis of the cost burden on private households. It is currently very likely that the increases in construction costs will also have an impact on yields.
REINVESTMENT NEED IS ENORMOUS
Even if prices are likely to continue rising in the coming months and years, particularly in the prime locations, demand for residential investments will remain high in the medium term.
Just a look at the expiring German government securities over the next five years shows how great the investment pressure will continue to be. Leaving treasury bonds aside for a moment, German government bonds with an average annual value of around €110 billion will expire up to and including 2026.
Even if only a small share of this huge sum flows into residential investments, the market is likely to be characterised by excess demand for years to come. Against a backdrop of rising inflation and economic uncertainty, it does not seem unlikely from today's perspective that the share of residential investment as an attractive reinvestment opportunity will continue to rise.
KEY TAKEAWAYS FOR THE YEAR 2022
- Fundamentals remain positive overall. Vacancy rates are marginally increasing, but this can be attributed to limited migration in the wake of the Corona pandemic. There continues to be excess demand in the rental housing market, although this varies by region.
- Institutional investors are increasingly competing with private investors in the metropolises, leading to significant price increases.
- Alternatives to A-locations are increasingly in focus in the search for product. In particular, surrounding communities of top locations offer healthy appreciation potential with very good fundamental data.
- Building land is in greater demand than ever before. While there is a desperate need for new developments in the Big 7, the focus is also shifting to well-connected communities in growth regions.
- Construction prices will continue to rise, so prices for new builds will also have to increase in order to cover costs.
- The "wall of money" continues to pile up. Great need for reinvestment due to maturing federal bonds.
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We are pleased to be able to show you the pleasing development of the residential market in detail in the fourth edition of the report specially designed for institutional investors. In addition to market data for the most important top locations, the report includes fact sheets for 110 cities.
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The statements, information and forecasts made by us represent our assessment at the time this report was prepared and are subject to change without notice. The data has been obtained from various sources that we believe to be reliable, but we do not guarantee its accuracy or correctness. This report explicitly does not constitute a recommendation or basis for investment or leasing/renting decisions. BNP Paribas Real Estate assumes no guarantee and no liability for the information contained and statements made.
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BNP Paribas Real Estate GmbH | Editing: BNP Paribas Real Estate Consult GmbH | Date: February 2022