Where will Germanys property prices go?


A view on the German
Property Market in 2006

The years 2004 to 2006 have shown a considerable interest and sales to foreign investors of all orders of magnitude, from the single apartment for 100.000 Euro up to some 100 Million and more deals. Many a private investor has come as follower in the wake of the global players, and Germany certainly was their main focus of attention. Generally the property market in Germany is still under-valued in comparison with other major European countries - indeed the prices seem to be incredibly low in many cases. One should not forget, however, that the purchase prices in Germany are the pure buying prices without the extra cost factors like stamp fee, brokerage fee, notary and registration costs, which add up to another approximately 8-11%. This should be taken into account on any calculation. Another issue is the taxation, which is not subject of this article but must be taken into account as well.

But despite of both factors, taxes and purchase costs, the property prices are comparatively low in Germany and have not shown any remarkable appreciation over the last eight to ten years with some exceptions.

One of the conclusions is, that due to German economy having been on a long-term low, the house market did not move up for a long while. And that despite of the low interest rates – the banks were not encouraging loans for property investments and set the criteria for loan applications very high. One reason for this has been too many forced sales and bad loans.

This trend is now – in the fall of 2006 – turning around and we assume that this period of time will mark the starting line for a value-increase in properties in the coming years.

One of the pluspoints is that the unemployment rate has reduced from 5 Million in January 2005 to 4.23 Million in September 2006, that’s an improvement of nearly 15%. The new-debts rate of the German state will meet the EU criteria first time this year 2006 since many years. These are general indicators of a substantial improvement and they may reflect on the rents and prices in the long run.

However, as of now the property prices are pretty constant. A real uptrend can only be observed in the upper segments of high class locations and large high quality apartments, on the major Cities like Frankfurt and Munich. This however is not so much the market of the typical investor who buys for the purpose of letting out the property but these are mainly owner-used.

We have been asked this question many times in the recent months and want to discuss some possible answers to it now: Will property prices in Germany really fulfil the high-flown expectations in the future? To get a better understanding of why the property prices are on such a long-term low in Germany, one must look back a bit in the latest chapters of history in Germany.

Hardly anyone has paid consideration to one historical factor: In 1989 the Berlin Wall and with it the Iron Curtain between East and West Germany fell. It was less than one year later that former West and East Germany became one country again after more than 40 years.

But what did that mean for former West Germanys economics? 60 Million people now were joined by about 18 Million new citizens. These new members, Germans from the East, economically spoken, had nothing much to bring along as assets. The houses, roads, infrastructure were in a terrible condition. The peoples were very happy to become “one people” again. And in the following years many of those in the eastern parts of Germany went to the western parts for jobs and education. At the same time, the German government decided to get the eastern part of the country completely renewed and modernized. In order to give sufficient encouragement to investors for real estate renewal, a special tax benefit was introduced, the so-called "Sonder-Afa" (special depreciation). Up to 100% depreciation of the investment could be depreciated, meaning deducted from the investors taxable income, in the first five or even less years. Banks at the same time would finance building projects for such investors and naturally, initiators ran to buy land and old houses and get plannings done for new ones as quickly as they could, because the prices were low. They sold their projects for high prices, but the investors – mainly the well-earning private investor – did not realize that rents cannot go up or stay high in an area where people have no jobs and from where they emigrate to other parts of the country.

Concurrently, almost all of the former large East German companies – most of which had been state owned, under the socialistic system – were sold out at bargain prices and subsequently closed down, for being totally out of date technically or for producing what was no longer needed and wanted. That meant more jobs lost. State support was increasing at a high rate, and Germanys public debt level grew at a never-before seen speed.

To this add another factor: The German Mark and the East Mark had been exchanged through the monetary union in 1990 by 1:1 or 1:2 depending on whether it was cash or savings, and this added another challenge to Germanys economy. The actual market value of the East Mark had been around 10% of the West Mark. The German government guaranteed that all eastern pensions had to be fulfilled by the German government practically at par value to the west pensions. But the number of unemployment was rising year by year, and especially so in the former eastern part of the country, so less and less was paid into the pension system by the working generation, and again, state support had to prevent a collapse.

Now if you add up all these economic factors and a few more that are not mentioned here, all of them happening in the era of the CDU, you will realize that in 1998 the social democrats in combination with the Greens inherited a nearly unresolvable problem: How to get the unemployment rate down when at the same time the public debts figures were running out of control. Lowering taxes and work cost and lowering social support from the government was inevitable and got pushed through in the years 2001-2004, but this did not yet turn the scene around. The German government was practically unable to reverse the trend of rising unemployment, increasing public debts and increasing rates of business and private bankruptcies.

We do not want to judge over history and for sure we do not object the process of the German reunion. In fact, Germany had no other choice. And nobody is in any position to say he would have known better. If you enlarge a country by 30% and that added part is 40 years back in technical development and economical condition, the other part will suffer for a long time of this no matter what. Some have said it takes a whole generation until Germany has really managed this in full.

And that is also the answer to the question: Why did Germanys property prices stay comparatively low over the last 10 years? And it answers why Germany was so much behind the development in many other countries in the world. No other country ever had to carry such a huge load economically, and we did not even mention the additional factor that Germany is one of the main contributors the European Union funds. Germany almost broke its back under those loads, but now seems to have started the recovery process, still struggling along but with more optimism, more willingness, more positive attitude and after all, more and more jobs being created and reducing the unemployment percentage almost month by month.

So as an investor in Germany one should always keep in mind that this country still has to carry a tremendous load with the reunion. And take into account that a horse with such a load may run slower than the other horses yet for quite a while.

To come back to the property market and how it will develop in the coming years: Certainly, if economy is doing better and better, it can be expected that we will have a fairly good value increase in all the major cities where the job places are available or being created. That would be the often quoted main cities like Frankfurt, Munich, Düsseldorf, Hamburg, Stuttgart, Berlin, but also less well known towns in well developing areas. In these segments of the market we can expect an annual appreciation between 3 to 5%. As long as interest rates are at a level around 5% the financial risk is not very high, as the rents normally will pay the monthly rates. But also medium size cities – local centers – should be looked upon as well, especially as these are places where the prices are very often very undervalued still.


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