Rental prices: A correlation analysis reveals something surprising
The rise in rental prices has become a key topic in public debate. In most large German cities, rents for new lettings have risen significantly in recent years – in some cases at an explosive rate. While, on the one hand, the topic is hotly debated in political and social circles, on the other hand, investors are wondering which (sub) markets still offer potential for continued positive rental price growth.
From an investor’s perspective, rental yield is a decisive factor in assessing the performance of a residential property portfolio – both directly through the current cash flow and indirectly through its impact on property price growth. For investors, reliable rent forecasts, or at least sound indications of trends and bandwidths, are therefore important instruments in shaping their investment strategies. First, we need to be clear on which factors have the greatest influence on the development of rental prices.
In a broad-based correlation analysis, the research team at Empira examined which regional and national economic and real estate factors correlate with the development of rental prices in 80 German cities with at least 70,000 inhabitants. In short, labour market data exhibit the strongest correlation with the development of rents over a ten-year period, taking into account a large number of significant influencing variables. At the same time, the analysis reveals that it can take some time before certain economic and sociodemographic developments are reflected in the housing market.
The correlation analysis also reveals some findings that may seem surprising, at least initially. One example is the positive correlation between the development of rental prices on the one hand and the number of building permits for new housing on the other. This means that, statistically speaking, an increase in the number of building permits correlates with rising rents. Although the resulting correlation coefficient indicates a moderate correlation, it is positive and statistically significant at both city and federal level – even up to two years later. The same applies at federal level for completions. According to popular opinion, these correlations should actually be negative, which means that an expansion of supply should cause rental prices to fall.
There are two main explanations for this effect: On the one hand, new property developments are generally applied for and approved in areas where demand is already high and rents are therefore rising. On the other hand, new apartments are typically rented at higher rents than existing properties. From a statistical perspective, significant increases in residential construction lead to higher rents, except where housing is subject to rent control. Finally, this positive correlation does not confirm that an increase in the number of building permits will satisfy the existing demand for housing in any given location. If demand remains higher than supply, rents will continue to rise, even as supply grows. This is confirmed by the positive correlation between rental price growth and the number of inhabitants in a city.
In its study, Empira’s research team analysed the correlations between rental price growth and a number of factors, including population, gross domestic product, disposable household income, gross wages and salaries, employment and unemployment rates, building permits and apartment completions, condominium purchase prices and vacancy rates. One thing is clear: the study analyses historical data and does not necessarily allow conclusions to be drawn about future trends. Moreover, correlations are not the same as causalities. However, when you compare Empira’s ranking of the 80 cities according to their rental price growth rates with the most important influencing variables, it becomes clear that the correlation analysis can certainly provide accurate indications of the factors investors should pay particular attention to as they seek to identify further rent increase potential at individual locations.
Link to the study
Link to the website
The “Berlin yield”: The benchmark for the German real estate market
What is it that still attracts international investors so enthusiastically to Berlin? It cannot be the nominal gross yields, which, in some cases, have dipped below three percent for residential properties within the commuter rail ring. The situation is not much better on the commercial property market. Over the last few years, Berlin has been playing catch up with other markets thanks to above-average price increases. Quite a few market participants are now expecting this cycle to come to a gradual end, especially as a tentative turnaround in interest rates is imminent. However, investors are looking for something else in Berlin. Something I call the “Berlin yield”.
International investors are used to regarding a country’s capital and major cities as a separate, independent market. In their view, the markets in London and Paris are quite different from the rest of Great Britain and France. Only in rare cases do countries have a second major city worth mentioning besides the capital, for example Milan or Barcelona. This view is also slowly gaining ground in Germany, where Berlin as the capital and largest metropolis lagged behind other markets such as Munich, Frankfurt and Hamburg for many years. Nevertheless, investors have long been looking primarily at one city: Berlin. Compared to London or Paris, however, the real estate markets – rents and prices – still have considerable catch-up potential. Berlin is no longer cheap, but it is still relatively inexpensive by international standards. Berlin is growing – last year alone the city’s population grew by more than 40,000 new Berliners. The economy is booming, salaries are now above the German average. Moreover, there is still plenty of space for new developments and retroactive densification.
Investors who are attracted by the “Berlin yield” do not expect high initial yields. They believe in the growth story of this town, in the potential that still lies dormant in Berlin even after the remarkable momentum of recent years and in the ever-increasing appeal of Berlin for people from Germany and all over the world. They also believe in Berlin’s growing status as Germany’s only truly world-class city. Even though Berlin will increasingly approach the status of Paris or London, its real estate market remains accessible with far lower entry prices.
For the real estate market, Berlin is the equivalent of a blue-chip stock. The Berlin yield is the benchmark for the German real estate market, just like German government bonds are for the bond market. It promises solidity and reliability – in combination with untapped potential and reduced downside risks. After all, the risks are not so high when prices remain low compared to other cities at home and abroad. Clearly, investors are willing to forego a few basis points given Berlin’s unique selling points.
Are property prices in Germany’s major cities about to fall? One recent study claims exactly that – but the reality is quite different
According to a number of recently published studies, real estate prices, in particular those in Germany’s largest cities, are about to fall. Such news spreads quickly, especially because it is opposed to the prevailing market opinion. On closer analysis, however, the facts behind these forecasts do not quite add up.
One example: According to a forecast from empirica, the popular Bavarian state capital of Munich is likely to experience long-term population decline.1 According to the institute’s latest study of ‘magnet cities’, “Munich’s population is set to decline more than almost any other major city in Germany”. The institute’s forecast is based on figures for the period from 2008 to 2013, which saw 14.2 percent of Munich’s 55-to-70-year-olds leave the city. “On balance, one-in-six of Munich’s residents leaves the city at retirement”, concludes the study. The situation could well become even more dramatic in the future. In cities such as Stuttgart, Düsseldorf, Cologne and Hamburg, the proportion of the population aged between 60 and 74 has already declined by at least 5.0 percent, and this decline is set to accelerate over the next few years. According to the study, such significant population losses will lead to property price drops.
It is all quite hard to believe, especially when you look at current market developments. Our conurbations certainly have a higher rate of population fluctuation than remote towns on the edge of the Alps or on the Baltic Sea coast. However, when institutes claim that property prices in Germany’s major cities are about fall drastically, we need to ask why. Their assertions are reasonable, but only because they choose which data they use.2 Yes, the proportion of German citizens is shrinking. Among Germany’s older generations (i.e. those above the age of 65), only one in ten has a migrant background. In the group aged 6 to 20, however, 38 percent have a migrant background. As a large number of cities have failed to adopt a uniform approach to tracking this generation of mobile young migrants, different figures emerge.
According to Deutsche Bank3 recent price rises in Germany’s Top 7 cities have averaged between 8 and 15 percent. Strong demand for housing is cited as the major price driver, and demand continues to strengthen. In the last three years alone – depending on the census – between 40,000 and 50,000 new inhabitants arrived in the German capital.4
Rental and property purchase prices will continue to rise. At most, we might see a slight slowdown in the pace of price rises in Germany’s largest cities.5 Ultimately, the decisive factor in price developments will be the strength of each city’s long-term economic growth.
For private investors and owner-occupiers, these are the key factors:
• As long as Germany’s largest cities keep on expanding, and not enough new housing is built, demand will remain high.
• Thus, property prices are set to keep on rising, even if some momentum is lost.
• We may see localized property price bubbles. However, these will only affect the most sought-after residential neighbourhoods.
Some have pointed to the fact that it can take several months to market certain properties as an indication that purchase prices have already risen too far. That is not true in the slightest. Developers have to absorb certain construction cost risks and are therefore willing to accept marketing periods of up to 12 months.
However, let us return to the seemingly imminent prospect of shrinking cities: Munich’s population has just grown again. Even though the city’s growth fell short of original forecasts, 2017 saw the population increase by 13,000.6 It is highly likely that some large cities failed to accurately report the growing proportion of people with migrant backgrounds. According to the latest figures, however, Germany’s Top 7 cities are definitely still growing.
The housing summit: An opportunity that simply needs to be seized
The housing summit is set for 21 September and preparations for are well underway. The summit gives us the opportunity to finally get housing policy on the right track.
The Chancellor has decided (or more precisely her calendar has decided): The much-anticipated housing summit, originally pencilled in for some time in October, has now been confirmed for 21 September, in Angela Merkel’s Chancellery. The fact that Angela Merkel is taking personal responsibility for the summit is a good political sign – a hopeful sign. When we at the IVD first raised the idea of a housing summit during the last federal election campaign, we explicitly requested the Chancellor’s direct involvement. After all, the housing shortage has taken on such an alarming scale that it cannot be remedied without coordination from the very top. In the words of Germany’s Interior and Building Minister, Horst Seehofer: “Housing has become the key social question of our age”.
Even if Seehofer’s words have been forgotten somewhat in recent months, largely because domestic policy priorities have been set elsewhere, they still represent a pregnant analysis of one of the greatest challenges Germany currently faces. To underestimate or ignore this challenge, as German politicians have negligently tended to do for years, could have fatal consequences. As we have seen repeatedly, the topic of housing has the potential to divide a society. You just have to look at the UK, for example, where lower income groups are now paying almost half of their incomes for rent. In addition, the Brexit vote, which can easily be interpreted as a serious expression of dissatisfaction and social grievances, is just one result of the country’s housing misery.
Of course, it would not be entirely correct to claim that German politicians have completely ignored the issue of housing. For years, they have only tried to tackle it from one direction: tenancy law regulations. Unfortunately, this approach has ultimately been less about solving the problem and more about symbolic politics. Shortly before the German parliament’s summer recess, the SPD’s Minister of Justice, Katarina Barley, presented yet another bill to tighten the rental price brake and reduce the modernisation levy. Her move was generally interpreted as a direct response to the CDU and CSU’s help-to-buy scheme for families with children. This approach may have resulted in an effective political compromise this time – the CDU/CSU and the SPD all got what they wanted – but it cannot deliver real solutions.
Isolated measures – however fundamentally meaningful they may be, as in the case of the help-to-buy scheme above – are not only less effective when they are not part of an overall strategy, they are also extremely susceptible to attack. The help-to-buy scheme for families with children is a prime example of what can happen: The scheme was pretty much ready to be rolled out when, as if out of nowhere, the SPD’s Finance Minister, Olaf Scholz, intervened. Measures to promote homeownership are not among his priorities; he is more concerned with maintaining a balanced budget. Scholz announced that he wanted to reduce significantly the number of beneficiaries. He also wanted to impose a limit on the size of the houses and apartments that would be eligible. In the face of a public backlash, he withdrew his proposals, but instead of imposing a limit on the size of eligible dwellings, the scheme now has a time limit – families can only apply until 2020. Anyone planning to buy real estate or start a family after 2020 is likely to miss out. It is clear that we are a long way away from a sustainable housing policy.
As this example shows, very little is achieved with the introduction of ad-hoc laws and isolated reforms. What we desperately need is a well thought-out and structured package; a combination of individual measures in pursuit of a common goal. With the housing summit, we now have the opportunity to put together such a package, provided the summit is not reduced to little more than a symbolic PR measure. Even so, as the summit gears up, committees all over the country are enthusiastically putting forward potential solutions and debating to find the most effective, solution-oriented measures. I hope that their ideas and proposals can be brought together on 21 September to develop a comprehensive plan. Accelerating construction approval procedures, making zoning more efficient, cutting construction costs, promoting homeownership – the list is long and the topics are complex, but solutions need to be found. If not, we risk endangering the cohesion of our society.
Housing shortage and the collective silence of developers
When it comes to the causes of housing shortage in Germany’s major cities, there are two worlds: those who know and those who do not. Developers know: They experience the obstacles created by politicians and government agencies on a daily basis. Everyone else is in the dark: Politicians, journalists, and the general public, whereby the few exceptions prove the rule. Their ignorance is by no means their fault and usually has nothing to do with ideological bias. Rather, the reason is that developers hardly ever dare to publicise the daily impositions made by politicians and government agencies. Understandably, they are afraid that bureaucrats will make their lives even more difficult if they name names and make specific cases public.
However, because I work with developers, I hear these stories almost every day. One developer is ready to build more than 1,000 affordable apartments in a large German city, but the development is on hold because an official from the city’s environmental office has found three hamsters. In another city, the development of several hundred new apartments, including some with low rents, others as condominiums, has come to a standstill because a damp cellar has been granted heritage preservation status. In one city with a serious housing shortage, the development of hundreds of apartments was initially delayed because the only official who could certify that the district had enough school places was ill for seven months and had no substitute. Once the official returned to work, a colony of sand lizards were discovered. An expert report was prepared to assess their number. The planning officials challenged the report’s findings. They met for an on-site “sand lizard summit”: officials, experts, project developers – 15 people. Result: A further expert opinion was requested, which would take several months to produce.
One-off cases? No. Unfortunately, these are typical. Every developer is familiar with such cases. They exist in Munich, Hamburg, Frankfurt – and worst of all in Berlin. The Senator for Urban Development and Housing from the left-wing Linke party has managed to reduce the number of building permits by 18.6 percent in one year. No wonder: Her advisors almost all come from left-wing extremist groups, including many from Berlin’s squatting scene. Investors are regarded as enemies who should be obstructed at every turn. For the Senator’s advisors, capitalism is the cause of the housing crisis. Particularly in this context, the opposite is true: Capitalism is not the problem, it is the solution.
The real problem is excessive government regulation. Unfortunately, developers have become accustomed to long and complicated approval procedures. It is not unusual for a whole decade to pass between the purchase of a plot of land and a development’s completion. Of these ten years, only two years are dedicated to actual construction work. The other eight years are spent resolving planning law issues and in discussions with politicians and government agencies. Moreover, digitalisation is making life easier everywhere, except in Germany. Recently a guest from the Netherlands was astounded when he saw 97 bulging files in the office of a Düsseldorf developer, who had to submit this paperwork to the authorities, all signed individually. In the Netherlands the whole process would have been digital. But not in Germany.
In addition, the introduction of new and ever stricter environmental regulations, many of which make absolutely no sense whatsoever, have made construction more expensive – without making any meaningful contribution to saving the planet from climate change. Since 2001, one EnEV (Energy Saving Ordinance) has been chasing the next and each new version makes construction even more expensive. The main beneficiary: the insulation industry. The German Medical Journal has reported that hermetically sealing indoor areas has led to a significant increase in mould infestation in apartments. This can cause asthma, pneumonia and other dangerous diseases. Some U.S. states have already banned the use of insulation panels because of these health risks.
In addition, developers are increasingly being required to offer apartments at uneconomically low rents, especially given the rapid rise in land prices and construction costs. All major cities have such mandatory requirements, even if they go by different names. The deal: You can only get permission to build condominiums if you set aside a quarter, a third or maybe even half of the units you develop to be rented at such low prices that you cannot even cover your construction costs. This forces developers to cross-subsidize, which is only possible if they develop very expensive condominiums. This leaves no place for mid-price units.
So, according to politicians, large sections of the media and therefore also the population, who is to blame for rising rents and the increasing scarcity of housing? Rapacious real estate investors and brokers who only have dollar signs in their eyes! However, this could not be further from the truth: Developers just want to build – they make their living from building, not from its prevention.
For years I have played with the idea of publishing a “black book on the prevention of housing construction”, which, like the Association of Taxpayers’ annual black book of wasteful public spending, would break through the wall of silence and attract public attention to such cases. Maybe, if enough developers are willing to break their silence, I will actually do it.