Germany Housing Market on a 'Downward Path'... Factor in Prolonged Economic Slump

Rising Construction Costs Amid High Interest Rates
"Government Housing Supply Activation Policy Likely Ineffective"

The German housing market, which is on a worsening path, is unlikely to see a short-term turnaround and is expected to be a major factor prolonging economic stagnation.

According to the International Finance Center's report titled "Deterioration of Germany's Housing Market and Its Implications" on the 4th, the worsening housing market in Germany is making negative impacts on the economy visible, including insolvency of real estate companies, housing supply shortages, and contraction of household consumption.

In the second quarter of this year, European housing prices fell for the first time since 2014 (-1.1% year-on-year), but showed a slight rebound compared to the previous quarter, indicating a easing of adjustment pressures.

In contrast, Germany's housing prices have fallen for four consecutive quarters, with a cumulative decline of -9.9% year-on-year. Construction industry Purchasing Managers' Index (PMI) also worsened, hitting 39.3, the lowest since April 2020. The housing price decline rate in seven major metropolitan cities including Hamburg and Munich reached -12.6%.

Both demand and supply in the housing market have significantly contracted, driven by factors such as overvalued housing prices, deteriorating financial conditions, rising construction costs, and strengthened environmental regulations.

Liquidity loosened through the European Central Bank's (ECB) quantitative easing flowed massively into the German real estate market, resulting in a 93% increase in housing prices from 2010 to 2021. This figure far exceeds the European regional increase of 45.2%, and it is analyzed that the surge in mortgage loans during the ultra-low interest rate period contributed to the sharp price rise. Last year, the ratio of housing prices to income and rent rose to levels exceeding long-term averages by 20% and 40%, respectively, spreading perceptions of overvaluation and accumulating adjustment pressures.

Moreover, with market interest rates rising, companies are facing difficulties in financing. The International Finance Center explained, "Due to the high leverage characteristic of the real estate sector, the rise in interest rates inevitably causes damage. As market interest rates have risen sharply, both homebuyers and developers have experienced worsening financial conditions."

In a high-interest-rate environment, rising raw material prices and labor costs have also caused construction costs to surge, worsening the profitability of housing construction projects. The International Finance Center added, "The number of new building permits in the first half of this year is 27% below the average since 2018."

Government policies to strengthen environmental regulations, such as improving building energy efficiency, are also increasing companies' cost burdens. In line with the European Commission's (EC) policy to improve building energy efficiency ratings, the German government is promoting the implementation of the Energy Efficiency Standard (EH40), which limits primary energy use of new buildings to within 40% starting in 2025. Currently, the share of renewable energy and heat pump use in German households is 18%, significantly lower than other countries such as France (32%), Portugal (46%), and Finland (43%). According to the German Real Estate and Housing Association (BFW), construction costs are estimated to increase by 20% upon the implementation of EH40.

The International Finance Center stated, "As the real estate and construction sectors, which account for 16% of Germany's total added value and 6.8% of total employment, experience worsening conditions, the risk of economic downturn has increased." It added, "Although government measures to activate housing supply and stimulate the construction market are expected to contribute to supply expansion, an immediate turnaround is unlikely due to high construction and financing costs." Bloomberg also reported on the 2nd (local time) that "Affordable housing was one of the key pledges of the coalition government led by Chancellor Olaf Scholz since taking office in 2021, but economists predict the government will not achieve the target of supplying 400,000 new homes before 2026."

Furthermore, the International Finance Center explained, "Although the housing market deterioration is particularly pronounced in Germany, it is necessary to note that prolonged high inflation and high interest rate environments could increase housing market weakness and economic downturn risks in other countries as well."