Residential property prices in Germany have already fallen significantly and the correction is likely to continue in the coming months. However, there are first glimmers of hope. According to an ECB survey among banks, demand for real estate loans has at least increased somewhat.
Price correction in full swing
Prices for German residential properties have fallen significantly since mid-2022. The trigger was the massive rise in interest rates after the central banks made a drastic change in their monetary policy due to increasing inflation. According to data from the Federal Statistical Office, prices for existing residential properties in particular have fallen. At the end of last year, these were on average 14% lower than at their peak in spring 2022. New buildings recorded a significantly smaller decline of 5%.
Low sales indicate further downside potential
The price correction is unlikely to be over yet. Despite the fall in house prices, the number of transactions remains significantly lower than before the interest rate increase. There is obviously still a large gap between the price expectations of buyers and sellers, which has arisen because many potential buyers cannot finance a property purchase at current prices under the current financing conditions.
However, many potential sellers of existing properties are apparently not prepared to make any noticeable price concessions, even though they mostly bought their properties a long time ago and at significantly lower prices than they could currently be achieved, meaning they are “just” foregoing book profits on further purchases. Many, however, are still based on the prices that were achievable three years ago. This is even more true as, according to a recent Bundesbank survey 40% of private individuals still assume that property prices will rise in the next twelve months. That is why the prices for existing properties have probably fallen in the last two years, primarily because some of the owners had to sell the properties for various reasons (e.g. due to moving, divorce, death). In the long run, however, the other owners are likely to realize that they will no longer be able to match the prices from 2021 for the time being and will have to make price concessions.
How far will prices fall?
This is what the estimates show Bundesbank in its monthly report for February that prices still need to fall to get back in line with their long-term determinants such as interest rates and income. Compared to the first quarter of 2024, they estimate that there is still a further correction potential of 5% to 10%.[1]
Our affordability index, which relates the debt service when purchasing a property (interest and repayment) to income, speaks more towards the lower limit of this range. Rising incomes and house prices that have now fallen have already made them somewhat more affordable (Figure 2). If incomes continue to rise at a healthy rate and interest rates for 10-year mortgage loans remain at the current level of around 3.5%, a further 5% decline in house prices would be enough to bring the affordability index to a similar level to 2010 by the end of the year press when the real estate boom began.
Uncertainty factor of renovation costs
However, additional downward potential for the prices of existing properties could result from the fact that potential buyers have become more aware of the costs of energy-saving renovations that are necessary in the medium term over the past two years. These are not insignificant, like one Report for the consumer advice center confirmed (Figure 3). The study calculates the renovation costs for buildings built between 1919 and 1978 in order to bring these properties up to date. Necessary basic repairs and maintenance measures have always played a role in determining prices, while energy-saving renovations were often of secondary importance. According to the study, the latter amount to between 400 and 510 euros per square meter – depending on the desired level of efficiency. Since the study was written in 2021, the costs today are likely to be a good 20% higher, based on the general development of construction costs. This would result in costs of between 70 thousand and 90 thousand euros for a house with a living space of 150 square meters. Around half of these costs could be financed through subsidies, at least at the time the study was prepared, so that the costs borne by the owner would correspond to around 6% of the purchase price with a purchase price of 500 thousand euros. However, the resulting further downward potential for the average purchase price of an existing property in Germany is likely to be smaller. These costs are likely to have played a role in price determination in the past – albeit not as prominently. In addition, the study only looks at houses built before 1978. In the case of younger houses, the costs for energy-saving renovation – if this is necessary at all – are likely to be significantly lower.
Number of real estate transactions hardly increased,…
The fact that the number of real estate transactions has barely increased again after its significant decline in 2022 speaks against a quick end to the price decline. The number of newly concluded mortgage contracts, which represents a good approximation and which we have seasonally adjusted on a monthly basis, is still a third below its level before the interest rate turnaround, and recently there has been at most a slight increase (Figure 4). Apparently, the price expectations of potential sellers and buyers are still far apart in many cases.
Given the fallen prices and therefore lower supply, the number of transactions is unlikely to reach the 2021 level again. However, a noticeable increase can be expected if residential properties were once again as affordable as before the interest rate turnaround, taking into account interest rates and income development.
… but somewhat stronger demand for credit
The recently published one offers more hope Bank Lending Survey (BLS) the ECB, in which the banks report that demand for real estate loans has recently increased again (Figure 5). The question is how the demand for real estate loans to private households has changed in the last three months, which on balance is viewed as positive by around 46% of banks, after the majority of credit houses had reported a decline in demand in the previous seven quarters.
Prices will probably fall until the end of the year
Despite these initial signs of hope, the prices of existing properties are likely to continue to fall. The further downward potential is likely to be 5% to 10%, even when taking into account the costs of energy-saving renovations. If there is no further noticeable rise in interest rates, prices are likely to stabilize around the turn of the year.
New construction continues to struggle with high construction costs
The situation with new buildings is different from the existing properties that have been the focus so far. Here too, higher interest rates make it more difficult for potential buyers to finance, which puts sales prices under pressure and has also fallen by 5% since their peak. However, the sellers are unlikely to be willing to make any further noticeable price concessions, as this would quickly put them in the red. Because construction costs have increased dramatically, especially in 2021 and 2022. Although this increase has largely come to a standstill, construction costs have not fallen, at least until the end of 2023; slightly lower material costs were offset by a further increase in labor costs (Figure 6).
Labor costs are likely to continue to rise for the foreseeable future. After the conclusion of this year’s collective bargaining round appears to be over, collective wages will be increased by 250 euros on May 1st, which, according to our estimate, corresponds to an average increase of around 6%. They will probably rise by another 4% on April 1st next year. The wage costs for the workers covered by the collective agreement will increase noticeably. This means that sellers of new buildings are unlikely to offer price discounts in the coming quarters to the extent that would be necessary to quickly find a new market equilibrium. That is why the adjustment here should primarily not be based on the price, but rather on the quantity, i.e. the number of newly built houses.
[1] Measured against the average for 2023, the Bundesbank estimates an overvaluation of 10% to 15%. However, prices fell over the course of 2023 and, according to our estimates, they are likely to have fallen further at the beginning of the year, so that real estate prices in the first quarter are likely to be around 5% below the annual average for 2023. This leaves a downside potential of 5% to 10%.