#03 A look behind the crisis scenes

It is worth taking a very close look and not generalising. Because unlike in China or the USA at the moment - or in Spain from 2007 - we are not experiencing a property crisis of its own accord in Germany. In other words, there is neither a fundamental imbalance between supply and demand nor massive over-indebtedness. What we are experiencing instead is a cyclical correction due to the rapid and massive turnaround in interest rates. And we are already largely through this.

What does crisis mean here?

Definitions of a crisis vary slightly. Oxford Languages defines a crisis as a "difficult situation, situation, time [that represents the climax and turning point of a dangerous development]". The German Federal Agency for Civic Education (bpb) speaks of a "period of [...] massive disruption to the [...] economic system". At the same time, it emphasises the "opportunity for improvement". A crisis is often seen as a turning point in events, but primarily from a geopolitical perspective.

A property crisis can best be seen as an endogenous development in which a phase of value adjustment and "stress" is triggered - either due to a fundamental or cyclical imbalance in the property sector itself.

What we experienced globally in 2007 and the following years was a property crisis in the USA: there was an over-financing of (private) investments and project developments, which ultimately led to excessive construction activity and over-indebtedness. In turn, the US financial system exported this problem to the world through financial products (1). Or the other way round: the world imported the problems - nobody was forced to buy these products. This resulted in a credit and financial crisis that impacted on the real economy. 

And it was the latter that hit the German property market. Germany basically had no endogenous property issue - leaving aside a few overly aggressively financed investments. What primarily affected the German property market was the overall economic development, which resulted in lower demand for commercial rental space. Residential property was virtually unaffected by this development. It is therefore hardly possible to speak of a property crisis in Germany.

It was a different story in Spain, for example, where massive speculative overbuilding - which failed to meet demand - led to a price correction in the residential property sector that lasted for years and exacerbated the recession.

Back to the present

What we have been experiencing in Germany since 2022 is primarily the effects of the interest rate turnaround and the rise in financing costs, which have led to a significant price correction. It is therefore primarily the exogenous factor that "money is no longer free" that is responsible for the current development. This is particularly pronounced because the low and zero interest rate policy that has been in place for years has made property more attractive than investment alternatives such as bonds or call money, even at very high entry prices.

As in other sectors, the refinancing situation remains a risk in the residential property sector. On the one hand, higher running costs may materialise. On the other hand, if values fall, the financing may be offset by an unhealthily high loan-to-value (LTV).

There is a shortage of space in the residential segment - no surplus

Fundamentally, however, large parts of the German property market are stable. On the contrary, we are experiencing a shortage of space in the residential property sector. Demand clearly exceeds supply, which is keeping pressure on rents high. With the price level now much more sustainable, we therefore consider it a very attractive time to enter the asset class.

In recent articles in Focus (2) and Business Punk (3), the author refers to the UBS Global Real Estate Bubble Index, stating that Munich and Frankfurt am Main are included. Munich has indeed been in bubble territory since its inclusion in the index in 2016. Looking back, however, we agree that it would have been a good idea to buy residential property in Munich in 2016 - or would it? In the 2016 issue, UBS also wrote that "all European cities, apart from Milan, are at least in overvalued territory (4)". This illustrates the difficulty of identifying a bubble and, above all, the imminent bursting of a bubble.

Structural change in the office segment

The situation is slightly different in the office property segment. Due to the overall economic situation, global structural issues are encountering cyclical headwinds. However, Germany should certainly not be seen as an isolated case. The problem is of a global nature and is very pronounced in the USA. The key issues are the opportunities for remote working, which is having a massive impact on the utilisation of rented space at many companies. This explains the currently very restrained demand from investors for the corresponding properties.

The risks emanating from developments in China and the USA nevertheless remain relevant for the market as a whole and the parties involved. As in the 2008/09 cycle, this may have an overall economic impact and affect demand for (commercial) space. Demand for residential space, on the other hand, remains negligible. 

The issues may also have a negative impact on general investment sentiment. However, this is offset by the fact that the German market has already undergone a significant repricing and is therefore more attractive again as an investment location.

So do we now have a property crisis in Germany, yes or no?

A very clear "yes". Or rather: "Yes, but only selectively." In some segments we have a crisis, in others an upswing phase should now begin.

The office sector is (still) in crisis, yes. However, the markets are perhaps even exaggerating and generalising there at the moment, so that there are interesting investment opportunities on an individual basis. The property development and construction sector is also in crisis. Some market participants that are dependent on the dynamics of the investment markets are also in crisis - but this is highly individual and less of a systemic issue.

But other sectors, such as logistics, hotels, life sciences, data centres and even retail and residential property in particular, should be removed from the general debate and considered on a very individual basis. In fact, there are currently more opportunities for those who take a closer look - and do not literally lump all property types together.

^{(1) MBS – Mortgage Backed Securities, CMOs and CDOs}

^{(2) Immobilienkrise frisst sich wieder um den Globus – die erste deutsche Bank wankt - FOCUS online.}

^{(3) China wankt, USA weint - Autsch, sind wir als nächstes dran? Die globale Immobilienkrise haut rein - Business Punk (business-punk.com).}

^{(4) UBS 2016: Bubbleindex_US_finalversion.pdf (ubs.com).}