Germany’s real estate market: Demographic shifts, economic trends and policy impacts
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The market for residential real estate in Germany has experienced significant changes since 2010. Initially, prices and rents rose substantially, making the residential real estate asset class increasingly attractive to institutional investors. Sentiment indicators for residential real estate outperformed all other real estate asset classes from the financial crisis until 2020. Over the last three years (2021 to 2023), the share of the national transaction volume for residential real estate can be estimated at around 30% on average, which is twice as high as in 2007 (15%).
Investors benefited from stable cash flows due to the diversified tenant structure and the limited default risk, particularly in the context of a low interest rate environment. However, the inflation shock on the supply side and the resulting interest rate increases led to a significant price correction in the market. As depicted in the chart, the house price index peaked around 2020 but has since declined sharply, coinciding with a rise in interest rates.
The higher base rate, crucial in risk calculations, has resulted in significantly higher capital costs (falling real estate factors) and thus in declining property values. Concurrently, financially strong potential buyers have increasingly shifted to renting, driving up rents across a wide range. This dual impact highlights the changing dynamics in the German housing market.
Demographic trends
Demographic shifts are becoming increasingly pronounced in Germany, reflecting trends seen across the European continent. While the overall population is expected to remain stable, the proportion of the older population (age cohort 65+) will increase significantly compared to the working-age population (15 to 64 years). The chart illustrates these changes, showing that while the total population has gradually increased since 1992, the 65+ age group has grown substantially faster.
In 1990, the share of elderly people was around 15% of the total population. Currently, the 65+ age cohort accounts for almost 20%, and by 2030, it is expected that one in four people will be 65 or older. This demographic shift highlights the growing challenges for state pension provision in Germany, which operates on a contribution-based system.
Contrary to the assurances of former German Labour Minister Norbert Blüm in the mid-1990s that "The state pension is guaranteed," it is now evident that all German citizens should also consider private retirement savings to ensure financial stability in their later years.
Impact on pricing and outlook
But what impact will these developments have on the long-term price development of residential property? On the one hand, demographic shifts are reflected in higher demand for age-appropriate flats and accommodation units, which supports the cash flow component. On the other hand, the ageing of society affects interest rates and consequently the derived capital costs. Higher life expectancy, in particular, requires increased savings until retirement to maintain consumption in old age.
The chart illustrates this savings behavior, showing a significant spike in the savings rate during the COVID-19 pandemic, often referred to as "forced savings" due to limited consumption opportunities. This behavior contributes to an aggregated increase in the overall supply of capital in the economy. As the interest rate serves as the equilibrium price of capital supply and demand, a higher supply of capital typically leads to lower interest rates.
In the long term, current debates (such as the "Deutsche Schuldenbremse" or "German debt cap") suggest that the demand for capital will not keep pace with the increasing supply in the coming years. This scenario will likely exert further downward pressure on interest rates, which could encourage investment in real assets such as residential real estate.
Conclusion
The German residential real estate market has seen significant changes over the past decades, driven by demographic shifts, economic trends and policy developments. Rising demand for age-appropriate housing, combined with the impact of higher life expectancy on savings behavior, underscores the need for strategic investment in the real estate sector. As interest rates are influenced by an increasing supply of capital and ongoing policy debates like the "German debt cap," the outlook suggests a continued interest in real assets. Investors and policymakers must navigate these trends carefully to sustain and enhance the market's stability and growth.