Real Estate in Germany. Boom or Bubble?

Bachelor Thesis, 2019

52 Pages, Grade: 1,7






2.3.1 Real Economic Terms
2.3.2 Fiscal Terms
2.3.3 Behavior Based Reasons
Limited Rationality
Greater-Fool Institutionalization/ Herd instinct
2.4.1 Displacement
2.4.2 Boom
2.4.3 Euphoria
2.4.4 Profit Taking
2.4.5 Panic
2.5.1 Absolute/Relative Price Development
2.5.2 Price-Rent-Relation
2.5.3 Price-Income-Indicator
2.5. 4 Fundamentally Justified Price


4.1.1 Development of the Demand Population Growth Household and age structure
4.1.2 Development of the Supply
4.1.3 Implications for the financial system
4.1.4 Bank Landing in Germany
4.2.1 Price-Rent Ratio
4.2.2 Price-Income Ratio
4.2.3 Tobin q
4.3.1 Inheritance
4.3.2 Foreign Investors




Figure Index

Figure 1: Equilibrium Price

Figure 2: Discrepancy of the market value from the fundamental value

Figure 3: Exemplary Causes of a Price Bubble

Figure 4: Formation of a Bubble

Figure 5: Circle of a recession caused by credit crunch

Table Index

Table 1: Population Size of Germany

Table 2: Price-Rent Ratio 2012-2015

Table 3: Price-Rent Ratio 2016-2018

Table 4: Price-Income Ratio 2012-2017

Table 5: Tobin q from 09/2017 until 09/2018

Table 6: Development of Apartment Prices from 09/2017 until 09/2018


Abbildung in dieser Leseprobe nicht enthalten


Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

The introductory chapter is intended to give the reader a basic understanding of the background to the research area in order to understand why the topic is being considered and how it is examined.

1.1 Problem Statement

Real house prices have been declining between 2008 and 2010. This trend has changed within the second half of 2010 when prices of houses and apartments in Germany started to rise at a rapid rate (REF. OECD, 2019).

This might recall the mortgage crisis in the US in 2007, which had a huge impact on the global economy and was followed by a bank and governmental crisis. A development of this kind can lead to concerns about the stability of the housing market in Germany (REF. DUCA ET AL., 2010, P. 203).

These kinds of concerns are shared among policy makers as well as the German central bank staff. A report of the Deutsche Bundesbank, which was published in 2013, demonstrates an overvaluation of German metropolitan real estate of up to 25% (REF. DEUTSCHE BUNDESBANK, 2013, P. 42). Due to this the International Monetary Fund (IMF) demanded Germany to enhance its macro-prudential resources to be prepared for a possible overheating of the housing market which would be a threat for the financial stability (REF. IMF,2014).

In July 2014, even Wolfgang Schäuble, the former minister of finance in Germany, once again drew attention to the importance of the warnings of the IMF and the European Central Bank (ECB) staff to observe the developments on the housing market with caution. He made his statement on the basis of the former developments in combination with expansionary policy by the ECB.

Many new house owners started to worry that they might have bought their property during the most expensive time. And they wondered what would happen if prices suddenly began to fall.

Rising real estate prices, a low interest policy and a lack of low-priced residential property lead to many people worry about a potential crisis arising from a so called “bubble”.

But are those worries reasonable? To what extend is the US mortgage crisis comparable to the current real-estate situation in Germany? Are there comparable predictors and to what extend might the German market be secured from a bubble?

Having a look at international real estate prices, German house prices are evaluated to be low compared to most other markets. Some argue that the growth rate is moderate, considering macro-economic fundamentals, the increasing number of immigrants and increasing rents (REF. HAAS ET AL., 2013. P.12). Moreover, the inflation is obvious in urban areas with a strong growth in economy and population while rural areas remain mostly unchanged at low price levels (REF. DOMBRET ET AT., 2013, P.3). Further, bubbles are usually associated with a surpassing increase of mortgage loans and construction activity which descriptive assessments do not identify in Germany which is an argument against an existing bubble (REF. EMPIRICA AG, 2014; IMF, 2014).

The possibility of a real estate bubble in Germany is obviously a controversial issue on which expert opinions diverge. An existing media presence shows the actuality and importance while a uniform opinion is not discernible.

1.2 Goal Setting and Question of Research

The main question which results through the theme is: “Are German real estates overvalued or can the development on the market be explained by macro- economic factors?”

The primary research goal of this scientific work is to examine the German real estate market for a price bubble. Therefore, an overview about general factors which provide bubbles and a more specific examination of the real estate market has to be given before analyzing the two largest former bubbles: the mortgage crisis in the USA in 2007 and the Japan crisis of the nineties. This will be compared to the German market and potential indicators of a real estate bubble in the country.

1.3 Structure and Procedure

The preset work is divided into two main parts. The main question of research will firstly be analyzed based on theoretical foundations and complemented by an empiric, statistic time series analysis.

In the first part the price setting on the real estate market will be explained and the term “bubble” will be defined. Connected to that the general expiration, reasons, and possibilities of identification are under investigation. Further, the two largest real estate bubbles of the past will be analyzed in their process and reasons for development.

In the second part a specific investigation of the German market will be done in which the movement of real estate prices will be analyzed and compared to the development of rental prices, population growth, and inflation. Moreover, the development of the gearing ratio for real estates will be preserved in this part.

Finally, a critical appraisal is given in the form of a summary of all the findings that could be drawn from both the literature research and the empirical investigation with a concluding interpretation.

2 Theoretical Reference Frame

This chapter presents the theoretical framework of the thesis. It aims to give the reader a definition of the term "real estate bubble" and explains the reasons which can lead to such a price bubble. In addition, possibilities which are supposed to determine a bubble are presented.

2.1 Price Formation on the Real Estate Market

Prices are formed by supply and demand, making them the main influencing factors of market events. Supply and demand determine how many of the goods get produced and sold. The total of all buyers constitutes the demand of a particular good. The group of sellers, in turn, determines how often and for which price a good is sold and offered on the market. Thus, supply and demand reflect the behavior of the individual market participants (REF. MANKIEW 2004, P.67). Since this definition also applies to the real estate industry, it has been adopted as the authoritative definition for this work.

If the real estate market would be a “perfect market”, the price and amount of goods on the side of the supply would be equal to the value of the demands side. In that case an equilibrium price would be supposed. Moreover, the offered goods would be homogeneous, there would be a variety of suppliers as well as demanders and all market participants would have complete knowledge about the market. Further, market participants would act without any personal preferences and without any time delay. They should know the effects of their actions and refer to that knowledge. If any of those criteria are not met, the market is imperfect (REF. SCHMOLL, 2015, P.1342 F.).

Abbildung in dieser Leseprobe nicht enthalten

Figure 1 Equilibrium Price

(Own depiction, comparable to Burdett and Judd, 1983)

The supply of the real estate market is then neither homogeneous, nor is the market development fully transparent or a perfect competition given. Based on the definition given above, the real estate market is not a “perfect market”, so the prices given are not equal to the equilibrium price (REF. GONDRING AND VORNHOLZ, 2016, P.4).

The special influences on the development of the real estate market are the general development of the economy – especially the income development and the monetary stability of the effected currency. Therefore, the property market is very cyclical (REF. MURFELD AND SAILER 2010, P.135).

Two of the main factors that determine the price on the real estate market are the position and condition. From a micro economic perspective, demanders rate the price according to their personal preferences, while the suppliers’ value the price mainly based on the production costs. This has the effect that the actual, objective value (e.g., rated by a qualified expert) is not of vital importance, but the willingness of agreement between supplier and demander which causes constantly fluctuating prices, is.

Other fluctuations are caused by the change of external influences for example by a change of the disposable income. This means a rapid increase of the price does not necessarily mean the formation of a price bubble (REF. GONDRING AND VORNHOLZ, 2016, P. 5).

The investment market of real estates can be characterized by the effect that speculations on price growths tend to cause those growths (REF. VORNHOLZ, 2015, P. 584).

2.2 Definition of Price Bubble

To be able to answer the question if there exists a bubble in the German real estate market at a later point, it is of importance to explain when to act on the assumption that there might be a bubble.

The fact that the most popular bubbles of the past, like the Subprime or Dotcom- bubble, have not been identified ex-ante but could only be completely determined after the burst of the bubbles (ex-post), shows that an identification is not quite easy (REF. HENS AND BACHMANN, 2008, P.94). Furthermore, there is still no standardized perception about a scientifically founded definition of the phenomenon of a “pricing bubble” which can be explained by the high degree of complexity and the interdisciplinary direction (REF. ROMBACH, 2011, P. 21). "The term 'bubble' is widely used but rarely clearly defined" (CASE AND SHILLER, 2003, P. 299) – so there are many different possible characteristics which are given in economic literature.

Referring to Nobel prize winner of economics Joseph Stieglitz who provides the most often used definition: “the basic intuition is straightforward: if the reason that the price is high today is only because investors believe that the selling price will be high tomorrow-when ‘‘fundamental’’ factors do not seem to justify such a price- then a bubble exists” (REF. STIEGLITZ, 1990, P. 13). Stieglitz’ approach focuses on the excessive expectation of investors in future prices connected to an expectation of a rate of return which is above the average, but which is not justified by circumstances of the real economy (REF. DREGER AND C. KHOLODILIN, 2013, P.3). The economist Shiller adds to Stieglitz’ definition that today’s media can reinforce the expectancy and that especially innovations can lead to an extraordinary demand with increasing an expectation of profits (REF. SHILLER, 2005, P. 299 F.).

Speculative bubbles often arise in metropolitan areas where the supply of real estate is restricted and the demand is high (REF. BAKER, 2006, P.7). The financing of the acquisitions is usually based on exceeding creation of loan. The goal of buying is to sell it at a later point with profit. Therefore, it seems worthwhile to buy with little owner’s equity to establish especially high returns. A supply of cheap loans is a requirement for that and stimulates the demand. Price bubbles usually occur in cyclical upturns in which real revenues increase as well (ARENTZ ET AL., 2010, P.8).

The rise in prices on the real estate market is observed as a long-term trend. In those phases investors assume that the trend continues like it did in the past, which leads to a blurred perception of wealth. As soon as the market participants realize that their expectations have been too optimistic, it comes to numerous sales which leads to a correction of the prices. The abrupt fall of prices is what is called “the pickle of the bubble” and which makes the difference to a boom-phase. This means that if the burst of a bubble could be prevented, the described phenomenon would only be a “boom” (REF. GARBER, 2007, P.7).

These theoretical considerations can help to identify and analyze a price bubble by particular models - but huge price changes only are not enough to convey a price bubble automatically as the reason can as well be changes in the market setting (REF., REHKUGLER, AND ROMBACH, 2011, P. 163). The term “bubble” should be able to differ an asset-price bubble from a totally cyclical determined development. Based on that a bubble occurs when the market price of an asset deviates long-term and extensively from its fundamental value. The fundamental is composed by different factors and can be defined with the price which an investor based on investigation of all market relevant information would pay. This usually measures up with the sum of all discounted and expected future rental incomes, but the market price is determined of demand and supply (REF. ROMBACH, 2011, S. 41 F.).

In the following picture you can see the typical development of an asset bubble based on a fundamental view. Between t0 and t1 the market price removes itself more and more from the fundamental value and reaches the largest spread of the bubble at t1.

Abbildung in dieser Leseprobe nicht enthalten

F igure 2: Discrepancy of the market value from the fundamental value

(Own depiction, comparable to Rombach, 2011, P. 47)

It continues with a radical correction of the prices and an adjustment to the justified price level after the market participants realize their expectations have been too optimistic. This procedure leads to a burst of the bubble. The extreme reduction of the prices due to the change of expectations already lead to the burst of asset price bubbles in the past during the Subprime crisis, for example, with the news about default of mortgage loans (REF. HENGER AND POMOGAJKO, K.; VOIGTLÄNDER, M. (2012) S.3).

Because of an existing housing bubble investor tend to enter the real estate market and invest into the formation of new buildings because of biased house prices rather than real scarcity. Therefore, resources for investments are misallocated as a high amount of capital, it is used for the housing market. This can become especially problematic for the economy in general if those investments are financed by a large part of mortgage loans under the background that after the burst of the bubble investors and households would be indebted to a high extend which would lead to an increase of bad loans.

In the worst case this negative effect on the households’ consumption behavior can lead to several banking crises which already happened during the Great Recession in 2007 to 2009 (REF. KONSTANTIN KHOLODILIN ET AL., 2015, P.1).

2.3 Reasons behind a Price Bubble

Price bubbles usually arise during an economic upturn phase in which a firstly reasonable price growth continues to rise due to speculations and departs more and more from a socio-economically justifiable price.

The following three factors are exemplary causes for the phenomenon in which the market participants tend to follow a speculative-based market trend instead of following objectifiable justified decision (DIW BERLIN, 2017).

Abbildung in dieser Leseprobe nicht enthalten

Figure 3: Exemplary Causes of a Price Bubble

(Own depiction, comparable to V ORNHOLZ AND G OLDRING , 2015, P. 4)

2.3.1 Real Economic Terms

Developments in the real economic sector can be direct reasons for the formation of price bubbles. A market constellation with a surplus demand is a fundamental prerequisite for the formation of a bubble. When the demand is higher than the supply it leads to an increase of prices on the one hand. On the other hand, a collapse in demand leads to a surplus of supply so the prices reduce.

In real estate economics an overall expanding economy is usually the basis for increasing prices. It leads to increasing household income, expectations of rising real estate prices and a low unemployment rate (REF. VORNHOLZ, 2014, P.42).

In addition, economic policy can have an influence on the formation of a price bubble. State intervention on the real estate market can lead to considerable undesirable developments on the real estate market. The state tries to positively influence developments through subsidies or tax incentives. One example is the USA, where from the 1990s onwards massive subsidies were provided for owner- occupied housing, including tax relief and securitization, which contributed to the housing bubble.

Furthermore, demographic trends have a major impact on the demand for real estate. Demand is influenced not only by pure population growth, but also by changes in demographic structures. The number of households is the most important demographic factor influencing the demand for housing, as this is the actual demand (REF. VORNHOLZ, 2014, P. 90F.).

2.3.2 Fiscal Terms

The influence of fiscal terms is based in changes of institutional, legal conditions and effects of the money policy and credit development. If the institutional conditions change to a more liberal financial market which leads to a deregulation of it, new providers enter the market. This leads to an increasing competition on the financial market which is responsible for the reduction of credit costs and therefore cheaper conditions for the costumers.

A further reason of a fiscal price increase is an expansive money policy. It causes a higher liquidity of institutional investor and higher capital inflow of the investment market, a so-called “Liquidity Hurricane”. Moreover, a speculative bubble is connected to an expansion of credits in the monetary sector. A price bubble and an increasing accommodation of a loan can enhance each other and lead to a destabilizing effect.

With regard to the real estate market the expansion of credit volume leads to a higher demand of it credits for real estates. This causes an increase of real estate prices. During a “boom” banks tend to a relaxing of lending standards so that more credit owners can finance a real estate. (REF. GONDRING & VORNHOLZ, 2016, P. 6).

2.3.3 Behavior Based Reasons

The efficient market hypothesis assumes that if there is a market in which the participants have the overall knowledge about it and act rationally, a speculative bubble should be excluded. The price should only be formed by the logically expected incomes of an asset. Nevertheless, even in experimental markets (no uncertainty: conditions for participants to determine the intrinsic value of an asset easily) a development of price bubbles can be detected. Why does the behavior of the market participants differ from the efficient market hypothesis? The following theories explain those behavior-based reasons.

Limited Rationality

One of the explanatory approaches sees the limited rationality of the human being as one factor due to which market participants can’t fully collect and interpret all relevant information of the market. This should normally only lead to a short-term discrepancy to the intrinsic value. The learning-process of the participants should ensure that the assets get priced realistically again and reduce an overvaluation medium-term and long-term (REF. SIMON,1955, P. 114).


The “Greater-Fool-Theory” implies that there is always a buyer in the market who is ready to pay more for an asset. Based on that consideration investors might buy assets which are already above their internist values with the motivation to sell those more expensive. Therefore, they might overestimate their ability of evaluating asset prices. The overestimation of the price rises until no „greater fool“ can be found, leading to a rapid price correction. The investors who bought the assets right before the price correction are those who realize the loss. (REF. LEVINE AND ZAJAC, 2007, P. 2 F.). Institutionalization/ Herd instinct

Individuals observe each other and make their decisions partly based on the perception of others. The phenomenon of cascading behavior is called “Herd Instinct” and means for the financial market that market actors operate cyclical in the direction of the market (REF. SHLEIFER AND SUMMERS, 1990, P. 19 F.). In this context it makes practices generally easier for people collectively in a group, even if what they do is counterproductive from the point of view of outsiders (REF. ZUCKER, 1977, P. 726).

People are able to match price estimations without the use of direct communication even in the case of including incorrect and disadvantageous results (REF. HOMMES ET AL., 2005, P. 12). The following example can illustrate the idea of the phenomenon more clearly: over time the information content reduces, and the formed structure becomes harder to break with new and possibly better information (REF. HIRTH AND WALTER, 2001, P. 8). As soon as it comes to the burst of the bubble, a reversal of the process follows (price reduction). In that point of time it is possible to achieve a reduction of the price under the fundamental value which would be the formation of a negative speculative bubble (REF. BELKE AND WIEDMANN, 2005, S. 8).

An obvious misconduct of the “herd” normally doesn’t give enough incentive for a different behavior of an individual as it usually remains unrewarded until the burst of the bubble (REF. NÖTH AND WEBER (2001) S. 13.F).

2.4 Construction Scheme of a Real Estate Bubble

The investigation of price bubbles leads to the question if the development of bubbles follows certain patterns and if single phases could be identified before their occurrence. The economist Hyman P. Minsky is one of the first economists who explained the development of financial instability and its interaction with the economy. Based on those findings he developed a model to constitute the expiration of a bubble from its formation until its burst in the five following steps.

Abbildung in dieser Leseprobe nicht enthalten

Figure 4: Formation of a Bubble

( Own depiction, comparable to


Excerpt out of 52 pages


Real Estate in Germany. Boom or Bubble?
University of Applied Sciences Frankfurt am Main
Catalog Number
ISBN (eBook)
ISBN (Book)
real estate, boom, bubble, economy, immobilienblase, wirtschaft
Quote paper
Valonita Berisha (Author), 2019, Real Estate in Germany. Boom or Bubble?, Munich, GRIN Verlag,


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