By
CFA
Institute Contributors
:
By Ron Rimkus, CFA
Where there's one cockroach, there's fire! Wait, that's not
quite right. Where there's smoke, there's a lot more cockroaches!
No, that's not it either. Let's see . . . ah, yes . . . where
there's smoke, there's fire! And when you see one cockroach you can
bet there are more lurking out of sight. So which analogy - smoke
or cockroaches - best describes German real estate? It may well be
both. Real estate prices in Germany suggest that trouble is afoot.
Pay attention: This should worry every investor in the world.
As the
European sovereign debt crisis
drags on, I have begun to focus my attention on Germany. Recently,
I came across a table of German real estate price changes. Consider
the quarterly price changes of the following seven-city index of
real estate prices:
Germany: Real Estate Prices for Seven Cities
(click to enlarge)
Sources: Bundesbank, BulwienGesa AG, CFA Institute.
First thought? Is a real-estate bubble in the offing? If so. . .
. Oh my! Germany is considered the bulwark of the European Union.
While everyone discusses Germany's fiscal strength and probity,
fewer investors may realize that the German dream might well be
structurally unsound.
How could Germany be experiencing a real estate bubble in the
midst of the euro crisis? It's quite simple, actually: the European
Central Bank has lowered rates in response to the global financial
crisis that began in 2008, and then dropped rates dramatically in
response to the euro crisis, which didn't gain steam until late
2009, and then pushed rates near zero in late 2011 - where they
have remained. As illustrated in the chart below, real estate
prices have risen in conjunction with falling rates for the same
seven-city index (the data are quarterly figures through June
2012).
Germany: Seven-Cities Real Estate Prices vs. Five-Year
Bond Yields
(click to enlarge)
Sources: Bundesbank, BulwienGesa AG, CFA Institute.
Now, just in case you think that this seven-city index is an
anomaly, consider the Bundesbank's 125-city index through 2011 (the
data are annual figures through December 2011).
Germany: Real Estate Prices for 125 Cities
(click to enlarge)
Sources: Bundesbank, BulwienGesa AG, CFA Institute.
And all this growth in real estate is happening even though the
German population is declining. That's right: Germany has a
population in decline.
Germany: Population in Decline
(click to enlarge)
Sources: Statistiches Bundesamt, Haver, CFA Institute.
So, where is all the new real estate demand coming from? In
part, the periphery of the European Union. As noted in a recent
piece in Der Spiegel, many
Italians are now investing in German real
estate
as a way to protect their money against the backdrop of the euro
crisis. In a worst-case scenario - if the euro were to break up,
then the German deutschmark would be reintroduced, and it is widely
believed that the currency would gain materially against the
remaining euro member currencies (to balance trade deficits). So in
a eurozone breakup scenario, a German real estate investor would
pick up a substantial currency gain. And shy of that (unlikely)
scenario, investors in the European periphery can avoid the
instability of their homeland.
Demand is also coming from institutional investors. As noted in
this clip from Press TV,
institutional real estate investors are snapping up
German real estate
and driving up prices and rents. The underlying momentum for the
creation of a real estate bubble is now established. However, we
can't simply look at real estate prices in isolation as purely a
monetary phenomenon without acknowledging the structural flaws at
work within the eurozone. For starters, because it is a monetary
union only, trade imbalances within the eurozone will persist.
Since Germany has maintained a persistent trade surplus within the
eurozone, Germans have strengthened their household income,
employment, and the overall economy at the expense of weaker
eurozone neighbors. Currencies in a "free exchange rate" regime
normally offset these imbalances by adjusting until trade
approaches balance. However, Germany has entered a fixed
exchange-rate system within the euro zone and, as such, it works to
Germany's advantage by preventing its trading partners from
revaluing or devaluing their currencies.
This faulty structure has led the eurozone straight into crisis.
Germany is now left with two choices: First, the country can unwind
the euro and go back to the deutschmark. This would force the value
of the deutschmark to rise relative to the remaining euro area
currencies and correct the imbalances - thereby reducing exports,
employment, and income. When employment and income decline, what do
you think happens to the housing market? Hold that thought.
Second, and more likely, Germany and the EU will forge ahead
with some form of fiscal union. Some think that there is already a
covert fiscal union as the ECB is buying sovereign bonds of select
peripheral nations. As such, it is the mechanism to engage in
transfers from the stable, northern eurozone economies to the
weaker, peripheral nations which, in effect, is somewhat similar to
what would happen in a formal fiscal union. By way of example, the
United States was born with a monetary union, fiscal union, and
political union. As such, people in Wisconsin regularly fund people
in Illinois. Also, people in Utah regularly fund people in
Colorado. And so on. This occurs through nationalized programs such
as welfare and housing in which money is taxed from all tax-paying
citizens nationally and redistributed in wide variety of ways that
differ from natural geographic boundaries of states.
Likewise, in whatever form a fiscal union takes, if money goes
from country A (Germany) to country B (say, Spain), then it is a
fiscal union. The only issue is how efficient or dysfunctional it
is. In any event, to the degree there is a fiscal union (or
quasi-fiscal union), then the Germany economy will be harmed on the
margin - meaning that the country will face less income and less
employment than it otherwise might.
And when employment and income decline, what do you think
happens to the housing market? Deja vu!
Now, in all fairness, Germany does have a more flexible real
estate market than many other European economies, so creating
additional supply is much easier in Germany than it is in, say, the
UK. Yet prices are escalating despite this flexibility. All things
considered, does it now make a little more sense why the EU just
wants to kick the can down the road?
My personal view: This won't end well.
Disclaimer: Please note that the content of this site should
not be construed as investment advice, nor do the opinions
expressed necessarily reflect the views of CFA Institute.
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on seekingalpha.com