The starting point for this thesis and the associated question were price developments observable on the residential property market as well as increased media reporting. Against this background, the following question was examined with scientific methods within the framework of this thesis: Is a bubble formation recognisable in the German residential real estate market and what regional differences can be identified in answering this question?
As a first step, price-influencing factors were examined in more detail and the price development relative to annual rent ratio, income and construction costs was examined. In addition, the effect of the ECB's interest rate policy and the interplay between property prices, monetary policy and asset price inflation were analysed. Hereby it became apparent that the significant price increase for residential property since 2010, and especially accelerated since 2016, can be explained against the backdrop of the extremely low interest rate level and the considerable expansion of money supply.
In order to be able to identify price bubbles on the residential property market in a measurable and comprehensible way, the price development was analysed in a second step with the mathematical procedure according to Diba and Grossmann, which uses the Augmented Dickey Fuller Test. The procedure is based on the premise that the price of a good is related to its fundamental value. To examine the price development in the residential property market, the fundamental value used for comparison purposes is derived from the development of the rent price index, the index of average gross monthly earnings and the construction cost index. The house price index was used as a price indicator for residential property. With the help of the Augmented-Dickey-Fuller Test, the development of the various indices was examined and compared with regard to their degree of stationarity. This investigation was carried out for the overall German residential real estate market in the observation period 2010-2021 in order to obtain an up-to-date picture. For the period under consideration from 01.01.2010 to 31.12.2021, a price bubble was not confirmed on the overall German residential property market.
Table of Contents
Table of Figures
Table of Tables
Table of Equations
List of Abbreviations
Abstract: Real estate bubble in Germany
1. Introduction
1.1 Problem statement
1.2 Objectives and structure of the work
2. Definition and theoretical basis of asset price bubbles
2.1 Asset price bubbles as recurring phenomena of the financial markets
2.1.1 Historical financial crises
2.1.2 Structure of financial crises
2.1.3 Price bubbles as triggers of financial crises
2.2 Characteristics of price bubbles
2.2.1 Definition of price bubbles
2.2.2 Critical delimitation of the definition of the term
2.2.3 Short-term effects on national economies
2.2.4 Long-term effects on national economies
3. Price bubbles on real estate markets
3.1 Real estate markets in the context of economics
3.1.1 Uniqueness of the residential property market
3.1.2 Segmentation into product submarkets
3.1.3 Segmentation into spatial submarkets
3.2 Characteristics of price bubbles in real estate markets
3.2.1 Long duration
3.2.2 Special behaviour of market participants
3.2.3 Locality
3.3 Explanatory approaches for a bubble in the residential property market
3.3.1 Interest rate policy
3.3.2 Interaction of property price - monetary policy - asset price inflation
3.3.3 Economic effects of interest rate changes on mortgage loans
3.4 Current market indicators of a possible price bubble on the German residential property market
4. Empirical approaches to the detection of price bubbles
4.1 Price to Rent Ratio
4.2 Price to Income Ratio
4.3 Price to Production Cost Ratio
4.4 Summary of the findings
5. Empirical analysis of the German residential real estate market using the Diba and Grossmann method
5.1 Empirical approach
5.2 Methodical preparation
5.3 Data basis and preparation of the data
5.4 Evaluation of the database for the overall German market
5.4.1 House price index
5.4.2 Index of net cold rents
5.4.3 Index of average gross monthly earnings
5.4.4 Construction cost index
5.5 Evaluation of the database subdivided according to district types
5.5.1 House price index by district type
5.5.2 Index of net cold rents by district type
5.6 Summary of the results
6. Conclusion
6.1 Achievement of work
6.2 Outlook
References
Appendix
Table of Figures
Figure 1: Structure of a speculative bubble according to Kindleberger
Figure 2: Net fixed assets by asset type 2020
Figure 3: Subdivision of the real estate market
Figure 4: Distribution of area and population in settlement-structural district types in %
Figure 5: Distribution of the district types in terms of settlement structure in Germany
Figure 6: Interplay between interest rate policy and property prices
Figure 7: Interest payments for housing loans of private households in % of disposable income
Figure 8: Housing loans of private households in % of disposable income in Germany
Figure 9: Housing loans by domestic banks to domestic private households % on previous year
Figure 10: Influence of monetary policy impulses on a possible real estate bubble
Figure 11: Yield on Germany's 10-year government bonds
Figure 12: Purchase price to annual lease
Figure 13: Purchase price/ annual rental ratio of condominiums in years German Market
Figure 14: Price to income ratio Germany
Figure 15: Price production costratio comparison Germany Europe
Figure 16: Comparison of the indices for the overall German residential property market
Figure 17: House Price Index Germany
Figure 18: Decomposition House Price Index Germany
Figure 19: ADF Test House Price Index Germany
Figure 20: Net Cold Rent Index Germany
Figure 21: Decomposition Net Cold Rent Index Germany
Figure 22: ADF Test Net Cold Rent Index Germany
Figure 23: Average Gross Monthly Earnings Germany
Figure 24: Decomposition Average Gross Monthly Earnings Germany
Figure 25: ADF Test Average Gross Monthly Earnings Germany
Figure 26: Construction Cost Index Germany
Figure 27: Decomposition Construction Cost Index Germany
Figure 28: ADF Test Construction Cost Index Germany
Figure 29: House Price Index Large District Free Cities
Figure 30: Decomposition House Price Index Large District Free Cities
Figure 31: ADF Test House Price Index Large District Free Cities
Figure 32: House Price Index Urban Districts
Figure 33: Decomposition House Price Index Urban Districts
Figure 34: ADF Test House Price Index Urban Districts
Figure 35: House Price Index Rural Districts with Densification Trends
Figure 36: Decomposition House Price Index Rural Districts with Densification Trends
Figure 37: ADF Test House Price Index Rural Districts with Densification Trends
Figure 38: House Price Index Sparsely Populated Rural Districts
Figure 39: Decomposition House Price Index Sparsely Populated Rural Districts
Figure 40: ADF Test House Price Index Sparsely Populated Rural Districts
Figure 41: Net Cold Rent Index Large District Free Cities
Figure 42: Net Cold Rent Index Urban Districts
Figure 43: Net Cold Rent Index Rural Districts with Densification Trends
Figure 44: Net Cold Rent Index Rural Districts Sparsely Populated
Figure 45: Decomposition Net Cold Rent Index Large District Free Cities
Figure 46: ADF Test Net Cold Rent Index Large District Free Cities
Figure 47: ADF Test Net Cold Rent Index Urban Districts
Figure 48: ADF Test Net Cold Rent Index Rural Districts with Densification Trends
Figure 49: ADF Test Net Cold Rent Index Sparsely Populated Rural Districts
Table of Tables
Table 1: Extract of historical financial crises
Table 2: Potential Case 1
Table 3: Potential Case 2
Table 4: Data Basis of the Study
Table 5: Results of the study for the German residential property market
Table 6: Results of the study for the German residential property market according to district types
Table of Equations
Equation 1: Relationship between key interest rates and investment in housing
Equation 2: Relationship between money supply and consumption
List of Abbreviations
ADF Augmented-Dickey-Fuller
BaFin Federal Financial Supervisory Authority
C Consume
D Demand
ECB European Central Bank
iA Interest Rate Investment Sector
iK Interest Rates Loan
K New Loans
LZ Key Interest Rate
M Money Supply
P Price
P/E Ratio Price to Earnings Ratio
Pi Property Values
S Supply
V Wealth Situation of Households
International Business Studies Master
Abstract: Real estate bubble in Germany
An Analysis of the German Residential Real Estate Market for the Presence of a Bubble
Kilian Köberlein
The starting point for this workandtheassociatedquestion were price developments observable on the residential property market as well as increased media reporting. Against this background, the following question was examined with scientific methods within the framework of this work:
Is a bubble formation recognisable on the German residential real estate market and what regional differences canbeidentified in answering this question?
As a first step, price-influencing factors were examined in more detail and the price development relative to annual rent ratio, income and construction costs was examined. In addition, the effect of the ECB's interest rate policy and the interplay between property prices, monetary policy and asset price inflation were analysed. Hereby it became apparent that the significant price increase for residential property since 2010, and especially accelerated since 2016, can be explained against the backdrop of the extremely low interest rate level and the considerable expansion of money supply.
In order to be able to identify price bubbles on the residential property market in a measurable and comprehensible way, the price development was analysed in a second step with the mathematical procedure according to Diba and Grossmann, which uses the Augmented Dickey Fuller Test. The procedure is based on the premise that the price of a good is related to its fundamental value. To examine the price development in the residential property market, the fundamental value used for comparison purposes is derived from the development of the rent price index, the index of average gross monthly earnings and the construction cost index. The house price index was used as a price indicator for residential property. With the help of the Augmented-Dickey-Fuller Test, the development of the various indices was examined and compared with regard to their degree of stationarity. This investigation was carried out for the overall German residential real estate market in the observation period 2010-2021 in order to obtain an up-to-date picture.
For the period under consideration from 01.01.2010 to 31.12.2021, a price bubble was not confirmed on the overall German residential property market.
Since the residential real estate market is very local, the analysis according to Diba and Grossmann was repeated in the third step on the basis of district types. For this purpose, the German real estate market was divided into four district types and the observation period was limited to the years 2016 - 2021 due to limited data availability and increased timeliness.
There was no indication of an overvaluation for the district type of large cities and sparsely populated rural areas. For the district types of urban districts and rural districts with densification trends on the other hand, there was an initial indication of overvaluation for the shortened observation period 01.01.2016 - 31.12.2021.
In summary, contrary to many press reports, from a scientific point of view it is not possible to speak of a bubble development for the overall residential real estate market in Germany, despite the recognisable price increase.
1. Introduction
1.1 Problem statement
"In the German real estate market, equity is being created out of nothing. How much longer will this go on ?" (Neue Züricher Zeitung, 2022)
This was the headline of the Neue Züricher Zeitung at the end of April 2022. "The German real estate market is running hot, very hot probably", the article continued (Neue Züricher Zeitung, 2022). But is this statement correct? For years, historically low interest rates have paved the way for easy entry into the wonderful world of home ownership; 110% financing was not uncommon. The best day to buy a property was yesterday, the second best is today, so the widespread belief (Florjancic, 2013). But the question of tomorrow is increasingly coming to the fore. Parallel to the general price increases, which have been evident in all goods and services since the beginning of the global Corona pandemic in 2020, house prices also increased. In 2022, for example, a square metre of built-up area in Munich cost an average of €10,154 and a condominium an average of €580,000 (Wohnungsbörse, 2022).
In view of the trigger of the financial and economic crisis in 2008, the bursting of the bubble on the US residential real estate market, the current price development of German residential real estate fuels fears that the development at that time could also be repeated in this form in Germany.
These considerations find expression in a strong increase in the presence of the topic in media reporting. Headlines such as "The bubble on the real estate market is getting bigger" were published on the daily (Frankfurter Allgemeine Zeitung, 2022). "Housing is becoming more and more expensive in Germany: When will the real estate bubble burst?” are examples of the current reporting (Berliner Kurier, 2022).
Argumentatively, these headline statements are supported in the press by three developments:
- Decoupling of house price development from income development
- House price development favoured by historically low financing interest rates
- Increase in demand for residential space due to population growth as a result of immigration.
The housing shortage analysed in a study by the Eduard Pestel Institute leads to excess demand, which in principle favours price increases for residential property. According to the Pestel Institute, 400,000 new flats would have to be completed annually in order to meet the demand for housing in the medium term (Eduard Pestel Institut e.V., 2022). This compares with an average of only 250,000 actual completions per year in the period 2010-2021 (Statistisches Bundesamt, 2022).
The combination of limited supply due to a relatively low number of new construction projects on the one hand and rising demand due to attractive financing conditions and high positive net immigration on the other hand creates an environment that favours price increases within the German real estate market. In addition, legal requirements, such as compliance with energy efficiency standards for new buildings, have a costincreasing and thus price-increasing effect.
Against the background of the experiences and consequences of the bursting of the real estate price bubble in the USA, it is necessary to investigate a possible bubble formation on the German residential real estate market. In recent years, there has been more media reporting on the issue, but insufficient scientific research. In scientific studies, the German market has never been divided into district types and examined in this way.
Consequently, this thesis asks the overdue research question:
Is a bubble formation recognisable on the German residential real estate market and what regional differences can be identified in answering this question?
By answering this question, this research aims at closing the gap in research regarding German financial stability.
1.2 Objectives and structure of the work
The objective of the study is to clarify whether a real estate price bubble is recognisable in Germany due to the currently observed price development for residential real estate and whether regional differences can be observed in answering this question.
The verification of a possible price bubble on the German residential property market is to be carried out by means of an empirical analysis based on key figures on the relative price development of residential real estate as well as an indicative analysis based on the method according to Diba and Grossmann (Diba and Grossman, 1988). In addition to the data-based key figure analysis, special attention will be paid to the economic interpretation and explanation of the empirical evaluation.
Chapter one shows the topicality of the research question and the methodological structure of the thesis.
Chapter two deals with asset price bubbles as a recurring phenomenon in the financial markets and sheds light on the historical background. It is underlined by a characterisation of price bubbles with definitions. In addition, the economic effects of price bubbles are shown. The last two sections of the second chapter are devoted to the effects of real estate price bubbles on the respective economy, both from a shortterm and long-term perspective.
Chapter three contains a detailed analysis of the real estate market including its uniqueness. The first section of chapter three deals with real estate as an asset in the context of economics and considers special features of the residential real estate market as well as segmentation into submarkets. The second section deals with the special characteristics of price bubbles on residential property markets with regard to temporal cyclicality and the extent of price fluctuation as well as their local reference. Section three of chapter three gives explanatory approaches for the formation of bubbles on the residential property market and sheds light on the dependence of price developments on interest rate policy, asset price inflation and the behaviour of market participants.
In chapter four, key figures are put into perspective in order to make statements on the relative price development. This relative view is important because many external factors are considered, especially in the pricing of residential property.
Chapter five deals with the empirical procedure for evaluating property price bubbles according to the Diba and Grossman method. The first step is an analysis of the overall German residential property market, followed by a differentiation by district type. The differentiation according to district types offers the possibility of making statements on the formation of price bubbles on regional submarkets.
After the theoretical and empirical analysis of a possible price bubble on the German residential property market, chapter six closes the thesis with the central conclusion, the limitation of the analysis results and an outlook.
2. Definition and theoretical basis of asset price bubbles
2.1 Asset price bubbles as recurring phenomena of the financial markets
Since the emergence of the first institutional financial markets, they have always been accompanied by recurring speculative excesses and crises. Probably the best-known speculative development was the Dutch tulip boom in 1636. It is considered the first speculative bubble in economic history (Garber, 1989). The background to this price bubble, which was triggered by collective mass hysteria, was an ever-increasing number of inexperienced and naive market participants with a relatively small supply of tulip bulbs. The history of the tulip as an object of speculation began at the beginning of the 17th century, when the most important botanist of his time, Charles de l'Écluse, the Habsburgs' court botanist in Vienna, received the first tulip bulbs as a gift from Constantinople. Encouraged by the fact that the Netherlands was on the threshold of a golden age at the beginning of the 17th century, especially due to its mastery of the highly lucrative East India trade, speculation with tulip bulbs became very popular. Dutch merchants began to express the wealth they derived from global trade with huge gardens (Garber, 1989). In this environment, the tulip bulb became a social status symbol.
Large quantities of gold and silver poured into the Netherlands from global trade, as only here was the precious metal exchanged into foreign currency at a fixed rate. Subsequently, the resulting inflationary monetary policy led to favouring the price bubble of tulip bulbs.
The position of the tulip as a status symbol, rising demand coupled with low supply and an inflationary monetary policy led to canal houses in prime locations in Amsterdam being exchanged for rare specimens of the tulip at the peak of the tulip mania. For example, the price of a bulb of the Semper Augustus variety rose to 5,500 guilders at an Amsterdam auction at the peak of the boom (Dennin, 2019; Garber, 1989). The next stage of speculation was reached when merchants no longer traded the onion itself, but rather the rights to it. As a result, the tulip bulbs themselves remained in the ground, but the rights to them and their offspring in the form of the first options and futures passed from hand to hand up to ten times a day.
The tulip boom came to an end when, for the first time at an auction, there were no more follow-up buyers willing to pay an even higher price. When word got out, prices dropped to less than 10% of their former value within a very short time (Garber, 1989). Statistics show that as a result of the bursting of the price bubble, the number of bankruptcies almost doubled from 1635 to 1637 (Herrmann, 2013).
2.1.1 Historical financial crises
Based on the following overview in Table 1, it becomes clear that misallocations on the financial markets have repeatedly occurred after the Tulipmania of 1637. It can be seen that mispricing occurred both in the markets for real assets such as commodities, trade goods or real estate and in the markets for financial assets such as shares, bonds or currencies.
Abbildung in dieser Leseprobe nicht enthalten
Table 1: Extract of historical financial crises (own representation)
It can be noted that before the beginning of the 20th century, financial crises were mostly exclusively country-specific and thus had little or no influence on the global markets, due to the disconnected nature of the markets in those times. At that time, the goods and financial markets of the respective countries were separated by borders and customs barriers. It has to be noted, that the exchange of goods and asset transactions was primarily national in character (Berger, 2012). With the beginning of the 20th century, this situation changed. The reduction and eventual abolition of capital controls and the increased integration of transnational goods markets led to a steady reduction in the corresponding transaction, information and transport costs (Smith and Smith, 2006). This led to a high degree of integration of international goods and financial markets.
The crucial point is that financial crises no longer affect individual countries locally but globally, due to their interdependence. This became clear not least in the course of the subprime crisis of 2008 in the USA, which spread to the entire world through interconnections via structured securities and thus led to the largest global financial and economic crisis since the Great Depression of 1929 (Unterdörfer, 2014).
In the majority of financial crises, previous price increases of the respective goods or assets were the trigger. As a rule, the financial crisis itself only arises as a result of a fall in the prices of goods or assets following the price increase, in that critical bottlenecks at banks and companies result from this. The initial problems of a limited sub-sector of an economy result, among other things, in falling wages and rising unemployment, which have effects on the entire economy. Via the corresponding transmission mechanisms of the economy, individuals who were not originally involved in the previous boom market are ultimately also affected by the crisis.
2.1.2 Structure of financial crises
The overview of financial crises considered in the last section makes it clear that the respective characteristics of the crises differ from one another in terms of their duration and severity as well as their economic impact. Nevertheless, in 1996 Kindleberger found in his analysis of financial crises that they are based on a striking pattern. This is explained in the following section as a basis for understanding the development of financial crises and price bubbles (Daxhammer and Facsar, 2017).
A deeper look reveals that all these bubbles were preceded by a triggering event. Kindleberger refers to this event as the shift (Kindleberger and Aliber, 2005a). Something transformative (for example, a financial innovation or a technological innovation) eventually heralds a speculative bubble. This shift is followed by a boom. Carried along by this boom, euphoria arises. This euphoria lasts until finally something unforeseen causes the bubble to burst and financial bottlenecks occur. There is panic and all investors turn away from the asset. The following figure illustrates the anatomy of a speculative bubble.
Abbildung in dieser Leseprobe nicht enthalten
Figure 1: Structure of a speculative bubble according to Kindleberger, 2005
1. Relocation
Bubbles usually have a economic background. Economists speak of an exogenous shock, i.e. one that comes from outside and fundamentally changes the economy. Examples of this are an interest rate turnaround, or technological innovation.
2. Positive feedback, Boom
In the second phase, a convincing argument is formed that stimulates demand and increases willingness to pay. The pioneers feel vindicated by this, and a selfreinforcing effect occurs. The propensity to invest spreads to broad investor circles and is supported by an expansion of lending on the part of the banks as well as intensive media coverage. The boom phase finally leads into a phase of euphoria (Kindleberger and Aliber, 2005b). A positive feedback effect, the so-called positive feedback loop, is created. Seemingly to market participants, this results in a self-fulfilling prophecy, as rising values attract new investors.
3. Euphoria
This is the dangerous phase. Investors believe that the boom is eternal and that property prices have never fallen. In other words, this time everything is different. Tried and tested valuation principles are being thrown overboard and deemed no longer up to date. New key figures or justifications are created to justify the exorbitant prices.
People no longer invest in assets because of the expected return, but because of the prospect of being able to resell the asset at a higher price, which is also called the Greater Fool Theory. Money seems to be free at this stage. The psychological component of wanting to participate in the seemingly easy and ubiquitous wealth creation also plays a central role.
4. Financial Misery
The fourth phase, financial dislocation, is then heralded by external factors that are usually only identifiable ex-post. Often, a reversal of monetary policy on the part of central banks, which poke the speculative bubble by raising interest rates, is the cause of the turnaround (Voigtländer and Rottke, 2017). An increase in the cost of credit causes a reduction in demand, which in turn puts pressure on asset prices. A lack of or significantly reduced willingness to invest leads to falling prices and, in extreme cases, causes the bubble to burst.
5. Disgust
Disgust describes the fifth and final phase. The bubble has now perceptibly burst. Investors turn away from the investment they thought was safe. The extent of the misinvestment becomes apparent. Asset prices, which exceeded their fundamental value in the upswing phase, fall below it in the disgust phase (Hilbert and Metzner, 2021). Gradually, the extent of the resources wasted in the euphoria becomes apparent. The price decline continues until the first investors make their presence felt again through investments. Kindleberger's five-stage model, which describes the course of a speculative bubble, is also called the boom-bust cycle.
2.1.3 Price bubbles as triggers of financial crises
It is clear from Kindleberger's flow chart that both the emergence and the bursting of a goods or asset price bubble can have an economic impact. The end of the bubble phase is reached with the fall of prices in a rapid price collapse, but not the end of its subsequent and infecting effect on the national economy, which can lead to the development of a financial crisis (Brauers, 2011). As a result of decreased asset values, credit institutions have to make value adjustments on existing engagements and restrict their lending due to the weakened equity base. This leads to a further aggravation of the situation, especially for companies and individuals who are already burdened by their asset losses in the course of the bubble bursting. In the course of the more restrictive lending by the credit institutions, investors are restricted in their refinancing options (Vieten, 2013). Companies and individuals who are themselves dependent on a liquid and intact refinancing environment and who have no alternative forms of financing available in the short term are threatened with insolvency. The resulting insolvency of borrowers in turn leads to further necessary value adjustments at credit institutions. As a reaction, credit institutions become even more restrictive (Vieten, 2013). Via the heart of an economy, in the form of the credit institutions as suppliers and guarantors of liquidity, the original bubble now leads to the development of a financial crisis affecting the entire economy. The subprime crisis, which originated in the USA, made it clear how a weakening of credit institutions and, as a consequence, a strained supply of liquidity to the economy, can bring the entire financial system to its limits.
This makes it clear that the early recognition of price bubbles is one of the decisive factors in recognising possible future financial crises and counteracting them with appropriate measures (Mandler, 2010).
2.2 Characteristics of price bubbles
Since the global financial and economic crisis of 2008, the term price bubble has entered the vernacular of the general public. Until around the middle of the 20th century, science was mainly concerned with describing and documenting the development and the resulting consequences. During this phase, the scientific debate had a primarily documentary character. The global financial crisis triggered by the subprime crisis in the USA moved the real estate market into the focus of scientific debate from 2008 onwards.
The characteristics of price bubbles are extremely complex. They are characterised by high complexity and a pronounced interdisciplinarity. The relevance of psychology as a factor influencing the formation of bubbles in particular requires a more in-depth analysis.
2.2.1 Definition of price bubbles
In order to answer the question of whether a bubble has formed in the German residential property market, a distinction must be made between fundamentally justified price increases and unjustified price increases. For this purpose, definitions of a price bubble used in the literature must be consulted and distinguished. Suitable definitions of a price bubble should provide explanatory approaches for the emergence of the bubble and anticipate the formation of the bubble in perspective, instead of recognising the formation of the bubble retrospectively only after it has burst.
The following is a selection of the definitions of the term price bubble given in the economic literature:
1. "Some seem to define a bubble as any time in which asset prices increase and subsequently fall" (Shiller, 2003)
2. " [...] A bubble is an upward price movement over a long period of time that eventually bursts. " (Federal Reserve Bank of Chicago, 2005)
3. "Asset price bubble is a rhetorical technique used by certain economists to characterize the magnitude of asset price movements: Small movements are known as fluctuations, but big, persistent swings that result in a sharp drop are known as asset price bubbles. " (Hunter et al., 2005)
4. "Bubbles - I'm referring to booms which comes before the crash. - [...] " (Cecchetti, 2006)
5. " [...] irrational exuberance [...] " (Le Heron, 2007)
6. "We think of a housing bubble as being fueled by homebuyers who are ready to pay exorbitant prices for homes now because they anticipate excessively high future property gains. " (Himmelberg et al., 2005)
7. "These financial cycles are typically triggered by a wave of optimism fueled by positive developments in the real economy. This optimism contributes to risk underestimation, excessive loan expansion, asset price inflation, physical capital overinvestment, and high consumer spending. When expectations match fundamentals, imbalances are quickly addressed as excessive optimism gives way to excessive pessimism, affecting both the financial and real economies. " (Hunter et al., 2005)
8. "[...] a typical bubble; a situation in which housing values have soared much above what fundamentals suggest, pushed by property purchasers eager to pay exorbitant prices solely because they expect unrealistically high future appreciation. " (Senhadji Semlali, 2002)
9. "The true definition of a bubble is when market prices exceed the assets expected cash flow. " (Smith and Smith, 2006)
10. "We should pay a price for the stock that reflects current company earnings as well as realistic forecasts for future profitability. When they get detached, a bubble is formed. " (Autor, 2012)
This overview is not complete as there are many other definitions. However, on the basis of these ten selected definitions it becomes clear that among economists the ideas, description and definition of a price bubble differs widely. Basically, three perspectives on price bubbles can be summarised from the various definitional explanations:
1. Definitions one to four are characterised by a price pattern that depicts the formation of a bubble. This is characterised by an extreme price rise followed by an abrupt price collapse. A prime example of such a boom-bust cycle is the five-stage model of Kindleberger and Minsky described in section 2.1.2. However, the anatomy of a price bubble and its chart-technical representation do not yet constitute a suitable definition - a mere price rise and a subsequent abrupt and sharp price decline do not necessarily characterise a price bubble. Many price fluctuations do not necessarily result from irrational behaviour of market players and may well be justified on the basis of changed fundamental data. Therefore, there is a danger of mistakenly interpreting ordinary price changes as a price bubble because they have a similar price pattern to a boombust cycle. Since the chart-technical analysis cannot provide a significant differentiation from other, fundamentally justifiable price movements and does not allow for a substantive justification of bubble formation, this type of definition appears unsuitable for the objective of the paper.
2. Definitions five to seven, on the other hand, use the prevailing mood on the market at the time of the formation of the bubble to describe bubbles by making the behaviour and thinking of market participants their basis. Descriptive characteristics for this are, for example, "irrational exuberance" (Le Heron, 2007) or "excessive optimism" (Hunter et al., 2005). In summary, these definitions, which use the behaviour of market participants as the basis for determination, can be classified as a behaviour-based view. The problems of the behavioural view lie in the lack of empirical verifiability. Rational and irrational behaviour of market participants are difficult to distinguish from each other. Furthermore, it is not an objectively, empirically verifiable bubble concept, as the analysis depends on the subjective judgement of the observer. Moreover, the behavioural view also fails to distinguish speculative price rises from fundamentally justifiable price movements. Therefore, this definitional approach also appears unsuitable for the research question of the paper.
3. Definitions eight to ten for determining a bubble formation use fundamental aspects as a basis, such as discounted cash flows of the investments for price valuation or the deviation of market prices from fundamental values of the respective assets. These definitions distinguish fundamentally based price developments from unfounded price fluctuations. In addition, this definition approach can be used for an empirical analysis of price developments. In this way, the true value of an asset can be approximately determined on the basis of its fundamental factors and then analysed for any over- or undervaluation by comparing it with the current market price. Thus, this definitional approach fulfils all desirable criteria for delineating the price trend. Therefore, the empirical analysis in this paper will refer to the fundamentals-based definition of a price bubble.
2.2.2 Critical delimitation of the definition of the term
Through the previous analysis of the three views of price bubbles, the chart-based, the behavioural and the fundamental view, it became clear that only the latter can depict all the required characteristics of a definition. From this point of view, a price bubble is defined as a price movement that is not fundamentally justified.
The second claim was that a suitable definitional approach must confirm the occurrence of a price bubble. According to the fundamental view, a price bubble occurs when the market price of a good moves away from its fundamentally justified value in the longer term (Rombach, 2011).
The third aspect of a suitable definition was the empirical verifiability of the formation or existence of a price bubble. A necessary prerequisite for this is that suitable procedures exist for determining the fundamental value of an economic good and that the fundamental value can be compared with the actual market prices. On this basis, conclusions can be drawn about the possible existence of a bubble before the bubble actually bursts.
Thus, the fundamental view of defining and establishing a price bubble appears to be suitable for an empirical analysis of the price development in the German housing market in chapter five of this thesis.
2.2.3 Short-term effects on national economies
In order to explain the importance of recognising price bubbles, the following part of this paper explains the effects of price bubbles on the national economy. For a better understanding, the effects are divided into short-term effects and long-term effects. Subsequently, the overall economic impact is described in summary. The aim of this part of the work is to work out the relevance of both the formation and the bursting of price bubbles, especially in the residential property market.
A first manifestation on a short-term basis is the distortion of market prices. Prices play a central role in an economy; in that they have both an indicator and an allocative function. The indicator function is understood to mean the possibility of being able to read the relative scarcity of a good on the basis of prices. Within this context, rising prices signal an increase in demand or a reduction in supply. Both indicators point to an existing or possible future scarcity of a good via the rising price. Conversely, falling prices have the converse meaning in that they indicate a reduction in scarcity. Both indicator statements subsequently lead to an adjustment of the corresponding production relations (Vornholz, 2013). The second function of price, in the form of the allocation function, is the property of prices to allocate limited resources to their most efficient use. Through price, the limited capital resources available are automatically directed to where they provide the greatest relative return to their owner. In this context, prices act as a signalling instrument (Ni, 2019). In order to be able to use both functions most effectively and not to influence them adversely, the free formation of prices on a market is the fundamental prerequisite. Only in this way, as a result of supply and demand, can prices form freely in accordance with their functions and thus fulfil their role. However, if there are interventions in a market that influence the market equilibrium, such as the rent brake introduced in Germany in 2015, the Residential Property Credit Directive introduced on 21 March 2016 or other regulatory interventions by the state, the prices observable on the market no longer reflect the true conditions of a market. This no longer leads to an optimal allocation of resources, but to inefficiencies, which can subsequently lead to a reduction in economic prosperity (Lindauer, 2016).
Taking into account the functions of the price mechanism, the formation of price bubbles, similar to e.g. regulatory interventions, leads to the fact that prices can increasingly break away from their fundamental levels and thus lead to resource misallocations (Keßler, 2010). The second short-term economic effect is the overinvestment of companies. Due to the increase in asset prices caused by a price bubble, not only individuals but also companies are led to believe that there will be an increasing economic upswing. As a result of more positive future growth prospects, companies now begin to adjust their supply to the increasing demand suggested by the generally rising prices by expanding their production. This effect can lead to misallocations and the formation of overcapacities. Induced by the formation of a price bubble, an economic upswing occurs. The third short-term effect is the so-called positive wealth effect. Through the occurrence of asset price bubbles, as outlined, asset prices rise comparatively quickly in a relatively short period of time. As a result, individuals in an economy who are asset owners begin to feel richer. With the awareness in the background that their assets have contributed to an increase in individual wealth, they begin to reduce their savings rate (Mütze, 2009). Through the reduction of the savings ratio and the resulting increase in consumption, there is increasingly a significant increase in economic growth (Anderegg, 2007). As a result, asset prices continue to rise. This leads to a positive loop of price increases, increased production, and an increase in demand.
In the context of the short-term economic effects presented, it becomes clear that these effects have stimulating effects on the national economy. At their foundation, however, they are all based on a misallocation of resources, the origin of which is to be found in a disruption of the allocation and information function of asset prices. Like the other circumstances of price bubble formation outlined above, the short-term economic effects also lead to the formation of a price bubble. It becomes clear that bubbles, once triggered, can carry themselves independently and continue to inflate (Klimonczyk, 2016).
2.2.4 Long-term effects on national economies
In addition to short-term developments, price bubbles also show long-term effects on an economy. These include a negative wealth effect, a decline in economic growth and financial market instabilities. Like the positive wealth effect during the price rise, a negative wealth effect results as a consequence of the bursting of a bubble (Brauers, 2011). Just as individuals feel richer on the basis of the previous positive development of their assets and were consequently stimulated to increase consumption, so, on the other hand, the return of asset prices to their original level leads individuals in an economy to restrict their consumption behaviour. For the majority of invested individuals, their own residential property is their most valuable asset. Due to the decline in house prices as a result of the bursting of a bubble, the individuals theoretically only suffer book losses for the time being. However, if the property values are based on high loan-to-value ratios or corresponding loans granted by the financing banks, the resulting loss in value can immediately lead to additional funding obligations for the individuals (Daxhammer and Facsar, 2017). As a result, the book loss can have a direct influence on the private assets of the individuals. The negative wealth effect has additional implications that reduce economic growth.
The reduction in the consumption behaviour of consumers in turn leads to effects on the companies of an economy. Due to reduced growth and falling demand, they can only sell their products to a limited extent, inventories begin to rise, and capacities are increasingly underutilised. As a consequence, companies reduce jobs, which induces a further downward spiral in which the income of private households begins to fall, which in turn has negative implications for consumption (Mankiw and Taylor, 2012). The decline in real estate prices also affects the value of collateral values for mortgage loans. This has an impact on the credit institutions of an economy, whose equity base is increasingly weakened by rising loan defaults due to the falling income of private households and the simultaneous reduction in collateral values. To counteract the negative developments, the credit institutions begin to restrict their lending, which in the worst case can lead to a so-called credit crunch, which in turn can lead to a weakening of the liquidity supply of the entire economy (Unterdörfer, 2014). The result is an increase in corporate insolvencies with corresponding implications for jobs, private incomes and necessary write-offs by the financing credit institutions (Glebe, 2012). The most representative example of the consequences of a burst property price bubble is Japan. In Japan, the many years of uncertainty among economic participants as a result of the bursting of the real estate price bubble in the 1990s has led to reduced consumption and declining investments, which have led the country into a deflation that continues to this day (Asami, 2021).
Another form of long-term impact is the occurrence of financial market instabilities. Since real estate accounts for a significant share of the collateral values of credit institutions, devaluations or necessary revaluations of the collateral values lead to write-downs within the balance sheets of the credit institutions, with corresponding equity implications. If the necessary write-offs exceed the equity buffers of individual credit institutions, they are forced to raise new equity capital on the capital market. If an increase in equity is not possible due to the general uncertainty of the market participants, this can lead to insolvencies in the area of credit institutions. As the example of Lehman Brothers in 2007 made clear, the loss of a part within the globally networked chain of interbank relationships can lead to the entire financial system of a country or even the worldwide system coming under pressure (Unterdörfer, 2014). Another aspect that can lead to instability is a possible loss of confidence on the part of a bank's depositors. A fundamental uncertainty of a bank's depositors based on a reduced credit rating can lead to a bank having to file for insolvency due to an outflow of liquidity. Rumours and speculation can already lead to such behaviour in the form of a so-called bank run (Faber and Vermunt, 2017). Self-fulfilling prophecy also plays a decisive role here.
Due to today's form of globalisation, financial market instabilities, despite their origin in individual markets, also have significant implications for the financial markets of other nations. Recognising price bubbles or actively countering such developments is thus no longer a national task alone, but requires joint action by global regulatory institutions due to the possible negative consequences for the world economy (Grundmann, 2009).
3. Price bubbles on real estate markets
3.1 Real estate markets in the context of economics
Chapter three looks at the specifics of the real estate markets, its characteristics and suggests explanatory approaches for price bubbles in residential real estate markets.
The real estate market is characterised by their central role in everyday human life, whether for living or working purposes, and is further typified by low market efficiency and high transaction costs compared to securities and commodity markets (Voigtländer and Rottke, 2017).
Although real estate is a fundamental necessity in industrialised nations, the real estate market has so far been underrepresented in economic research despite this high relevance. This is especially accurate in economies, where the real estate commodity oftentimes represents the single most valuable property of private households.
The following chart illustrates the role of real estate in the context of the total net assets of German citizens.
Abbildung in dieser Leseprobe nicht enthalten
Figure 2: Net fixed assets by asset type 2020 (Own figure according to Federal Statistical Office Germany)
Net fixed assets are defined according to the classification of the Federal Statistical Office as all assets that are used repeatedly and permanently for more than one year.
With a total of 82%, investments in real estate assets make up the largest part of the total net fixed assets of the Germans in 2020, amounting to EUR 11.686 trillion. This example already shows how high the real estate share of the Germans' net investment assets is. Even marginal price changes therefore have a serious impact on total net fixed assets.
In addition to the limited availability of data, another series of characteristics that are not found to a comparable extent in other goods were decisive for the low prior scientific consideration of the real estate market:
- Location-bound
- Long life / service life
- High stable value
- Low transaction frequency
- High transaction costs (Winter and Rottke, 2017)
The comparatively low transaction frequency for residential properties combined with simultaneously high relative and absolute transaction costs leads to a limited number of current and reliable data regarding traded property prices.
As a consequence, this leads to weaknesses in the market-oriented calculation of yield and value assessments (Donath, 2014). To some extent, this is compensated for by the function of appraisers and real estate agents, who in turn contribute to increasing market transparency and efficiency and thus at least partially compensate for the deficits in the information and data basis.
The conclusion that can be derived from this, is that the market is only partially efficient. This can be explained and classified in more detail with the help of Fama's efficient market hypothesis. According to Fama, markets can be classified into three information efficiency levels: weak, semi-rigid and strict information efficiency (Scheufele and Haas, 2008). The information efficiency of a market reflects the degree of information processing in that market.
- Weak information efficiency exists when market prices reflect or are priced in all past information and data.
- The semi-rigid form is when market prices reflect all publicly available information and data both past, present and future.
- Strict information efficiency would exist if market prices included all information, both public and non-public, e.g. insider information, in their entirety (Scheufele and Haas, 2008). This level is more theoretical than practical.
Transferring these criteria of information efficiency to the real estate market, it becomes evident that only a weak information efficiency is given here, since the data basis is quantitatively limited and only past and present information flows into the market pricing.
3.1.1 Uniqueness of the residential property market
In the economic literature, the residential real estate market is assigned a dual character. This is expressed in the fact that residential real estate is to be regarded as both a consumption and an investment good. As a consumption good, the focus is on condominiums and single-family houses. In contrast, multi-family houses are often investment goods (Winter and Rottke, 2017). However, there are overlaps in both classifications that do not allow a clear distinction between the two characteristics, especially as the very same entity can switch from one classification to another.
In the area of real estate as a consumer good, individual demands and preferences of investors increasingly significance the essential role (Voigtländer and Rottke, 2017). Here, buyers are often willing to pay a higher price for a property that suits them. Therefore, purchase prices for single-family houses tend to be higher than their fundamentally justified price. However, this price deviation from the fundamental value is limited by budget and income restrictions. This is based on the consideration that individuals will only be prepared to a limited extent to base a private house purchase exclusively on subjective ideas (Bischoff, 2015). Multi-family houses, on the other hand, are primarily purchased under yield considerations, which means that they are not affected by this problem (Brunner, 2009).
Another special feature of the residential real estate market is the investor behaviour in this market, which, according to the available literature, differs significantly from the behaviour in other markets (Rombach, 2011). This deviation can be attributed to the special features of the residential real estate market in the form of low market transparency and efficiency. Consequently, there is a high degree of uncertainty for investors with regard to a possible assessment of the price of a property. In addition to the limited transparency and efficiency of the market, another special feature results from the high number of inexperienced market participants (Voigtländer and Rottke, 2017). Since the purchase of a property represents a one-time investment decision for the vast majority of private market participants during their lifetime, buyers have little or no familiarity with valuation practices and procedures. In this context, private investors orient themselves, among other things, to current market sentiments, which in turn leads to pro-cyclical action on the part of market participants (Francke and Rehkugler, 2011). All in all, the aspects described are responsible for the significant deviations in pricing compared to other markets.
3.1.2 Segmentation into product submarkets
In addition to the special characteristics already mentioned, real estate markets are distinguished from other markets in particular by their segmentation into submarkets (Thomas and Rottke, 2017). Real estate markets can be divided into spatial and product submarkets, the delineation of which is explained in more detail below. For the subdivision of the market, a differentiation between residential, commercial and special properties is appropriate.
Abbildung in dieser Leseprobe nicht enthalten
Figure 3: Subdivision of the real estate market (Own figure)
Residential real estate is the most clearly defined category. The benefit of this type of real estate is the provision of living space. Against the background of the strong public interest in providing the population with adequate and affordable housing, this also includes apartment buildings or apartment blocks and other rentable housing as well as weekend homes.
Commercial real estate is real estate that the user uses to create a product or service. In addition to production and office buildings, this also includes public buildings, leisure facilities or other real estate that serves economic purposes in the broadest sense. The category of commercial real estate is far more inhomogeneous than that of residential real estate.
Special real estate is real estate that was built for a special purpose and specifically tailored to that purpose. The original purpose can hardly be redefined, and other uses are only possible to a very limited extent. Examples are petrol stations, multi-storey car parks or hotels (Glück, 1997).
In addition to the subdivisions already made, properties can be subdivided into new buildings and existing properties on the basis of their respective age. For new buildings, the price of the property is primarily influenced by the price of the land, the construction costs and the amount of any state subsidies. In the case of existing properties, the expected rents, the supply of existing properties and possible investment alternatives are among the factors that influence the price (Winter and Rottke, 2017). In addition to the outlined aspects, legal building requirements, construction and equipment features are also relevant, which in turn can justify price differences.
3.1.3 Segmentation into spatial submarkets
In addition to segmentation into product submarkets, it is also possible and necessary to subdivide real estate markets into spatial submarkets (Gromer, 2012).
For a subdivision according to spatial factors, the subdivision according to settlement- structural district types is suitable. The settlement-structural district types were developed at the end of the 1970s for the old Federal Republic. The starting point was an inventory of rural areas based on indicators. The necessary delimitation was carried out on the basis of the spatial planning regions through their settlement structure characteristics presence and size of a conurbation core and population density (Bundesinstitut für Bau- Stadt- und Raumforschung).
Especially with regard to the study of suburbanisation and urban-rural effects, this summary district typology gained importance (Brunner, 2009). Another argument in favour of simplifying the district typology was the fact that when distinguishing between East and West, individual groups in East Germany were weakly populated, so that variance-analytical considerations were hardly possible under this diversity (Heineberg, 2017).
Nowadays, a distinction is made between four types of districts: large cities free of districts, urban districts and rural districts, which either have a tendency towards densification or are very sparsely populated (Heineberg, 2017).
In summary, the overall German market can be divided into four types of circles:
1. Large cities free of district: Cities with at least 100,000 inhabitants (Bundesinstitut für Bau- Stadt- und Raumforschung).
2. Urban districts: Counties with a population share in large and medium-sized cities of at least 50% and a population density of at least 150 units/km[2]; as well as counties with a population density without large and medium-sized cities of at least 150 units/km2 (Bundesinstitut für Bau- Stadt- und Raumforschung).
3. Rural districts with densification trends: Counties with a population share in large and medium-sized cities of at least 50% but a population density of less than 150 units/km2, as well as counties with a population share in large and medium-sized cities of less than 50% with a population density excluding large and medium-sized cities of at least 100 units/km2 (Bundesinstitut für BauStadt- und Raumforschung).
4. Sparsely populated rural districts: Counties with a population share in large and medium-sized cities of less than 50% and a population density excluding large and medium-sized cities of less than 100 units/km2 (Bundesinstitut für Bau- Stadt- und Raumforschung).
Based on the latest publication of the Federal Institute for Research on Building, Urban Affairs and Spatial Development, the distribution of area and population in settlement- structural district types is shown below.
[...]
- Arbeit zitieren
- Kilian Köberlein (Autor:in), Real Estate Bubble in Germany. The German Residential Real Estate Market for the Presence of a Bubble, München, GRIN Verlag, https://www.grin.com/document/1268386
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