Authors
Kerstin Hansen Olafur Margeirsson

In our previous piece, we laid out why the current market situation indicates an attractive entry point into European real estate markets as the cycle starts turning. This is particularly the case for those segments or markets where leasing market fundamentals are favorable. In this article, we elaborate on the market fundamentals of German residential real estate.

Growing demand…

The German residential market has a traditionally strong rental market with more than 50% tenants1. Over the past two years, the tenant market has received a further boost due to increased mortgage costs and further decreasing affordability of owner-occupied property despite the fall in prices observed in 2023.

In addition, strong population growth, driven by net migration, has boosted demand. Over the past 10 years, the German population has grown by 3.5 million people to around 84.7 million at the end of 20232.

… and low construction activity …

However, the increasing demand meets a declining expansion of supply. The government's target of 400,000 new apartments per year has been undercut continuously with the number of yearly newly built residential units ranging somewhere between 220,000 and 275,000 over the past 10 years. Thus, the problem of insufficient construction activity has existed for some time. It has even become significantly worse in the wake of the increase in construction and financing costs over the last two and a half years. This shows in the number of building permits, which have dropped by 42% between June 2022 and June 2024 (see Figure 1).

Figure 1: Monthly approved apartments (seasonally adjusted)

The number of building permits have dropped by 42% between June 2022 and June 2024.
Sources: Federal Statistical Office (DESTATIS); UBS Asset Management, Real Estate & Private Markets (REPM), June 2024

This chart illustrates the number of building permits, which have dropped by 42% between June 2022 and June 2024.

The combination of rising demand and declining supply expansion results, unsurprisingly, in falling vacancies. Over the period 2012 to 2022, the average German apartment vacancy rate fell from 3.3% to 2.5%.4 The low vacancy rate is particularly pronounced in key cities, which recorded a vacancy rate of only 1% in 2022.

… result in strong rental growth …

As we learned in Econ 101, demand exceeding supply results in price increases. Accordingly, the shortage in the rental housing market is reflected in significant rental growth. From 2014 to 2023, median rents in Germany’s eight major population centers rose by around 60%, according to JLL (see Figure 2). Berlin stands out with particularly strong growth with its median rents doubling. Over the same time frame, the population in Berlin also grew by 9%, significantly more than in Germany as a whole (4.3%).

Figure 2: Development of median rents in the top 8 German cities
(Index, 1H14=100)

From 2014 to 2023, the median rents in the eight major population centers in Germany rose by around 60%, according to JLL.
Sources: JLL; UBS Asset Management, Real Estate & Private Markets (REPM), as of 2H23

This chart illustrates that the median rents in the eight major population centers in Germany rose by around 60% from 2014 to 2023, according to JLL.

… which is expected to remain substantial

According to the projections of the Federal Statistical Office, the population in Germany is expected to grow by 0.7% from 2022 to 2040. The number of households is, however, expected to grow more strongly due to the continued trend towards a smaller household size. This will then continue to increase the demand for housing. Furthermore, due to ongoing urbanization, household growth should be stronger in cities and their agglomerations.

In view of the projected increases in demand, while construction activity is expected to remain subdued, one can hardly expect rental growth to calm down significantly. PMA expects average rental growth of around 3.1% p.a. in the 15 largest German cities and 3.4% p.a. in the top eight between 2024 and 2028 (see Figure 3). Again, Berlin is expected to outpace the rest of the country with an expected rental growth of 4.4% p.a., followed by Stuttgart at 3.9% p.a. With a forecasted inflation rate of 1.7% p.a. over the same time frame, the segment's inflation protection should, however, be more than a given in the next years across all of the 15 largest cities.

Figure 3: Projected residential rental growth 2024–2028 (%, p.a.) in the 15 largest German cities

Between 2024 and 2028, PMA expects average rental growth of around 3.1% p.a. in the 15 largest German cities and 3.4% in the Top 8.
Sources: PMA; Oxford Economics; UBS Asset Management, Real Estate & Private Markets (REPM), April 2024. Note: Past / expected performance is not a guarantee for future results.

This chart illustrates that PMA expects average rental growth of around 3.1% p.a. in the 15 largest German cities and 3.4% in the Top 8 between 2024 and 2028.

As discussed in our previous piece, the corrections that have taken place in the course of the interest rate turnaround are helping investors to find attractive entry opportunities. Although capital growth cannot be expected to return to levels as during the negative interest rate era, growing cashflows can still be expected to increase for real estate investors in the near future.

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