Dhe Deutsche Bundesbank warns that the risks on the German real estate market have increased significantly. In 2020, the prices for residential real estate rose sharply again with an average of 6.7 percent, and prices are expected to continue to rise, writes the central bank in its financial stability report presented on Thursday. The Bundesbank does not speak of a threatening real estate bubble, but states that real estate prices are now 10 to 30 percent above the values that are fundamentally justified by the level of rents, for example. “This is increasingly the case outside of the metropolitan areas,” said Bundesbank Vice President Claudia Buch.
It is typical of real estate bubbles that some people only invest in real estate because they expect prices to continue to rise. In this context, it is noteworthy that the Bundesbank presented a survey according to which 90 percent of people in Germany currently expect real estate prices to continue to rise. “The effects of price adjustments could be underestimated,” said Buch. Lending for residential real estate in Germany has recently increased by 7.2 percent over the year, a not inconsiderable rate of increase.
The interest rate risks have increased
The Bundesbank also expressed concern that banks could lower their lending standards because so little has gone wrong so far. According to the Bundesbank, a high proportion of long-term loans and investments makes the financial system vulnerable to risks that arise from a change in interest rates. Around half of the bank loans for residential property in Germany meanwhile have a fixed interest period of more than ten years. “Rising real estate prices can be critical for financial stability if more loans are granted with greatly relaxed lending standards and rising prices are expected,” said Buch.
Bundesbank board member Joachim Wuermeling explained how the current high inflation in particular could pose a risk to the real estate market – while it is generally believed that real estate in particular is a good protection against inflation. Wuermeling explained it like this: The central banks are currently counting on the fact that the high inflation rates will only be temporary. However, the upside risks to inflation have recently increased. The Bundesbank therefore believes that inflation rates are likely to decline somewhat again next year, but they could remain well above 3 percent for a longer period of time.
“The risk of higher inflation in the medium term has increased,” said Wuermeling. This in turn could lead to rising interest rates, with an impact on property prices as well. With the upside risks for inflation, the risks of interest rate changes are also increasing at the moment.
What is politics doing?
The Bundesbank expressed doubts as to whether the banks were already sufficiently aware of these risks. Many banks would see a rise in interest rates primarily positively because they expect a higher interest margin from it, said Wuermeling. But then it is important to be careful. The banks should not underestimate the risks from rising interest rates for real estate financing. You would have to arm yourself for the interest rate turnaround. Smaller banks in particular could suffer from abruptly rising interest rates if they had long-term loan agreements on their books, while many larger banks would have hedged themselves more strongly against the risk of interest rate changes. The German financial system could probably live well with a slow, continuous rise in interest rates: “But an abrupt rise in interest rates could put large parts of the financial system under pressure.”
Above all, the central bankers consider increasing the countercyclical capital buffers of the banks after the crisis to be the most important instrument for countering the danger of a bubble. Regulations on how high the loan to value of real estate may be in relation to the house value would be possible in Germany, but should not be activated at the moment, unlike in other European countries. The traffic light coalition had issued a declaration of intent to create the possibility of limiting the ratio of debt servicing to the borrower’s income. However, the Bundesbank considers the banks’ countercyclical capital buffer to be the instrument of choice at the moment.
Effects of climate policy
The Bundesbank also examined the possible effects of a more stringent climate policy on the financial system in its financial stability report. However, the focus was mainly on short-term, so-called transitory risks. For example, what kind of loan defaults there could be in banks if the CO2 price now rises faster than expected. The physical risks of climate change were not considered, for example the question of which loan defaults there can be if the sea level rises in the long term and calls into question company locations.
For the short-term risks, based on model analyzes for the next ten years, the Bundesbank comes to the conclusion that they are lower than the public discussion might suggest. The effects of, for example, a sharp rise in the price of carbon dioxide on bank balance sheets should be manageable. “Overall, the losses in the portfolios of banks, insurers and investment funds are in the single-digit percentage range,” said Buch. The Bundesbank concludes: “If clear and reliable decisions are made towards climate neutrality, the short-term costs for the financial system should be comparatively low.”