As you know, I am concerned about what is happening in Germany right now: 1) Acute housing shortage in the metropolitan regions, especially in the Top 7 cities and their surrounding areas. 2) Ongoing stagnation of economic strength. 3) Internal conflict over prosperity and values, manifesting in dysfunctional political conflicts. 4) Powerless financial budget questioning the eligibility of projects.5) Domino effect of insolvencies in the real estate sector. 6) Uncertainty among financial institutions in assessing the current market situation and potential undercapitalization for the coming months, which could lead to a banking crisis. I believe we have reached a turning point, and 2024 will be a pivotal year in which we find consensus on the direction of the market, and we will no longer use the word "hope" in our forecasts. Either we collectively act intelligently enough to avert the crisis, or we plunge into a much larger hole than we had hoped for. Regarding the acute housing shortage, the weakening economy, and the dysfunctionality of the state, including the powerless financial budget, I personally had the opportunity to hold a press conference on November 29, 2023, with Dieter Becken from Becken Holding, Michael Keune from Catella Residential, and Dr. Simon Kempf from DLE, discussing the solutions we can pursue to prevent the current crisis from escalating further. We are in a room full of hay with a spark. Small and seemingly harmless, but with the potential to ignite everything. For reasons I will explain below, I would like to express my personal opinion on these crucial matters in our company blog again before the end of the year, in addition to the press conference. This is a personal opinion and does not directly come from the PREA Research Lab, but I would like to leverage the reach of our blog to do so.

The impact of the structural crisis on the housing market

• • The persistent waves of refugees resulting from repeatedly escalating crises will put a much greater strain on the housing market than initially anticipated. By 2026, there will be a shortage of between 1.5 to 2 million housing units in the metropolitan regions of Germany.
• • The exponentially increasing demand for housing in metropolitan areas, coupled with a lack of available residential rental spaces and reduced purchasing power due to a rapidly changing interest rate market, is driving rental prices to new heights upon contract signings for new constructions. In 5 out of 7 top cities in Germany, median rents range between 20.00 and 25.00 EUR. Additionally, 50 percent of listings are already furnished apartments, commanding peak rents of up to 42.00 EUR.
• • Rising and persistently high rents in the new construction segment are hindering the growth trajectory of the economy. Companies are unable to guarantee employee growth due to extremely elevated cost of living. Real wages in metropolitan areas are growing significantly slower than rents, resulting in rental burdens exceeding 40% of household income.
• • The birth rate decline is weakening rural areas and exacerbating the housing crisis in metropolitan regions as economic growth continues to centralize on Germany's key locations, and particularly as economic activities in independent cities are expected to decline over the next 10 years.
• • The dysfunctionality of the German financial budget and ongoing insolvencies of major asset managers and project developers are complicating the financing of new construction projects.
• • Institutional investment capital is increasingly seeking better opportunities in housing projects in other markets, which could lead to a reassessment of country risk in 2024. There is less domestic capital available in the German residential real estate market. The institutional market perceives project development risk in forward deals.

Background

Despite the economically attractive growth of the Federal Republic of Germany, the country has grappled with recurring crises, beginning with the financial crisis of 2008/2009, followed by the revision crisis of 2013/2014, and the refugee crisis of 2015/2016, which was one of the first indicators of accelerated vacancy reduction in metropolitan regions, leading to the initial major political debates on affordable housing. Due to the regional rent cap of 2019/2020, the subsequent global COVID-19 crisis, and now the ongoing energy crisis caused by the Russia-Ukraine conflict and the dismantling of the North Stream pipeline, the Federal Republic of Germany has been terribly divided in terms of income, opportunities, and values. This division has contributed to political extremism and the rise of the AFD (Alternative for Germany) party. Ideological extremism on both the left and right, coupled with weak leadership in the ruling party, has contributed to a dysfunctional financial budget that has unsettled investors regarding long-term investments in Germany. At the same time, Germany is facing significant challenges stemming from: 1) Rising interest rates due to persistent inflation. 2) Rapidly increasing national debt, burdened more than ever by the new interest rate environment and fiscal policies. 3) Expensive and harmful climate changes that have an extreme impact on construction costs and rents. 4) Unregulated waves of refugees that have reduced housing vacancies in Germany's key economic hubs. 5) Reduced purchasing power of the population due to inflation and rising interest rates. All these challenges can only be addressed through targeted and intelligent government subsidies. The upcoming federal elections may be crucial, but by 2025, it might be too late to effectively tackle these issues.

Data and Facts on the Case Study of Berlin

In the last 22 months, Berlin has witnessed a significant increase in its population, triggered by an unexpected wave of refugees. Concurrently, Germany's attractiveness as an immigration destination has diminished. This phenomenon depends on various factors - ecological, economic, political, and emotional. Despite their complexity, all these aspects can be measured and expressed in quantifiable data.

1. 1. The refugee wave has exacerbated the housing shortage in the metropolitan regions of Germany.
2. 2. Developers and investors face challenges in the new capital environment, as Forward Deals have changed, requiring higher equity contributions, and interest rates are influencing return expectations.
3. 3. The new AfA (depreciation) regulation at 11% and subsidy programs from state-owned investment banks offer partial compensation, but only for projects in rental housing construction and not for tax-exempt entities like pension funds and insurance companies.

Property Market in Berlin:

1. 1. Despite changes in purchasing power, there is still a demand for property ownership. To keep Berlin economically attractive and competitive as the capital city, it is necessary to have condominiums in the price range of €250,000 to €450,000. This price range aligns with the current purchasing power in Berlin and takes into account the need for a workforce that promotes the growth of regional companies.
2. 2. The current rental structure in the capital city does not attract new workers but rather encourages poaching. The cost of living for new rentals is not sustainable for the average employee.
3. 3. Developers should therefore focus on building apartments with a square meter price ranging from €4,000 to €5,500, and this should be done at a volume of approximately 25,000 apartments in the coming years.

Rental Market in Berlin

I am increasingly concerned about the current developments in the rental housing markets. Our analyses at PREA show that in 124 out of 127 cities we examined, rents for existing apartments are rising. This trend is particularly noticeable in new apartments in the top cities. Here, rents of up to €30 per square meter are expected, a dynamic largely driven by the trend towards furnished apartments. This is increasingly affecting the competitiveness of cities and the influx of workers. In German metropolises like Berlin, Hamburg, and Munich, we have seen a significant increase in new lease rents since the beginning of 2022. For new construction rents, these increased by 24.1%, 19.1%, and 9.3% respectively, averaging 8.9% across the A-cities. On a 10-year growth rate, it can be as high as 6.5% annually. Even households with moderate incomes are increasingly affected by this shortage.

An essential factor contributing to the recent growth in rental prices is the influx of international professionals. They are often willing to pay higher rents than local workers, especially when they are familiar with rental levels in other European and non-European countries. The market for furnished housing has evolved from a niche segment to an established entity in major cities. In Berlin, for instance, every second housing listing now pertains to this market. Square meter prices in German metropolises are now comparable to those in European cities like Amsterdam (€32.90), Milan (€29.20), or Lisbon (€35.70). In Paris, they are even higher at €44.00 per square meter. This development also has implications for the local population. In Berlin, for example, 32% of households with incomes between €1,500 and €2,600 can no longer afford a 2-room apartment in a new building if a maximum rental burden of 40% is assumed. Households with an income of €5,000 can afford a maximum of a 3-room apartment in a new building.

The Birth Collapse and the Myth of Rural Exodus

In the long term, the rising rental prices have negative effects on the competitiveness of cities and hinder their attractiveness for new workers. I know that what I am saying will be criticized by some people, including some who may want to attack me for expressing these views. I also know that I have grown up in a wonderful country at a wonderful time, which has given me the right and the duty to speak about important matters. Particularly, the decline in our economy and affordable housing in metropolitan regions are one of the most critical factors for further economic growth in our country. This is because: 1) The birth collapse will lead to the extinction of rural regions. 2) Consequently, the major economic hubs in Germany will benefit from population growth and continue to drive the price spiral in the new rental world. 3) The rural exodus for a better life from the metropolises during the rent cap, the COVID-19 crisis, and our current energy crisis was a lie, as people moved to rural areas due to: 3a) No available supply in the market 3b) Extremely rising household costs of more than 40 percent and 3c) Clear evidence that vacancy rates in the top 7 cities never increased. The result is a rapidly growing willingness to commute from the outskirts to the metropolis. More and more people are willing to commute to their workplaces. The crises have accelerated the trend of terrible income, opportunity, and value disparities, forcing workers to move to the outskirts out of necessity.

The current developments regarding urbanization and demographic changes pose significant challenges in the real estate market. A notable decline in births in many regions of Germany increases investment risks. In addition, there are risks of rental income losses caused by declines in productivity in regionally significant industries. According to our analysts, especially independent cities in East Germany, with a high risk of poverty and extensive rental housing stocks, are heavily affected by the risk of rental income loss. Another alarming scenario is emerging in rural regions. Here, population declines of up to 60 percent are looming over the next 20 years, as seen in places like Saale-Holzland-Kreis. This inevitably leads to increased vacancy rates. Particularly striking is the decline in the younger population in rural states like Saxony, Saxony-Anhalt, and Thuringia, which are experiencing declines of 9.5 percent, 17.2 percent, and 14.9 percent, respectively. In these regions, away from larger cities, an oversupply of housing is on the horizon. These developments underscore the need to adapt investment strategies and policy measures to keep both the urban and rural real estate markets in Germany stable and attractive. The decline of existing industries can also present an opportunity for new businesses to integrate into existing infrastructure and utilize vacant housing for the growth of their new personnel. This can only be achieved, for example, in Berlin or the Berlin metropolitan area through substantial investment costs for commercially used factory apartments.

Solution for the Future

As I see it:

1. 1. There is only one way to rescue the German residential real estate market and simultaneously strengthen the economy, and that is through a clear reform of our support mechanisms for housing construction, an accelerated zoning approval process for residential construction, similar to what Robert Habeck has already achieved for the solar industry, and the introduction of standardized approvals, especially for high-rise buildings.
2. 2. If we fail to accomplish this, the likelihood of a stagnant economy is uncomfortably high, as we face relatively high cost of living for new rental agreements in new buildings, which is in strong competition with our necessary immigration policy.
3. 3. If either the same coalition or a new one with the AfD is elected, it would be detrimental to the country because we would not have the wise bipartisan leadership needed to prevent the dysfunctionality of our country. Surveys clearly show that a majority does not want extremism from ideologies in either direction.

Therefore, I believe that the negative scenarios mentioned above will not materialize if we take targeted measures in the current term to promote housing construction where the actual shortage or even emergency exists. To achieve this, tax incentives, KfW and state bank subsidies, as well as accelerated planning procedures, should only intervene in regions that exhibit the pattern of necessity. For example, AI-based analyses allow for a more effective use of subsidy programs. Clustering locations based on ESG criteria can identify the neediest regions and target funds effectively. To define the ESG value of a property location, we consider the location and relevant spatial levels. Over 330 features per rental and purchase offer data point are categorized into areas such as residential properties, points of interest, socio-economic and air quality features, etc. These data points are plotted on a coordinate system defined by rental price and floor area. A grid with machine learning-based models is placed on this system to use model accuracy as a price risk. Another model structures the features.

The goal is to enhance the quantifiability of ESG factors in the real estate context. There are existing approaches like CRREM or ECORE, but these often focus only on individual ESG factors or take a purely building-centric perspective. PREA identified challenges such as the lack of consideration of interactions between factors, the neglect of local and global aspects, and reliance on manually maintained data instead of automated and transparent models. As a company, we propose splitting the Governance factor (G) into two subfactors: Corporate Governance (CG) and National Governance (NG). Corporate ESG assessment approaches used by companies near real estate locations can be utilized to determine the CG factor. The determination of the ESG value of a property location is achieved by combining the structural arrangements of various features and the G factor. By assessing the ESG values of different locations at various spatial levels, a spatially differentiated ESG profile is created. In the schematic representation, adjacent postal code areas in Berlin are visualized in relation to a specific postal code.

Conclusion

In conclusion, it can be said that innovations and technologies, especially in the era of AI, have the potential to make housing construction in Germany more efficient and sustainable without significantly burdening the political budget and resorting to imprecise subsidy programs. If it were to unfold as I have attempted to describe in my article, then I see a high likelihood of finding a proactive solution to combat the housing shortage and create affordable housing in metropolitan regions. I hope you, as a reader, share this vision and keep your fingers crossed for these scenarios, perhaps even working towards them.