It’s Another Bubble. Or Is It?

Since the end of the previous millennium, a number of bubbles formed and popped. For one thing, there was the New Economy bubble which in Germany manifested itself most conspicuously in oddball valuations on the New Market. When the bubble burst, the head of the US Federal Reserve Bank, Alan Greenspan, combated the subsequent crisis with a cheap-money policy. The result was the formation of another bubble, this time on the US housing market. No sooner had it burst than the central banks fell back on their “field-tested” recipe that had already failed several times over, battling the ramifications with yet cheaper cash. The key lending rate was lowered to near zero, and at the same time, the central bank began to buy up government bonds, cranking up the mint, as it were.

It is perfectly understandable that people are getting worried that the next bubble might be waiting in the wings. Wherever prices are pushing up these days, it fans fear that a new bubble is possibly forming. Certain voices have already warned against the formation of a bubble on the German housing market.

Not every price hike is necessarily a sign for a bubble, though, and the term does not begin to apply until prices move clear of their underlying valuation. Unlike with gold, where no valuation criteria exist, sound indicators to evaluate stocks and real estate are readily available. In the case of equities, these include factors such as the price earnings ratio (P/E ratio). For example: On occasion of the stock market bubble in the 1980s in Japan or during the New Economy bubble ten years later, this ratio soared to astronomic levels.

In the case of residential real estate, experts monitor the relationship of home prices to rents as well as the relationship of homes prices to income. As it turns out, German apartments are more affordable than apartments on any other market by either criterion. No matter where you look, be it Spain, the United Kingdom, France or the Nordics – apartment prices everywhere clearly exceed those in Germany.
Germany has been, and continues to be, subject to a massive catch-up need because prices and rents deteriorated for the longest time or were slower to rise than in any other country. The IVD German real estate association recently presented some rather interesting figures: While condominiums in Berlin used to cost 200,000 Euros and thus more than in most European cities in 1992, they are now as affordable as in few other cities at barely 120,000 Euros.

The difference between the supposedly “risk-free” interest offered by a ten-year government bond, and the yield rate for residential real estate approximates three percent in Germany today – a wider gap than ever before. In the early to mid-1990s, by contrast, government bonds paid returns between seven and nine percent, whereas the rent yields for German apartments averaged 4.5 percent. This means: Back then, the yield gap between German apartments and ten-year government bonds was actually negative. This comparison is thus another argument against the probability of a price bubble on Germany’s housing market.