A black swan of sorts no one was ready for: Negative interest rates turned positive, and all heck broke loose in the property development sector.
We just got back from vacation in Franconia, Germany, where we wanted to taste the local culinary specialties and different beers, do some hiking, and do a lot of walking around the charming historic towns with their half-timbered buildings, some of them 500-plus years old, sandstone castles, and magnificent cathedrals.
In Germany, consumers, though still spending on experiences, have cut back on spending on some goods, and are no longer able to single-handedly make up for the downturn of some of the export industries that are losing business in China and the widespread crisis of the construction sector.
Unlike in the US, the German economy is not being fired up by gigantic deficit spending by the government. Deficits are relatively muted, by US standards. So Germany is now contemplating another quarter of mildly declining GDP. In Q2, GDP had 0% growth, following Q1 of -0.1%, Q4 2022 of -0.4%, and Q3 2022 of +0.4%.
End of Free Money plunges German construction industry into “crisis.”
The impossible happened in Germany, a black swan of sorts that no one was ready for: Negative interest rates turned positive.
It now actually costs money to borrow money. Which apparently came as a shock in an economy where negative interest rates were perceived to be the new normal. This is topped off by a massive bout of inflation – including construction cost inflation. And all prior assumptions went out the window.
There are innumerable construction projects all over the place –– medium- and high-rise office and multifamily buildings, industrial buildings, large-scale renovation projects of historic buildings, expressway expansion and interchange projects, other road construction, etc. They’re visible from the train, from the car, and on foot.
In Nuremberg – where I spent some time in the Old City, in some of the neighborhoods surrounding the Old City, and in the outlying residential area of Langwasser – there were construction projects everywhere, from fill-in projects in the Old City, to huge complexes of multifamily medium-rise buildings in other areas. This is far more construction than I’d seen during my last visit a dozen years ago and in my prior visits over the decades.
The German government – after opening the floodgates to immigration – has exhorted the construction industry to create 400,000 new apartments a year. That’s the government’s official target to deal with the surging rents that have turned into a housing affordability crisis, and that are further fueling inflation.
Actual construction is falling way short of the government’s target of 400,000 apartments; the current rate is about 300,000 units per year. And this is likely to get worse over the next two years, given the construction crisis.
Rental apartments are hugely important in Germany. Over half the households rent, and rents have become unaffordable.
But home prices – both single-family and condos – are now in steep decline, due to a different dynamic: Much higher mortgage rates, triggered by the ECB’s QT and rate hikes, following the multi-year price spike powered by the ECB’s QE and negative rates. I discussed this phenomenon here: QE Giveth, QT Taketh Away: German Home Prices vs. ECB Balance Sheet.
“Construction industry crisis” was term that kept cropping up in conversation and in the local news media.
The higher interest rates, when negative interest rates had been assumed to be the new normal, surging construction cost inflation, labor cost inflation, lower property prices, and difficulties in getting financing at all have caused widespread, let’s say, complications in the German construction industry. And due to the lower prices, the cost increases cannot be passed on to buyers.
Under these conditions – falling prices, surging construction costs, higher rates, and difficulties in getting financing – property developers are holding large tracts of land that cannot be economically developed, and that can be sold only at much lower prices, if buyers can be found at all. And they’re working on construction projects whose economic assumptions got wiped out by higher interest rates and falling property prices. All of these factors are leading to liquidity and insolvency issues.
Since July, there have been a series of insolvency and bankruptcy filings by major property developers, including:
Gerch Group, a Duesseldorf-based property developer with €4 billion in construction projects;
Development Partner, a Duesseldorf-based property developer, which specializes in office construction;
Euroboden, a Munich-based property developer, with big projects around the country, after emergency property sales had fallen through;
Project Immobilien Group, with about 60 big projects around Germany;
Centrum Group, which blamed a “toxic triangle” of higher interest rates, cost increases, and stalled investment.
The largest German residential property firm, Vonovia, wrote down its properties by €6.4 billion, blaming the drop in value on surging building costs, higher interest rates, difficulties in getting financing, and the widening gap between buyers’ and sellers’ price expectations, all of which are causing transaction activity to plunge. It warned that new construction developments are “barely viable.” In January, it had announced that it would not start any new projects in 2023, blaming inflation in construction costs and interest rates.
Given the crisis, building permits have plunged by 35% from the levels in late 2021, to the lowest level since 2012, on a seasonally adjusted basis, according to the German statistical agency Destatis, a harbinger of industry activity to come.
No one needs more office towers, with working-from-home at least on a hybrid basis having gotten entrenched in Germany, same as in the US. And no one needs more retail spaces, with ecommerce taking over brick-and-mortar retail except in some segments, such as groceries, gasoline, and services such as restaurants, hair salons, nail salons, etc., same as in the US. And that’s the price to be paid for structural changes in the economy.
But multifamily construction is crucial in Germany to deal with surging rents and the affordability crisis. And the conditions to develop residential properties have become very difficult.
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