KYNASTUDIO/Envato
The German residential construction market continues to face significant headwinds, with falling building permits, rising construction costs, and persistent affordability challenges. While incremental improvements in regulation and financing offer glimpses of hope, the outlook remains complex.
The latest data from the Ifo Institute reveals a slight easing of pressure on developers. In October 2024, the share of companies reporting a lack of orders dropped to 49.9%, down from 52.9% the previous month. This marks the first time in months that the figure has dipped below 50%.
However, order cancellations rose slightly to 11.8%, highlighting the ongoing uncertainty.
Klaus Wohlrabe of the Ifo Institute did not mince words: "If no projects are commissioned today, there will be no housing tomorrow." Developers are caught in a precarious cycle, struggling to maintain skilled workforces and capacity as demand stagnates. The long-term risks of this bottleneck are significant, especially if activity picks up again in a few years.
Berlin-based investor Jakob Mähren recently provided a blunt assessment of the challenges in a media interview: "For many project developers, it’s like riding through hell. The business models that worked in a world of low interest rates and rising property prices simply don’t function anymore." He emphasized the need for systemic change, pointing to regulatory hurdles and unsustainable cost structures as major barriers. "Without significant reform, developers will keep collapsing under the weight of rising costs and falling margins," Mähren warned.
After a period of calm, construction prices have recently been rising again. Data from August 2024 shows a 3.1% year-on-year increase in costs for new residential buildings, with finishing work up 4% and roofing and heat pumps nearing a 5% increase. While these price hikes are more subdued than the surges seen in 2022, they still weigh heavily on project feasibility.
Mähren highlighted the disconnect between rising costs and market conditions: "Anyone who bought expensive land and now faces higher construction costs and interest rates is in serious trouble. If buyers are only willing to pay lower prices, there’s no exit—and no cash flow."
Demand for home loans rising, but affordability still a problem
The European Central Bank’s rate cuts have begun to ease financing conditions, with demand for home loans rising sharply. The Bundesbank reported the largest quarterly increase in mortgage demand in over 15 years during Q3 2024, as banks passed on lower interest rates and improved terms to borrowers.
Yet, affordability remains a barrier for many households. While homeownership costs fell to 40% of monthly income for a typical family in Q3 2024, this is still significantly higher than the 30% level seen a decade ago. In major cities like Berlin, middle-income households must allocate a staggering 62% of their income to buy a home.
Economist Pekka Sagner of the German Economic Institute (IW) was direct: "Without significant new residential construction, there is no way to sustainably ease the housing market." He called for bold political action, including tax relief measures like halving the land transfer tax to stimulate development.
Mecklenburg-Vorpommern reforms could pave way for other states
One of the more encouraging developments comes from Mecklenburg-Western Pomerania, where the state government has approved a series of measures to simplify building regulations. These include:
- Allowing master tradesmen and technicians, in addition to architects and engineers, to submit building applications.
- Eliminating parking space requirements for attic conversions, additional storeys, and subdivisions.
- Reducing clearance requirements for heat pumps and solar panels, enabling more efficient installations.
- Expanding approval-free attic conversions for residential use.
These changes have been lauded by industry leaders, including Andreas Breitner of the Association of North German Housing Companies (VNW), who described them as "important and correct steps." He tempered his optimism, however, with a note of caution: "In the end, it’s not intentions that count, but actions."
While Mecklenburg-Vorpommern's steps are commendable, their implementation may face delays or resistance. Similar measures, such as the "small building permit authorization," have seen uneven adoption in other regions due to entrenched bureaucratic processes. Investors should view these reforms as a potential catalyst, but not a guarantee of immediate improvement.
"A bazooka is needed - not an air rifle"
Despite his warnings about the broader challenges facing developers, investor Mähren sees opportunities emerging in the current market. "The mood in the industry is better than the reality, but we’ve now gradually reached the low point," he said. "After difficult years with hardly any transactions, buyers and sellers are finally approaching each other on prices."
Mähren’s firm, MÄHREN AG, plans to invest €200 million in residential portfolios, focusing on Berlin and the Ruhr area. He sees signs of stabilization, with transactions picking up and property prices bottoming out. However, he remains critical of political efforts to address the housing crisis, arguing that incremental measures will not suffice. "The housing market doesn’t need an air rifle—it needs a bazooka," he said, calling for significant tax relief and bold government intervention.
Takeaways for investors
While there’s plenty of trouble ahead for the German residential construction sector, there are still actionable strategies for investors who can navigate the tricky path ahead:
- Monitor regulatory reforms: Mecklenburg-Western Pomerania’s moves could set a precedent for broader regulatory change. Investors should monitor how other states respond and position themselves for opportunities tied to streamlined approvals and cost reductions.
- Focus on stabilizing markets: Berlin and the Ruhr, where Mähren is targeting investment, represent markets with resilient demand and improving transaction volumes. Strategic acquisitions in these regions could offer long-term growth.
- Anticipate political shifts: Political instability could delay vital reforms, such as housing subsidies or tax incentives, leaving the sector in a holding pattern until a new government is in place. With elections in early 2025, investors should remain agile and prepared to adapt strategies to new housing policies.
- Prepare for a slow recovery: Financing conditions are improving, but the broader recovery in residential construction is unlikely before 2026. Investors should avoid overexposure to projects reliant on short-term rebounds.
