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Pfandbrief banks expect the rise in prices to slow down, but not a severe correction in the residential property market

• German real estate market benefits further from very robust economic growth, high employment and low interest rates
• Mortgage Pfandbriefe remain on growth path – Pfandbrief sales and volume outstanding expected to rise slightly in 2018
• Future regulatory setting taking shape

The Association of German Pfandbrief Banks (vdp) is not expecting the dynamic price growth in the German market for residential properties to continue at the pace seen over the last few years. “We expect the rise in prices in the German housing market, both nationwide and in the metropolitan areas, which has been particularly strong of late to decelerate perceptibly,” remarked Dr. Louis Hagen, the Association’s President, at the vdp’s annual press conference in Frankfurt am Main. That said, the Association does not anticipate a severe correction. “We are not expecting residential property prices to plummet,” Dr. Hagen continued.

In particular, the still very robust economic growth as well as the developments in incomes, employment, interest rates and consumer prices remain, in the view of the vdp – whose market assessments are founded on a database that is unique in its breadth and depth – key drivers of the current boom in the German real estate market. The situation in the residential property markets in Germany’s top 7 cities (Berlin, Hamburg, Munich, Cologne, Frankfurt am Main, Düsseldorf and Stuttgart) continues to be especially tense. However, rising nominal interest rates are likely to dampen demand for residential properties as a whole, and this will ultimately also affect the trend in prices. There are no signs of a repetition of the vacancy rates which were seen in the residential property market after the construction boom of the 1990s.

Moreover, due to high levels of capacity utilization in the construction sector and the scarcity of building land, new construction activity currently lacks the strength to develop into an exuberant boom. The vdp presents a similar assessment for the market for German office properties. Here, too, prices have risen sharply in recent years; but the vdp considers it unlikely that the disproportionately strong growth in capital values compared with the growth in rents will continue indefinitely.

The rise in German property prices accelerated again slightly last year. The vdp property price index, which is calculated on the basis of real transaction data, advanced by 6.8% on average for 2017 (2016: + 6.4%). Residential properties went up in price by 6.9% (2016: + 6.5%).

Growth was even more pronounced in Germany’s top 7 cities, with residential property prices climbing by 13.7% compared with the year before. Prices continued on their upward trajectory in the commercial property market, too, rising by 6.5% (2016: +5.8%). Here, prices for office premises saw above-average growth of 8.4% (2016: +7.7%).

High levels in Pfandbrief banks’ real estate business persist

Real estate finance has also benefited from positive macroeconomic developments, which have fueled the unbroken and high demand in the property market, as well as from the ongoing low-interest-rate environment. Last year, lending volumes remained high. New loan commitments by the Pfandbrief banks in this area were largely unchanged in 2017 following distinct increases in the years before, standing at €143.1 (2016: €144.4) billion. Broken down into the two segments, residential property loans accounted for €74.5 (2016: €74.2) billion of new commitment activity. On the other hand, commercial property loans totaled €68.5 (2016: €70.1) billion. The figures for public sector financing, meanwhile, reflect budget consolidation by the German federal government and the German federal states, with new commitment activity falling to €14.5 billion in 2017 following €15,9 billion the previous year. All in all, Pfandbrief banks’ new lending receded by 4.6% last year to €165.3 (2016: €173.2) billion.

Mortgage Pfandbriefe remain on growth path

After issue volume declined in 2016, Pfandbriefe sales rebounded in 2017 to €48.8 (2016: €45.4) billion. Here, Mortgage Pfandbriefe amounted to €36.9 (2016: €35.1) billion and Public Pfandbriefe to €11.9 (2016: €10.3) billion. Over the last few years, the latter have ranged between €10 and 15 billion.

The positive development of the Mortgage Pfandbrief is most clearly reflected in the growth in Pfandbriefe outstanding. At €218 (2016: €212) billion, the volume of Mortgage Pfandbriefe outstanding rose again in 2017. As a result, the share of total Pfandbriefe outstanding accounted for by Mortgage Pfandbriefe increased to 59%, compared with 44% five years earlier. Due to high maturities in the case of Public Pfandbriefe, the total volume of Pfandbriefe outstanding fell again slightly last year to €366 (2016: €374) billion.

Based on a survey conducted among its member banks, the vdp expects that Pfandbrief sales this year will see another slight increase of around €50 billion. Of this total, €39 billion are likely to be accounted for by Mortgage Pfandbriefe, sales of which are therefore expected to increase once again over the previous year. “Last year, too, the Pfandbrief consolidated its position as an indispensable element of the strategic funding mix of many banks – and retained its benchmark status in the European covered bond market despite growing product diversity,” observed Dr. Louis Hagen.

Future regulatory setting taking shape

Steady progress is being made on the regulatory initiatives which the vdp launched and has been closely involved in over recent years. Regarding the aim of seeing covered bonds harmonized, the publication of the proposal by the European Commission for a directive and a regulation in March 2018 was a major milestone on the path to implementation. “The decision in favor of a principle-based approach which features all the main quality characteristics of covered bonds and, at the same time, shows a high degree of compatibility with the German Pfandbrief Act meets important demands of the vdp,” stated Jens Tolckmitt, Chief Executive of the Association of German Pfandbrief Banks. The Commission’s proposal calls for a minimum of harmonization and leaves sufficient leeway from the perspective of the German Pfandbrief banks – based on national laws – for maintaining, and for enhancing the quality of national products such as the Pfandbrief which have proven themselves in the past. However, there is need for improvement in how the eligible cover assets should be defined. In the vdp’s view, the definition is too general and leaves too much scope to widen the range of assets that might qualify as cover. The requirements in the directive need to be more detailed and more rigorous in order to better protect the covered bond asset class and prevent it from being watered down.

Besides the harmonization of covered bonds, another lengthy regulatory process is also on the home stretch: the reform of Basel III. A great deal was achieved at the technical level under the compromise reached in December of last year; and now that planning security is given, the agreed output floor (lower limit for capital backing) constitutes a significant burden for a great many banks and makes low-risk business activities such as parts of real estate finance much less attractive. In the context of the implementation of the reform package in the European Union the vdp will, for this reason, push for unjustified burdens in European bank-based real estate finance to be removed.

Another initiative the German Pfandbrief banks are currently concerned with is the EU action plan on financing sustainable growth, with which the European Commission wishes, in particular, to see more capital flow into long-term investments and to improve transparency and long-termism in the financial sector. The Association of German Pfandbrief banks supports the initiative in principle and considers its objectives to be desirable, yet believes that a number of key points are still in need of clarification. For instance, in the vdp’s view, the planned classification of sustainable assets and the creation of standards (e.g. for green bonds) calls for a framework that is both robust and flexible enough to grant progress and innovation the necessary scope within a fast growing market. Above all, the vdp believes that industrial standards that are already in place and have proved their worth should be taken into consideration and serve as a frame of reference. Moreover, before any lower obligations on capital cover can be introduced, it would be necessary to examine thoroughly whether a relationship actually exists between green assets and a low (default) risk.

“The German and European institutions continue to face considerable regulatory pressures, although signs that several key initiatives are nearing conclusion finally give hope of a certain degree of planning security,” said Jens Tolckmitt. “The decisive criterion here is that potential interventions in functioning and successful markets should always take a measured approach and be kept to the necessary minimum. The Association of German Pfandbrief banks will continue, with its member banks, to do its utmost towards this goal.”

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