How is the German housing market doing? In my second take on this question, I compare rent to purchase prices for apartments in Germany.

A common measure of valuation, the buy-to-annual rent ratio relates purchase price to annual rent (excluding utilities) for comparable apartments, that is, ideally, apartments of the same size, amenities and location. From an investor's perspective, the ratio answers the question: How many years does it take until my investment is amortized (excluding issues of taxation, maintenance, …), keeping rent fixed?

To compute the price-to-rent ratio, I group apartments by city and size and compute the mean purchase prices and annual rent in each group. I keep only groups with at least 10 apartments listed for rent and 10 apartments listed for purchase. The mean price-to-rent ratio is about 25.

A first result, illustrated in the figure below, is that the price-to-rent ratio increases in apartment size, so it seems that it is relatively better to rent rather than to buy larger apartments right now (unless purchase and rental listings differ more in other characteristics for larger apartments than for smaller ones).

How do the big cities do? To illustrate, I focus on apartments with living space between 80 and 110 square meters. Munich and Frankfurt are about on par with price-to-rent ratios above 30, while buying seems relatively more attractive in Hamburg or Cologne.

##                City medianPriceToRent
## 1           München             32.62
## 2 Frankfurt am Main             31.09
## 3            Berlin             28.01
## 4           Hamburg             26.92
## 5              Köln             25.95
## 6         Stuttgart             22.11

Where are price-to-rent ratios highest? Perhaps surprisingly, the top 10 miss a few big cities and include a few unexpected ones (Rostock, Solingen?). In each of these cities, one can buy an apartment for the equivalent of 30 years of rent (without purchase fees, maintenance and such). To put these values in perspective, note that they are about on par with average price-to-rent ratios in cities such as Los Angeles, Seattle or Boston (see here).

##             City medianPriceToRent
## 1         Lübeck             38.94
## 2       Landshut             36.80
## 3        Rostock             36.43
## 4  Halle (Saale)             36.01
## 5       Erlangen             35.42
## 6     Ingolstadt             33.00
## 7        München             32.62
## 8       Solingen             32.56
## 9         Coburg             31.42
## 10       Leipzig             31.27

To provide more context, it would be nice to compare these values to historical price-to-rent ratios in Germany, data that I don't have. Overall, it seems fair to say, though, that buying does not seem like an attractive investment in many places as yields are very poor. Of course, buying comes with other non-monetary utility and benefits which might still make buying a good choice for some.

How is the German housing market doing? This morning, Zeit-Online reported results of a recent survey suggesting that most people looking for houses consider a price range of between EUR 200,000 and EUR 400,000. The price range aligns relatively well with German median income, yet, it is difficult to find housing in that price range close to the big cities (the article portrays a family that is willing to take on a 2 hour daily commute to find housing that price range).

To get a sense of valuations, I’m starting a series of posts about housing in Germany. I focus on apartments rather than houses (the apartment market seems more liquid and has more observations of listings).

In the first post, I am trying to get a quick sense of how much apartment rents are driven by apartment characteristics versus location characteristics. I start with a simple model of monthly apartment rent as a function of living space, the number of rooms, whether or not the apartment has a balcony, a garden or a kitchen. The idea is that the above apartment characteristics (to the extent available) can be viewed as fundamentals and are unrelated to location characteristics. Of course, location is important and can also provide quality of life. You can think of this post as trying to decompose rents in a part given by apartment quality and a part that might reflect location quality.

I omit the model details here, but the model explains about 70% of the variation in apartment rents. For each apartment, I compute the fundamental apartment rent as the prediced value from my model above.

The figure below shows the distribution of actual rent and rent based on fundamental value. As one can see, fundamental rent is often higher than actual rent.

How is this difference between actual and fundamental rent distributed across regions? The figure below shows results. In particular, it shows by how much actual rent deviates from fundamental rent (in percent). Positive values mean actual rent is above fundamental rent and negative values mean the opposite.
Not surprisingly, renting in cities is more expensive conditional on fixed apartment characteristics. You can clearly see Munich, Frankfurt, Stuttgart, Cologne and Berlin on the map.

Which are the cities with the highest share of apartments that are listed at least 50% above fundamental value? The top 25 are in the table below and they do include the usual suspects, in particular Munich and its surrounding region. It’s interesting to note that Cologne appears to have a much higher share of those fundamentally overvalued apartment listings than its neighboring city Dusseldorf. Does that suggest higher quality of life in Cologne?

##                               City ShareMorethan50
## 1                          München            0.76
## 2                  München (Kreis)            0.48
## 3                Starnberg (Kreis)            0.48
## 4         Fürstenfeldbruck (Kreis)            0.47
## 5                Frankfurt am Main            0.45
## 6                        Stuttgart            0.44
## 7                  Lörrach (Kreis)            0.43
## 8                            Fürth            0.35
## 9                       Heidelberg            0.35
## 10                            Köln            0.35
## 11                  Dachau (Kreis)            0.34
## 12                Miesbach (Kreis)            0.33
## 13                        Nürnberg            0.33
## 14                          Berlin            0.31
## 15                        Würzburg            0.31
## 16               Ebersberg (Kreis)            0.29
## 17                      Ingolstadt            0.29
## 18                      Regensburg            0.28
## 19                         Hamburg            0.27
## 20                      Düsseldorf            0.24
## 21                       Karlsruhe            0.23
## 22 Bad Tölz-Wolfratshausen (Kreis)            0.22
## 23                        Erlangen            0.22
## 24                         Münster            0.22
## 25               Oberhavel (Kreis)            0.22