Tax cut might overheat German real estate

One of the peculiarities of acquiring property in Germany is that the price of sale is by no means all the buyer will end up forking out. Every one of the country's 16 federal states levies a real-estate-acquisition tax of between 3.5 and 6.5 percent. In 1999, I purchased an apartment in Berlin, paying an additional 3.5 percent. In 2012, I bought another flat and coughed up 5 percent. Someone buying this year would have to pay 6 percent.

Critics argue that the burgeoning tax is keeping low- and middle-income people out of the housing market and are saying it should be reduced or abolished.

"We want to encourage people to buy residential property to live in," Jan Marco-Luczak - property law expert and member of parliament for the conservative CDU - told Die Welt newspaper this weekend. "I'm calling for a basic exemption of 100,000 euros to the property acquisition tax."

Other conservatives are saying the tax should be done away with completely. Experts at Cologne's Institute for the German Economy (IW) agree, pointing out that in other EU countries the tax doesn't exist or only kicks in for extremely expensive properties.

"An exemption would most clearly benefit those households with low incomes," IW real estate market specialist Michael Voigtländer told Die Welt.

Proposals to cut taxes are hardly uncommon in election years, and Germany goes to the polls in September 2017. But would doing away with the levies that cost people like me thousands of euros really help the less affluent cope with booming real-estate prices in Germany? Or would it just further ramp up the property boom?

Cheap credit, expensive property

Ironically, one reason that some would-be property owners may now find it hard to enter the market is the fact that financing real estate has gotten so much cheaper. That's led to an unprecedented demand and transformed the traditionally sluggish German property market. 

Germany has a lower percentage of homeowners than any other Western country (52.5 percent compared with an EU average of over 70), and in the past real estate values, adjusted for inflation, didn't usually increase very much. That changed after the financial crisis in 2007-8, when central banks lowered their interest rates to at or near zero. Credit was cheap, and both domestic and international investors seized upon the "undervalued" German property market as a place where there was money to be made.

"German house prices went nowhere for years," analyst Chris Bryant wrote early this year for the financial news service Bloomberg.  "Recently they've grown faster than the UK. A gauge of advertised apartment prices in seven major cities including Frankfurt and Berlin rose 14.5 percent in 2015."

Residential property transactions in Germany rocketed up to 23.3 billion euros ($24.7 billion) in 2015 compared with 13.3 billion the previous year according to real-estate consultant CBRE. The Professional Association of Bankruptcy Administrators says that property prices in Frankfurt went up by 19 percent in the past year.

I don't need any outside statistics to comprehend how much the property market has heated up. In 1999, I paid roughly 2700 deutschmarks per square meter for an apartment in Berlin's Neukölln district. In 2012, I paid around 2900 euros per square meter for an apartment in the same house - the euro being worth approximately twice what the deutschmark was. And a mere two days after the sale went through, I already had a letter in my postbox from a real-estate agent asking if I wanted to sell the apartment I'd just succeeded in purchasing.

That's largely down to interest rates. In 1999 I got what was considered to be a low-interest mortgage of about five percent annually. My mortgage on the second apartment is half that. Low- and middle-income property buyers would also benefit from low rates - but only if they can overcome the hurdle of ancillary costs, chiefly the real estate acquisition tax.

Extra costs a real burden

Unlike banks in many other countries, German financial institutions nearly always require property buyers to invest at least 20 percent of the price of sale. 100 percent financing of the sort that greatly contributed to the real-estate bubble in the United States doesn't exist. The real estate acquisition tax in essence dramatically lowers how much money prospective buyers can expect to get from banks.

In theory, someone investing 20,000 euros might apply for a 100,000-euro loan to buy a property in Berlin valued at 120,000 euros. But if the sale went through, the purchaser would need to pay 7200 acquisition tax plus other ancillary costs for notaries as well as possible real estate agent fees. So in reality, the potential buyer has far less than 20,000 euros to invest, and a bank won't offer him or her anything like 100,000 euros in credit. That person is thus effectively shut out of the property market.

"Property is often unaffordable for families, among other things because you can't finance ancillary costs with credit." Voigtländer told Reiters news agency.

If the acquisition tax were reduced or removed, more people would be able to take advantage of low-interest loans and buy property. But they would need to act fast since a tax cut would almost certainly cause a further rise in real-estate prices. The acquisition tax has thus far not acted as a deterrent to investors, and international demand for German property remains high.

According to an estimate made in 2015 by an online real-estate network to the financial newspaper Handelsblatt, some forty percent of apartments sold in Germany are bought by foreign investors. And a 2016 report on the property market by Germany's largest housing association, Vonovia, concluded: "Private owner-occupiers and investors from Germany and abroad are taking advantage of the favorable financing conditions to invest in 'concrete gold.'"

The proverbial small fry are likely to continue to be squeezed out. But what if the German real estate market is a bubble about to burst anyway?

Concrete or fool's gold

Germany may not have the sort of sub-prime loans that proved so disastrous in the US and other countries, but skeptics worry that the foundations of the German real-estate market might not be as solid as they appear.

This summer, the financial Internet site Marketwatch quoted two Commerzbank analysts as saying that the German housing boom was starting to look "like a bubble." Handelblatt has also warned that a downturn could be coming.

Earlier this week, the vice-president of Germany's national bank, Claudia Buch, announced that domestic property prices had risen by 5.5 percent in the first half of 2016. Buch said that this was not necessarily a sign of a credit financed bubble, but she also had words of warning.

"In the current macro-economic environment, there is the danger that people participating in the market underestimate the risks and don't sufficiently consider the possibility that levels of wealth may decline and interest rates rise," Buch said.

As a real-estate owner, I'm all too aware that there are no guarantees my property or any other investment will continue to appreciate in value. So even if Germany does decide to reduce or remove some of the ancillary costs of playing the real-estate market, potential buyers are well-advised to think carefully about what they can and cannot afford.