Residential construction in Germany - Deutsche Bank Research

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Difficulty of capturing data seriously hampered analysis Current Issues higher than the reproduction costs. Given a sufficiently long useful life for a piece of real estate, the discounted rents of a property equal the property price in the existing stock. So Tobin‗s q for real estate is calculated as being the quotient of the price of existing stock and the respective reproduction costs (for its formal derivation, see the box in the margin on page 3). 3 Furthermore, Hayashi (1982) argues that the ratio of the existing stock price to the reproduction price does not reflect the actual investment strategy since stock prices show the profit expectations for past investment projects and not for future ones. To this extent, the Tobin q described above is an average q (qD). This is why Hayashi suggests that it is better to choose marginal q (qM) as a guideline. For real estate markets, Hayashi‘s marginal qM can be calculated by a simple additional ratio of newbuild rent and existing stock rent (Nitsch, 2011). The higher the prices of existing houses and the higher the rents for newbuild houses, the greater is this qM, ceteris paribus. Empirical findings Empirical findings on Tobin‗s q to date have not been unambiguous – neither at company level nor for real estate markets. 4 This is frequently explained by the difficulty of capturing the appropriate data. There are indeed substantial difficulties to determine the exact reproduction costs for real estate in particular, owing to its heterogeneity. After all, every piece of real estate is ultimately unique, making it impossible to reproduce and re-offer it on the market. Nailing down market prices is not an easy task either. If a given building has not been put up for sale of late, its market value can only be approximated via rules-based procedures. In economic literature there have been only few studies hitherto focusing on the correlation between Tobin‗s q and investments in construction. Jud and Winkler (2003) were the first to apply Tobin‗s and Hayashi‗s theories to the real estate sector in detail. Furthermore, using US data they demonstrated that Tobin‗s q can explain a large part of real estate investment. Berg and Berger (2006) reaffirmed these findings for the Swedish market. For Germany, Nitsch (2011) determined that around 75% of real estate investment can be described by Tobin‗s q for some markets. Data and model used Our study analyses investment in residential construction in 127 of Germany‘s major cities. The data was sourced from BulwienGesa‘s RIWIS database, which stores largely seamless annualised statistics both on prices and rents for existing stock and newbuild houses 5 , as well as from the German Federal Statistical Office‘s statistics on building activity. To ascertain Tobin‗s q we take the price and rent ratios between stock and newbuild housing. As explained in the previous section, newbuild prices are used to approximate reproduction costs. The average price and rent developments for all of the cities are depicted together with Tobin‗s q in chart 4. All the time series 3 For a detailed discussion of Tobin‗s q for real estate see Nitsch (2011). 4 See Schulz & Werwatz (2008) for an overview of the literature for real estate market analyses. 5 The variables are called: ―Purchase price owner-occupied home, resale average‖, ―Purchase price owner-occupied home, newbuild average‖, ―Re-let homes, average‖, ―Rent newbuild, average‖. For a more detailed description of the variables and list of the cities, see www.riwis.de. 4 August 22, 2011
Residential construction in Germany Tobin's q still decreasing – for Germany as a whole 1995=100 115 110 105 100 95 90 85 80 75 70 1990 1994 1998 2002 2006 2010 Marginal q Rent (newbuild) Rent (existing stock) Price (newbuild) Price (existing stock) Sources: BulwienGesa, Destatis, IW Cologne Institute for Economic Research 4 Fewer newbuilds Building permits and completions, in % of housing stock 1990 1993 1996 1999 2002 2005 2008 Completions Completions incl. measures in existing stock Building permits Building permits incl. measures in existing stock Average for 127 German cities 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Sources: Destatis, DB Research, IW Cologne Institut for Economic Research 5 indicate a very strong increase in prices and rents following German unification, even though there was a significant correction starting in the years 1993/1994. The rent ratio remained relatively constant over time. For prices, the gap widened considerably. This is because after the recession in the second half of the 1990s newbuild prices have remained relatively constant to this very day, while prices of existing stock have constantly trended downward since then. In the case of rents, the differences narrowed towards the end of the 1990s when newbuild rents noticeably eased relatively. All in all, this has resulted in a steady decline in Tobin‗s q in Germany. The estimate of investment activity was based on the number of newly built dwellings. The official statistics offer four different time series with housing completion and permit data, both including and excluding measures in the existing stock, respectively. 6 Building permit statistics are used for the following regressions since these are the starting basis for the other statistics on building activity; moreover, they coincide very closely with the start of the investment process. The measures in existing stock were added in order to also factor in investments in the interior of existing stock. Since the focus of interest is not the absolute volume, but the relative change in the capital stock, these data are set in relation, respectively, to the housing stock data (see Meier 2011). The relative growth of the housing stock from 1990 to 2009 is displayed in chart 5. All in all, the housing market expanded by roughly 1% per year in the 1990s, with the rate slowing to not quite 0.5% over the past ten years. For our empirical evaluation we took recourse to panel data sets on 95 major cities in Germany. The panel analysis only includes the data from the years 1995 through 2009, since the price and rent data before 1994 show certain quality-related shortcomings on account of differing data-collection procedures in the individual cities and since the building-activity statistics for 2010 were not yet available at the time of this analysis. Moreover, in this period the data set includes the entire information necessary for every unit under review. On the basis of these data empirical tests were performed to establish the correlation between investment activity I (building activity) in relation to the capital stock K (existing housing stock) and Tobin‗s q with the following estimating equation in a fixedeffects model: �Iit Kit � � �i � �itqit � � it The variable q is the q value of a city i in period t. it � and i � are it coefficients to be estimated. � is an error term. An applied fixed- it effects model, unlike with the pooled-regression model introduces a dummy or a city-specific constant for every city. This enables us to control for potential systematic unobserved differences between the cities. 6 The individual time series are called: 1) Completions in residential buildings; 2) Completions incl. measures in existing stock: total houses; 3) Housing permits in residential buildings; 4) Housing permits incl. measures in existing stock: total houses. August 22, 2011 5
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Residential construction in Germany - Deutsche Bank Research

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