Residential construction in Germany - Deutsche Bank Research

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Tobin's q increasing in Munich 1995=100 70 1990 1994 1998 2002 2006 2010 Marginal q Rent (existing stock) Rent (newbuild) Price (existing stock) Price (newbuild) 120 110 100 90 80 Sources: BulwienGesa, Destatis, IW Cologne Institute for Economic Research 8 Correlation of Tobin's q for building activity in individual cities and their surrounding counties Current Issues Ring 1 Ring 2 The results of the individual regressions for the cities reveal stark differences. For half of the cities, Tobin‘s q correlates very heavily with building activity. For these cities the correlation coefficient is greater than 0.5. For the other half there is virtually no correlation between investment and Tobin‘s q. A host of causes may provide the explanation for the differences. However, the main reason is probably that the demand for construction investment expressed by Tobin‘s q cannot be satisfied within a major city by a corresponding supply of attractive locations. The inclusion of the surrounding counties can therefore significantly boost the explanatory power of Tobin‘s q. In 8 out of 10 cities the coefficient of determination climbs in some cases very significantly if the building activity in the counties of the first ring is factored in (Bremen, Düsseldorf, Essen, Hamburg). These values can be boosted further for the metropolitan region as a whole. So price dynamics in one city have spill-over effects far beyond the city limits. (see table 7). By contrast, there does not appear to be any improvement in the meaningfulness of Tobin‘s q when the counties surrounding the two cities of Munich and Stuttgart are included. However, there is no explanatory power to be recognised for these two cities from the outset. On account of its valley basin location, Stuttgart faces heavy restrictions on how much land can be made available for building purposes, a fact which may not be reflected in market prices. There are no such obvious explanatory approaches for Munich. The Bavarian capital is an attractive residential location despite high land prices, as evidenced by the price and rent trends (see chart 8). At the same time, there have been sharp increases in land prices which can never be fully stripped out of the prices and rents. Furthermore, distortions might also emerge because of pronounced demand overhangs, since Munich takes a very conservative approach to residential construction. What this all boils down to is that Tobin‘s q can offer very good explanations for housing growth. Even though the significance of investment activity in the surrounding counties varies for all the cities to a very considerable degree on account of their size, political structure and significance for a region, the explanatory power of 8 August 22, 2011 City Directly adjacent counties Metropolitan region Berlin 0.902 0.946 0.957 Bremen 0.685 0.846 0.859 Dortmund 0.402 0.349 -- Dusseldorf 0.719 0.844 -- Essen 0.306 0.958 -- Frankfurt 0.255 0.904 0.920 Hamburg 0.726 0.809 0.835 Cologne 0.775 0.859 -- Munich 0.059 0.379 -0.021 Stuttgart -0.286 -0.110 -0.116 Sources: BulwienGesa, Destatis, DB Research, IW Cologne Institut for Economic Research 7
Residential construction in Germany Tobin's q jumps in Hamburg 1995=100 120 115 110 105 100 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 9 Newbuilds are popular Growth differentials, owner-occupied housing, (Newbuild-Existing stock), pp, p.a. q increases q decreases -4 -2 0 2 4 6 8 2000-2005 2005-2010 Frequency distribution of growth diffentials in 127 German cities. A positive value means newbuild prices rose faster than prices of existing stock. The x-axis designates the upper limit of the respective interval, e.g. a value of -2 stands for the interval [-4 bis -2]. Sources: BulwienGesa, DB Research 60 50 40 30 20 10 0 10 Tobin‘s q increases rapidly when the surrounding counties are factored in. Implications for building activity Our analysis has shown that the concept of Tobin‘s q may also be applied to real estate markets. Even though the investment processes there evolve on a very long-term horizon and therefore the supply of new houses remains relatively constant, Tobin‘s q may provide an explanation for part of the building activity. In this context, Tobin‘s q seems to have an immediate impact and leads to changes in residential construction investment in the very same year. Since it is plausible that adjustment processes, first of all, are not constant for all cities and, second, do not necessarily occur simultaneously, the fundamental mechanics of Tobin‘s q may also be illustrated by means of a comparison of two longer time intervals: to this end we shall now compare the interval from 2000 to 2005 (period 1) with 2005 through 2010 (period 2). If the prices of existing houses climb considerably faster than building prices (using newbuild prices as a proxy) and/or the rental prices for newbuilds pick up considerably faster than rents for existing stock, the increase in marginal qm points to higher demand for newbuild houses (under respective ceteris paribus conditions). This enables us to demonstrate that, firstly, construction demand at the beginning of the millennium was low and, secondly, that it is now (moderately) rising. To this end, we look separately at the development of relative prices and rents in the two time frames for 127 German cities: on average, newbuild prices picked up faster than prices of existing stock in both periods. For this reason, Tobin‘s q steadily declined. The widening price gap has narrowed again by nearly half, however. This also shows the low demand for residential building at the start of the millennium. Since demand may differ by region, it is necessary to look at the regional distribution of this development. Chart 10 shows the frequency distribution of the cities‗ growth differentials. A positive growth differential in a city indicates that newbuild prices have increased faster than stock prices. As can be seen, there were many more cities with faster increases in stock prices than newbuild prices during the second period from 2005 to 2010. There is a distinct shift to the left in the frequency distribution of the 127 cities in period 2. This goes hand in hand with rising q values and, in keeping with Tobin‘s theory, with higher demand for construction. Some of the cities with a negative growth differential, i.e. an uptrend in marginal qm, include markets such as Munich, Frankfurt am Main, Cologne, Hamburg and several university cities such as Bamberg, Darmstadt, Würzburg and Heidelberg. It is a familiar pattern that demand for construction tends to grow particularly in the robust business clusters as well as in popular university towns. Of course, it is also worth noting that the list includes several east German cities: Rostock, Cottbus and Potsdam, for instance. However, the picture changes if we look at the development of relative rent dynamics: according to the design of marginal q additional building activity will be induced if rents for newbuilds climb more quickly than rents for existing stock. On average, though, the increase in rents for existing stock slightly outstripped newbuild August 22, 2011 9
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Residential construction in Germany - Deutsche Bank Research

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