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Monday, June 15, 2009

College towns are recession proof: the Euro version

College towns are relatively recession-proof in the United States. This recent Deutsche Bank research says this is true also in Europe:

The recession is also affecting the European real estate sector. True, many German housing markets are regarded as relatively stable. However, differentiation is called for, since regional differences, as in other countries, are considerable in Germany as well. Two simple criteria are good indications of price dynamics of housing investments: for one thing, the share of students in a city, and for another, the share of the manufacturing sector.

The economic crisis has unsettled many investors. Currently, they are looking less for risky products with high yield potential but rather for low-risk investments with a stable return. This is precisely why many people are turning to residential property: they are interested either in owner-occupied housing or in buying rented property. Is this a sound assumption? Although no housing bubble for residential markets has occurred in Germany yet, the low financing rates currently also make residential property an interesting investment. Thus, an investment in German residential property currently offers potential.

It should be kept in mind, however, that investments in residential property per se are not risk-free. In particular, investors should always be aware of the location risk of housing investments. But what makes a good location in housing? No doubt, good utility connections and the proximity to infrastructure systems are among the key criteria. In particular, such micro factors require a case-by-case examination of properties, i.e. very good market knowledge, though. Before starting the selection, the quality of a region, that is its macroeconomic factors, should be checked. What are the prospects for the economic structure? How good is the location with regard to transport links? For these factors have a decisive influence on the future demographic and income situation and thus the development of house prices.

In a thorough location analysis, forecasts have to be made of a very large number of macro factors. This is a very demanding task, especially as various factors have reciprocal effects, and some variables can change quickly, e.g. the registered office of a major company. Thus, factors subject to only minor fluctuations are particularly useful indicators for risk-averse real-estate investors. This can be illustrated by two selected factors: the share of students and the share of employees in the manufacturing sector. To show the influence of these two factors, the average price development of new owner-occupied housing units in over 100 German cities over the last ten years has been analysed.

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This shows the 20 cities which post the best gains do not only include the usual suspects like Munich and Hamburg but also smaller cities such as Marburg, Heidelberg, Trier, Wuerzburg and Muenster. These five cities are marked by a very high share of students in the residential population. The value development in typical university towns was more favourable all in all than in towns without a sizeable share of college students. In the last ten years, the average value increase of new condominium apartments in university cities, i.e. towns with a share of college students of at least 15% in the population, rose by roughly 0.75 percentage points more than the increase in house prices in towns with very few students or no students, respectively – annualised, that is. This applies to both east and west Germany. At first glance it may come as a surprise that the value of residential property – and even more so, condominiums – in university towns has increased disproportionately well, for the disposable incomes of college students are of course by no means above average. The correlation is plausible, though: first, universities serve as large employers, and many jobs in university towns are not influenced by the economic cycle. Second, many college students stay in their college town after graduation as they still find their university town so attractive. The incomes of these graduates usually exceed that of people without a college degree. University towns therefore – also in times of crisis – are a safe haven for housing investments.

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Risk-conscious investors should currently act cautiously with regard to typical industry locations. Average house prices in highly industrialized towns (with a share of employees in manufacturing of over 30%) were about 0.50 percentage point per year below price levels in towns with very small industrial bases. Even though the number of manufacturing employees increased strongly in the latest upswing, the gap reflects Germany's continuing structural change towards a service society, especially wage moderation in many segments of manufacturing. As in the current recession manufacturing is severely battered by the decline in exports, it is plausible that towns with a strong industrial base in this crisis will be hit even harder than in the last ten years. Thus, investors considering towns such as Ludwigshafen, Schweinfurt, Ingolstadt and Salzgitter as locations for an investment will probably have to pay a higher risk premium at present.

Investors should be aware of the fact that these two correlations are stable and statistically verified. It should be kept in mind, however, that these are only two individual criteria. Not every university town can guarantee value, and the risks among industrial towns do vary. In particular, the microeconomic factors mentioned above always play a major role. What is more, attention must also be paid to the change in value retention and the yield. For example, Wolfsburg and Ludwigshafen are the beneficiaries of a relatively favourable multiplier while the ratios for Freiburg and Bamberg are rather unfavourable.