Real Estate Cycles in Germany-Causes, Empirical Analysis and Recommendations for the Management Decision Process
Rottke, Nico, Wernecke, Martin, Schwartz, Arthur L., Jr., Journal of Real Estate Literature
Unlike in the United States or the United Kingdom, research on real estate cycles in Germany exists only to a limited extent. Therefore, this article has three objectives: (1) to briefly introduce the unfamiliar reader to the theory of real estate cycles; (2) to empirically analyze the observable and quantifiable variables of the German office market and to make an attempt to validate the cyclical behavior of the German real estate market; and (3) to present recommendations for the management decision process based on theoretical causes and empirical analysis.
Real estate cycles have been the subject of much research over the last ten years throughout the world. Although some academics believe real estate cycles are irrelevant or non-existent, others believe that cycles are a key variable, impacting property performance and they have published numerous articles and papers on the subject. Various researchers approach real estate cycles from differing viewpoints and try to determine the best ways to describe and forecast them and how to integrate them into an overall context. These viewpoints can be classified as the macroeconomic, microeconomic, finance or management view.1
From the perspective of the macroeconomic view, real estate cycles are regarded as part of the business cycle and focus on overall construction activity and sector unemployment rates in order to find relationships between the cyclical behavior of real estate and other aggregate markets.
The microeconomic view, concentrating on individual decisions rather than the aggregate, differentiates four markets as parts of the real estate market: the space market, the investment market, the market for new construction and the land market (Ball, Lizieri and MacGregor, 1998). Studies often focus on elements such as rent levels, vacancy and absorption rates and the role of different forms of expectations formation.
The finance view on cycles is based on Modern Portfolio Theory (MPT) and draws its conclusions out of valuation frameworks such as the Capital Asset Pricing Model (CAPM), the Arbitrage Pricing Theory (APT) or Real Options Models. Central variables are interest rates, relative volatility, higher moments, serial correlations and risk premiums.
A fourth view that has hardly been studied is the management view. This view examines whether and how cycles can be integrated into the management aspects of real estate. Management aspects are part of the so-called "house of real estate economics," a framework for real estate economics as a scientific discipline that focuses on the interdisciplinary aspects of real estate.2
Within the category of management, a distinction can be made between phase-oriented, function-specific and strategy-related aspects. Whereas phase-oriented aspects stand for the temporal determinant in the life cycle of real estate (project development, construction and facilities management), the function-specific approach examines the real estate-related particularities of business administrative functions (real estate analysis, appraisal, marketing, finance and investment). Strategy-related aspects, on the other hand, are concerned with the portfolio management of investors and corporate and public real estate management (Schulte, 2001) (see Exhibit 1).
Research on real estate cycles in the United States began as early as the 1930s with the pioneering work of Kuznets (1930). The number of publications on real estate cycles rose rapidly beginning in the 1980s, but the coverage remained widespread and inconsistent. In the beginning of the 1990s, Pyhrr, Born and Webb (1990) made an effort to systematize the findings and to put them into an ex ante framework for investment strategies. This effort has continued up to today. Mueller, Pyhrr and Born (1999) noticed that a common terminology, methodology and agenda in cycle research are not in place yet. …