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Auf Wiedersehen German real estate? Not so fast

As soon as someone mutters the words London property, the word "bubble" is never far away.

London house prices displayed a jaw-dropping 20 percent growth year-on-year in July– even though last week's RICS indicator showed that the housing market is pausing for breath. Bank of England (BoE) Governor Mark Carney has sounded a warning on tougher mortgage rates and the expectation of higher rates.

But London isn't the only place which is seeing a dizzying increase in property prices. Look no further than across the channel – to the euro zone's economic powerhouse - Germany.

Major cities like Frankfurt, the financial capital, Munich with its famous beer gardens and proximity to the Alps and Stuttgart, the home of Mercedes and Porsche, are becoming increasingly attractive as a place to live and work. Germans from rural settings and immigrants are flocking to the cities.

But like in London, an equally potent driver of the property market in Germany is the good old "search for yield".

Poll: Which property market is seeing a bubble?

"Near zero interest rates in the euro zone make sense for the region but not for Germany. The economy has been relatively strong and the interest rate policy is disjointed from economic reality," Patrick Armstrong from Plurimi Global Macro Fund told CNBC.

"With 10-year Bund yields at 1 percent, free money will have to flow towards property at some point. Rental yields of 4-5 percent are attractive with current interest rates, and German property is the least expensive per square meter in Western Europe."

Rolf Buch, CEO of Deutsche Annington, Germany's largest private-sector residential real estate company, echoed these comments when he told CNBC the German housing market is in a "sweet spot" because of stable incomes and the benefit from low interest rates.

Ulrich Baumgarten | Ulrich Baumgarten | Getty Images

Contrary to the U.K. though, it's not Germany's capital that is seeing the highest prices.

According to research from B+D, the most expensive properties in Germany are found in Munich (an average 4,800 euros ($6,427) per square meter). Berlin is relatively cheap, as a square meter there only costs 2,930 euros, while Frankfurt properties will set you back an average of 3,400 euros per square meter.

Read MoreProperty: The greatest risk to the UK economy?

Compare that with an average square meter price of 8,900 pounds (around 11,120 euros) in London's Westminster and you'll think Germany is a bargain.

However, it is the capital that is showing the highest growth in values. Prices of apartments in the trendiest part of Berlin have seen a 40 percent increase since 2007, while they have grown by an equally impressive 25-30 percent in popular cities like Munich, Hamburg and Frankfurt.

Concerns of overheating

Just as the BoE has sounded alarm over the overheating of the property market in London, Germany's Bundesbank has recently voiced concern over the health of Germany's property market, saying that "there is an increasing risk of a housing bubble in Germany". It also warned certain cities showed prices that were overvalued by up to 25 percent.

German property prices have recently shown signs of moderation, yet analysts agree the environment is still a very favorable one for continued increases in prices and rents.

How do you participate in the German property market if you're not willing to say Guten Tag to your own home in the country?

One of Patrick Armstrong's preferred stocks is Deutsche Annington. He also likes Grand City Properties which focuses on the acquisition and turning around of distressed portfolios with high vacancy. He estimates it generates a rental yield on capital expenditure of almost 15 percent.

Analysts at Goldman Sachs expect LEG, Germany's second biggest property company, to continue to show "good like-for-like rental growth from an acceleration in rent per square meter growth over the next few quarters and vacancy continuing lower from an already low 3.0 percent".

Yet, with all this money attracted into the German property market, are rental yields starting to decline, taking into account that prices and rental yields usually move inversely to each other?

Deutsche Annington's Buch says he sees no signs of this yet, but "a decline in yield could be on the horizon."

For now, the CEO says an improvement in capital value and residential yield is still possible for the next year, which is why the group raised its guidance for 2014.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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