We can make an analogy between the bottleneck in supply that creates economic growth constraints and puts pressure on prices, and the real estate sector in Luxembourg, where prices keep rising. Both are clear illustrations of how tensions between supply and demand impact prices, especially when supply is inelastic.
Globally, inflation is on everyone’s minds but in Luxembourg, the discussion around housing prices is capturing a lot of attention. The asymmetry is ever-more apparent, with owners benefitting from an incredible wealth effect while young citizens are struggling to find affordable housing. Moreover, companies are perceiving the impacts of an increasingly expensive housing market, finding it challenging to attract talents at a reasonable cost.
To counter recent inflationary tensions, central banks are stepping up, curbing incentives to avoid this issue becoming long-term. Measures adopted to counter the housing market pressure, however, may have been too limited in Luxembourg as evidenced by housing prices skyrocketing in recent years. The underlying reason, as we will show throughout this article, is the imbalance between supply and demand.
We thank Christelle Sapata, our guest blogger this week, who works as Manager at the Market Research Centre for helping us to put this article together. Also, we’d like to thank Amaury Evrard and Julien Ghata for their support.
Three characteristics of the Luxembourg Market
There are several characteristics of the Luxembourg housing market that make it unique compared to other European countries.
1. Housing prices have risen continuously, with each quarter experiencing uninterrupted growth since 2010, as evidenced by BIS’s residential property prices index.
This is quite a unique phenomenon in that this upward trend has lasted for more than 10 years now. While the IMF, in its latest Global Housing Watch, points to an increase in the global housing price in the COVID aftermath, in Luxembourg, the observed increase over the past year is part of a long-term phenomenon.
In addition, the pace of growth is also unique to Luxembourg’s housing market, with prices increasing at a CAGR of 9.6% between 2015 and 2020, far above the Euro area average (4.8%) and that of dynamic countries, such as Germany (7.2%), and Ireland (5.7%) or France (3.6%), according to BIS data*.
With the rate of ownership at 70.9%**, a significant proportion of the population has benefited from the significant wealth effect, which largely explains why Luxembourg’s financial wealth is mainly tied up in real estate assets.
(*) BIS residential property prices index (August 2021) / (**) Eurostat (October 2021)
2. House prices in Luxembourg appear to have increased more than rents, as indicated by OECD’s price-to-rent ratio, which compares the evolution of house prices to rents.
This ratio has increased drastically over the past years and, once again, surpasses most other EU countries. The computation of the rent evolution can be challenged as the index tends to underweight the evolution of the rents in Luxembourg, especially of small newly built flats in Luxembourg city with better energy ratings.
Still, for young employees and newcomers finding a place to rent remains an alternative more accessible option—in particular with the development of shared flats—than buying a flat, whose acquisition is now submitted to a loan to value ratio of 80% / 90%.
3. The housing price surge, which was previously observed solely in the capital area, has now begun spreading to surrounding neighborhoods and cities.
While there had been a direct relationship between house prices and the distance to the capital, as demonstrated by the Observatoire de l’Habitat, this factor is losing importance, with Dippach, Bettembourg and Esch-sur-Alzette experiencing the highest increase in house prices per square meter in the last three years.
The phenomenon of moving from the big city to the suburbs is not new, however, given the small size of Luxembourg and the limited number of cities, Luxembourg residents are getting squeezed out, forced to look across borders for cheaper housing.
The underlying drivers that keep demand high amidst rising prices
With these figures in mind, one may find it surprising that Luxembourg has not been included in UBS’s recently released real estate bubble index or that Statec and the BCL, to a large extent, confirm the soundness of the real estate market. Actually, the forecasted house prices growth remains strong for 2021 (+9%) and 2022 (+5%), according to Statec*, because of the fundamentals that largely explain price dynamics.
Indeed, demand remains strong while supply has been relatively inelastic, thus “unable” to respond to it. Considering that housing is a social need and not only a financial asset, it would be interesting to determine the peak housing price that can be reached if supply remains unresponsive to demand. In this sense, one needs to investigate the underlying drivers that keep demand high amidst rising prices.
The demographic pressure
Luxembourg is feeling extraordinary demographic pressure. While on average, the EU population has increased by about 0.2% year-on-year in the last 10 years, the Luxembourg population has grown by 2.4% yearly for the same period**.
In absolute numbers, in nine years, the country has welcomed about 100,000 inhabitants, the equivalent of adding a second Luxembourg city. Given the relatively small size of households in Luxembourg (2.4 as of 2020***), especially when it comes to newcomers, this represents an incredible amount of housing needs that have yet to be met.
The purchasing power
Demand is also sustained by high purchasing power. In fact, most people can still afford these housing prices as they benefit from especially high living standards: the mean disposable income for a Luxembourg household was €6,475 in 2019****.
Further evidence is that 39% of annual disposable income is dedicated to loan repayment, according to CSSF’s 2020 annual report. A very basic simulation implies that on a monthly basis, once the repayment is due, every household still has more than €3,900 at its disposal.
The current employment dynamics in the service sector, especially in the financial sector, are expected to continue feeding this demographic growth and high living standards.
Demand has been pushed by historically low-interest rates. Currently, the average property loan rate in Luxembourg is 1.28% for a variable rate and 1.38% for a fixed rate as of August 2021*****, with a high share of fixed interest rates for mortgages.
In this context, people have spent less on interest repayments, which means they can afford to borrow more. Amid this low-interest-rate environment, a household’s borrowing capacity has increased by nearly 60%, according to Spuerkeess.
Last but not least, the fiscal treatment favours the acquisition of houses with a low level of taxes on property and the possibility to receive advantageous tax treatment when buying. On the contrary, legal restrictions exist on rent levels, making them less elastic to the demand.
(*) Statec – Note de conjoncture 1-2021 / (**) Eurostat, July 2021 / (***) Statec 2020 – Luxembourg in Figures / (****) Statec, May 2021 / (*****) Banque Centrale du Luxembourg (August 2021)
While demand stays dynamic, supply is lacking momentum, with building permits unable to keep up with the pace of demographic growth. In fact, since 2010, an average of 2,891 dwellings have been built for a surplus of 5,390 households.
As Luxembourg continues to ramp up its effort to attract and retain talent, the attractivity of the country will require even more effort on the supply side. We will further investigate why supply measures are the most appropriate answers and which could likely be taken in the upcoming article.
What we think
The Luxembourg housing market definitely—and almost unavoidably—deserves much attention. Why are prices still increasing and at such a pace? What are the dynamics at stake? Given the impact of the housing market on households and companies, we are pleased to publish the first article of a content series dedicated to the topic. Enjoy the reading!