Luxembourg’s housing market weakens

Last Updated: Jul 11, 2008

Luxembourg’s housing market weakens

After rising 2% in 2007, house prices in Luxembourg rose by a mere 0.5% y-o-y to Q1 2008, according to figures from the Department of Housing. When adjusted for inflation, house prices actually fell 1% in 2007, and fell 2.7% y-o-y to end-Q1 2008.

Apartment prices performed a bit better. The price index for apartments rose 1.2% y-o-y in real terms to end-Q1 2008 (4.5% in nominal terms). During 2007, apartment prices rose 4.5% in nominal terms and 1.3% in real terms.

Luxembourg is on a decelerating trend. House prices rose 12.7% in 2004 (10% in real terms), 3.5% in 2005 (0.8% real) and 7.5% in 2006 (5.5% real).

Apartment prices rose 15% in 2004 (12.5% in real terms), 4.6% in 2005 (1.8% real) and 5.3% in 2006 (3.3% real).

Rising interest rates combined with the government’s effort to increase housing supply led to the weakening rate of increase of house prices, despite strong economic growth.

Housing supply

After Malta, Luxembourg is the smallest country in the European Union (EU) with a land area of 2,586 sq. km. In spite of its size, it is home to several key EU offices, such as the commission itself, the Court of Justice and the Secretariat of the Parliament. Luxembourg is also a key banking and financial centre for Europe.

Demand for housing typically exceeds supply. To increase the supply of land and housing, fiscal measures were passed in July 2002. The standard VAT 12% was “super-reduced” to 3% for the renovation and construction of eligible properties. To encourage construction outside of Luxembourg City, a special surcharge of 50% is applied to the registration of buildings sold in the city.

Permits for construction rose from 2,956 housing units in 2002 to more than 4,000 units from 2005 to 2007. More than 60% of dwellings set for construction were apartments. Dwellings authorized for construction reached 4,934 in 2007, 3,365 of which were apartments (68%), while only 28% were houses.

Tax credit and mortgage

On the other hand, tax credits of €20,000 for singles and €40,000 for couples were given to all persons purchasing property for dwelling purposes since July 2002.

Mortgage market developments helped housing demand accelerate, leading to house price increases. The mortgage interest rate dropped from an annual average of 5.28% in 2001 to below 4% between May 2003 and July 2006. With 83% of new lending in 2003 and 2004 at variable rates, the number of loans intended for home purchases grew remarkably. In 2003, the number of such loans grew by 23%, in 2004 by 7.96%, in 2005 by 13.8%, and in 2006 by 11.4%.

Outstanding mortgage loans rose from €6.647 billion in 2002 (27.6% of GDP) to €13.847 billion in 2007 (39.8% of GDP). More than 95% of outstanding loans have a maturity of more than 5 years.

In line with interest rate hikes implemented by the European Central Bank (ECB) since Dec 2005, mortgage interest rates have also risen. The mortgage rate for loans with a maturity of 5 years or more has been above 4.9% since Aug 2007%, up from the historic low 3.41% in Nov 2005. The rate of growth of new loans also slowed to 4.09% in 2007.

Rental market

Luxembourg’s owner-occupancy rate was around 70% of housing stock in 2004. Private rentals account for 25% of the stock, while 2% is social housing.

The growth of the private rental sector is constrained by strict tenancy laws. The rent can only be increased every three years. Dwellings built or substantially renovated after 10 September 1944 cannot produce for the landlord more than a 5% return on the capital invested in the building (see Landlord and Tenant section).

Despite strong house price increases in the past, rents have been declining. Inflation-adjusted rents for houses were 10% lower in Q1 2008 than in Q2 2003. Rents for apartments have been relatively unchanged over the same period.

These factors have led to low yields. Rental yields of apartments in Luxembourg City range from 4.3% to 5.07%, according to Global Property Guide research, with the smallest units getting the highest returns.