If there is one economic lesson my father, a construction engineer, taught me, it’s that mortgage rates in Europe always follow what’s happening in the United States. When rates go up across the Atlantic, they’re bound to do the same in our part of the world. So when it comes to locking in a good mortgage rate, look west.
My father’s wisdom of course is heavily inspired by the economic reality of the 1980s, a sluggish economy with massive unemployment, high inflation and ditto interest rates. The benchmark US 30-year mortgage rate was above 10 percent throughout almost the entire decade, with an all-time high at 18.6 percent in 1981. Borrowing for a home was expensive.
My dad was made redundant those days. It took a while before he found work again. As teenagers, my brother and I were largely shielded from economic hardship because my mother worked as a school teacher. It meant my parents did not have to sell their house. Their 1960s mortgage was relatively small and almost paid off. That also helped.
Up 200 basis points
This week’s move in US mortgage rates reminded me of my father’s economic mantra. Merely six months ago the 30-year rate stood at 3 percent. This week, it reached 5.25 percent, up more than two full percentage points in the space of half a year. The last time US mortgage rates moved up at that speed was back in 1994, rising from 6.5 to 8.5 percent.
Today’s numbers mean that monthly mortgage payments for those looking to buy a home now are up significantly, in the US as well as in Europe, including Luxembourg, where a 30-year mortgage now costs around 2.7 percent, nearly double what it was in December. Rising mortgage rates now cut significantly into the budgets of those buying a home and those looking to refinance their mortgages. And other living costs go up as well.
Inflation fears are rocking our economy. Yet, Europe’s central bankers, unlike their US counterparts at the Federal Reserve, remain reluctant to raise policy rates, fearing potential detrimental effects in the eurozone’s weaker economies.
Bubbling Luxembourg
With rates pointing north, potential home buyers may become more reluctant to commit to long-term financing a home. Property prices could be at risk, especially in highly inflated markets such as in the southern half of Luxembourg, where homes easily fetch more than 10.000 euros per square metre or more. Near Luxembourg city new 35 square metre studios are on offer for more than 600.000 euros.
Even the New York Times in March noticed the “totally insane” Luxembourg housing market.
Of course there are domestic conditions in Luxembourg that underpin its market. Its population has doubled in the last 30 years. There is a continuous influx of thousands of expats, earning attractive salaries in the booming financial sector, at tech giants such as Amazon or with a tax free high income as EU civil servants. But even they will start scratching their heads when mortgage rates go up.
Yet even without these domestic factors, home prices are supported across Europe because there is a generic shortage of family homes. James Pomeroy, Global Economist at HSBC, told a recent Alfi conference that family homes anywhere will continue to be a good investment because there simply are not enough of them around.
More than 500 Real Estate Investment Funds
It also affects professional investors. Luxembourg in recent years has seen a steady increase in new Real Estate Investment Funds, known as Reifs. This is a relatively new European vehicle that seeks to replicate the success of Real Estate Investment Trusts, or Reits, in the US. Reits had a market capitalisation of 1,250 billion dollars in 2020. Many of the US trusts are publicly traded, while Reifs tend to be private.
According to an Alfi study, Luxembourg was home to more than 500 Reifs by end 2020, collectively managing some 104 billion euro in real estate such as residential homes, apartments and offices.
These Luxembourg Reifs largely invest in the Benelux, Germany, UK and the United States. Some 134 Reifs leverage the Grand Duchy’s Reserve Alternative Investment Fund vehicle. It means investors don’t face a capital gains tax and do not have to pay taxes on rental income properties in the fund.
That rental income on Luxembourg Reifs is untaxed unless the properties are located in Luxembourg. In that case investors face a new, 20 percent tax on their rental income from 2021. First such tax filings are due by end May, consultancy Atoz reminded clients this week.
IMF, central bank see risks
Even before Russia invaded Ukraine, inflation was already an issue, and so were home prices. Financial authorities expressed concern over what they saw as excessive home prices, also in Luxembourg. The International Monetary Fund has told the Grand Duchy that “urgent actions” are needed to reduce pressure in the housing market, saying the market poses “medium-term financial stability risks” while affordability is under threat.
Luxembourg’s central bank governor Gaston Reinesch wrote in a blog post in January that he is worried because the ratio of household debt to disposable income has more than doubled since 2000, a dynamic further amplified by monetary policy measures in response to the pandemic. Among eurozone countries, Luxembourg is the one with the highest risks in the residential real estate market, as this central bank graphic shows.
“The persistence of house price growth at rates as high as those observed in Luxembourg is unsustainable and poses real challenges to the national economy and policy makers,” Reinesch said, adding a handful of recommendations which so far have yet to be taken up.
Historically, bricks and mortar investments have always been seen as solid, even at times of crisis. A house, even if expensive, still offers a roof over one’s head. But when the economy’s tectonic plates start shifting, nothing should be taken for granted.
So homeowners and investors, consider my father’s wisdom and look west.
In Flux is a regular column on Investment Officer Luxembourg shedding light on the Luxembourg financial ecosystem. Financial journalist Raymond Frenken is Editorial Manager of InvestmentOfficer.lu. He has followed financial markets and EU regulation for more than two decades. Earlier in his career he was Amsterdam bureau chief for Bloomberg News, Benelux correspondent for FT/MarketWatch, EU correspondent for CNBC in Brussels, and until 2021 director of communications at the European Banking Federation in Brussels.
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