The price of an average house in Luxembourg has now risen well above €1m, making the Grand Duchy Europe’s second-most expensive housing market after Monaco. The regulators have just announced plans to impose tough minimum deposit requirements on new housing loans. Are these signs of speculative exuberance and is there a risk to the banking sector? Should investors be worried?
From next year, mortgages will require a 20% deposit for almost all housing loans granted by domestic lenders. This follows an 18 November recommendation by Luxembourg’s Systemic Risk Committee. This body was founded last year and is chaired by finance minister Pierre Gramegna and includes representatives of the CSSF, the Luxembourg Central Bank and insurance regulator the Insurance Commissariat. They cited reasons for concern being 7.2% growth in average housing prices over the last five years, a 13.9% year-on-year increase in prices in the first quarter of 2020, and a 9.4% rise in the volume of residential property loans granted in the third quarter.
Signs of a bubble?
To the naked eye these figures would suggest a price bubble driven by speculation that could already have formed a while ago. Yet the committee merely talked of ‘medium-term risk’ of there being an overheated market and excessive household indebtedness. Indeed, for several years, the annual Financial Stability Review from the Central Bank has featured studies on residential property prices, and in each it suggested supply and demand were the principle causes of the inflation.
The last such report looked at 2018 figures and using four econometric models they found ‘overvalued prices moderated by the fundamentals, which are affected by significant rigidity of housing supply.’ Demand was driven by the near one-quarter rise in the resident population, as well as ‘excess demand encouraged both by low interest rates and by tax incentives.’ Luxembourg’s planning procedures are notoriously slow and difficult to navigate.
Covid consequences
Yet could Covid be about to upset these uneasy balances? To probe these questions, analysis from the University of Luxembourg’s Department of Finance and the national statistics office Statec was presented at a seminar entitled “Covid-19 and the Mortgage Market in Luxembourg” on 27 November.
‘A major fragility in the mortgage market is that households in Luxembourg are very indebted,’ said François Koulischer, a researcher at the university. Luxembourg had the third highest household debt to income ratio in the EU at 170% in 2018, says Eurostat, compared to a figure of between 70%-90% in the neighbouring countries. Could it be that this leverage might magnify any small drop in housing prices creating a major impact on some household’s net worth? Could the reaction to house price falls be a reduction in consumption and increased saving, thus exacerbating any macro-economic downturn?
Koulischer was relatively sanguine, pointing to the results of stress-tests conducted with his fellow researcher at the university Huyen Tran. ‘There are a number of features of the mortgage market in Luxembourg that may help attenuate any COVID-19 shock,’ he said. In particular, residents hold relatively high levels of liquid assets, the labour market has high levels of job security and is likely to be less impacted by lockdown, and banks have high levels of equity.
Luxembourg residents earn, on average twice as much as other Europeans, and this is true across different income groups, according to Eurostat data. The 25% highest earners in Luxembourg earn nearly three times more than the EU average, but for the other three quartiles the difference is close to double.
This is not to deny that the lowest earners in the Grand Duchy are more heavily burdened by housing costs. Indeed, the ratios published by the OECD that compare prices to income and rent have shifted considerably. In the mid-2000s Luxembourg ratios were well below the eurozone average but now they are above average. This contributed to 37% of the lowest earning quintile of Luxembourg residents being classified as being ‘overburdened’ by housing costs in 2019, says Eurostat. Yet this is similar to the figure of 33% for the rest of the EU.
Low unemployment risk
So how did COVID affect the economy? Unemployment went from around 5.5% before the pandemic to 7%, and is currently 6.3%. This relatively mild impact was due to state support to businesses (particularly short time working subsidies of 80% of salary bills) and loan moratoriums granted by banks. So even sectors such as construction and hospitality (which had almost 90% of staff on wage support) have been able to bounce back. This contrasts with the financial sector where there was no need for such support as staff moved to near total remote working mode.
Significantly, much of the resident workforce is protected from the impact of SARS-CoV-2. No fewer than 42% of resident employment is in the public sector: 31% in national administrations, with 11% international (EU, NATO and others). Other secure sectors include finance and ICT which account for 12% and 5% of resident employment respectively. Moreover, as well as being safe, these jobs tend to be well paid. Conversely, industries most affected by lockdown tend to be staffed by cross-border commuters and be less well remunerated. Construction and manufacturing have workforces with 71% non-residents, and retail, transport, and accommodation 59%. Hence if jobs are lost in these stressed sectors, the impact will tend to be felt on the residential property markets in France, Belgium and Germany.
High capitalisation, low speculation
Added to all of this, Luxembourg’s five main housing loan lenders are well capitalised. Koulischer pointed to their leverage ratio, which Basel III rules require this equity to assets ratio to be above 3%. In the Grand Duchy, the range is nearly 5% for the cooperative bank Raiffeisen through to 14% for BGL BNP Paribas, according to 2019 figures by Bankfocus.
Another contributor to market stability is that restrictive planning laws have created a relatively fragmented market. This makes it uneconomic for institutional money to get involved. ‘Fund investors tend to start considering projects valued at around €50m, but in Luxembourg purely residential assets tend to worth be much less than this,’ said Robby Cluyssen the director of the agency JLL residential. He said exceptions were student residences and multi-asset projects which combine residential, retail and commercial. ‘Generally, investors in Luxembourg residential property tend to be family offices and wealthy individuals,’ he said.