Luxembourg real estate market at risk of 'overheating'

The Luxembourg real estate market is at serious risk of overheating, according to the latest edition of the BIL immo index, which came out at the end of July. 

The index measuring the 'temperature' of the market more than doubled between the end of 2015 and the end of 2016, "driven by rising prices and the credit boom", said the head of BIL's business department, Marcel Leyers. 

The "overheating zone is not far away", he added, before prescribing the remedy: increasing the housing supply. Successive governments, however, have been working to increase housing supply for several years now without achieving any convincing results. 

Meanwhile, due to historically low rates, banks' books are piling up with loans that are increasingly difficult to manage for households.

Danger linked to too much debt

Serge de Cillia, director of the Luxembourg Bankers' Association (ABBL), agreed that the subject was a "sensitive" one. The European Systemic Risk Board (ESRB) already raised its concerns about the market in November 2016. 

In a report on the "Vulnerabilities in the European real estate sector" emerging from the subprime mortgage crisis, the ESRB identifies eight countries likely to face systemic risks over the medium term.

Luxembourg is one of them. In particular, the ESRB cites Luxembourg's "structural imbalance between a strong demand for real estate and supply-side constraints" and the high debt burden of households in relation to their disposable income. 

Over-valuation of assets and excessive amounts of household debt are the two main dangers. In an opinion delivered at the beginning of the year, the Systemic Risk Committee (CRS) – Luxembourg's equivalent of the ESRB – seeks to put things into perspective.

It acknowledges that "the appreciation of the valuation of real estate prices relative to the fundamentals is a central issue in the assessment of the risks to financial stability", but the body, chaired by the Minister of Finance, argues that residential prices "remain more or less in line with economic fundamentals".

The CRS's qualification suggests the Luxembourg authorities lack the suitable tools to measure the risk.

An uncontrollable increase 

The data used by the authorities, the Central Bank of Luxembourg (BCL) and the Financial Sector Supervisory Commission (CSSF), are not precise enough. "We do not know, for example, whether the property is a place of residence or a rental investment," said the ABBL's Cillia.

Regarding excessive household debt, the CRS concedes that "a prolonged period of house prices increasing more than income can constitute a vector that weakens the financial situation of the households through a mechanical increase of the debt".

The average price of the square metre increased by 7.7 per cent in 2016, according to the latest figures of the housing observatory. The trend started in 2012, and prospects for growth  – economic and demographic – suggest an increase in property prices in the coming months and years.

The debt burden of Luxembourg households is high, although figures differ according to the organisation measuring them. The ESRB set the debt-to-disposable income ratio at 149 per cent at the end of 2016, the CRS at 124%. This is a primary concern for risk-analysis committees.

Towards more fixed rates

The average loan-to-asset-value ratio – 67 per cent for new loans – does not worry the ESRB. But the growing number of large loans in relation to the value of the property is a real concern.

The household debt ratio is rising "rapidly" (by 6 per cent in 2016), notes the European body. Its Luxembourg counterpart confirms that the rise "raises questions about the sustainability of this indebtedness" in the medium or long term.

In the event that interest rates are raised, which could be envisaged over the coming months, the monthly payments for households with a variable-rate loan would increase as well.

"Such an increase would be likely to affect the solvency of part of Luxembourg's households," warns the CRS. The banks would suffer next, especially since loans have traditionally been given out with variable rates in Luxembourg. 

"Sixty per cent of new credit is at fixed rates, but if you take the stock, 70 per cent remains at variable rates," De Cillia said. 

To mitigate the existing risk, banks gradually convert variable-rate borrowings into fixed-rate loans, but the process takes time.

According to the information provided to the Luxemburger Wort, and in line with the CERS recommendations, the CSSF is working on the identification of potential risks linked to possible overvaluation of real estate and household over-indebtedness. 

The objective is to improve the quality of risk management within banks. 

Legislative elections

In its report, the ESRB identifies tools that "may be appropriate" to mitigate the risks associated with the residential market. 

"In addition to instruments aimed at acting on banks' own funds, there are instruments such as setting an upper limit to the loan-to-value ratio of the real estate, minimum standards in terms of amortisation of a loan or limits to the initial duration of a loan," it says.

Replying to a parliamentary question by Franz Fayot in January, Luxembourg Finance Minister Pierre Gramegna said the CRS would "analyse which of these instruments could be clarified in national legislation".

(By Pierre Sorlut, translated from French by Barbara Tasch)