Decline in Luxembourg's Residential Property Prices Amidst Rising Interest Rates

Discover the reasons behind the recent plummet in residential property prices in Luxembourg due to the surge in interest rates. Gain insights into the current market situation and future projections.

Luxembourg, the affluent European nation known for its thriving financial industry, has experienced a stark decline in residential property prices due to the surge in interest rates. According to the country's national statistics agency, STATEC Luxembourg, the average selling price for apartments fell by 1.93% to €8,548 per square metre (sqm) in the first quarter of 2023, marking the first decline since Q3 2014. When adjusted for inflation, the decline in prices was even more significant, coming in at 5.91% on a yearly basis.

This article delves into the factors contributing to the downturn in the housing market and explores the outlook for the future.

The Plunging Demand for Residential Properties

1. Resounding Impact of Rising Mortgage Interest Rates

2. Significant Decrease in Apartment Transactions and Sales Value

- Statistics from STATEC Luxembourg show a decline of 14.1% in total apartment transactions and 10.7% in sales value throughout 2022.

- Q1 2023 witnessed a drastic drop, with the number of transactions plummeting by 52.7% and sales value declining by 52.5%.

3. Cautious Approach of Foreign Homebuyers

- Global economic and geopolitical uncertainties have led foreign investors to adopt a wait-and-see strategy.

- Despite weak demand, the total number of dwellings in residential buildings with approved permits rose by 39.3% year-on-year (y-o-y) to 1,470 units in Q1 2023.

Luxembourg's Economy Struggles

1. Contraction in the Overall Economy

- Q1 2023 saw the Luxembourgish economy contract by 0.4% compared to the previous year.

- A y-o-y decline of 2.2% occurred in Q4 2022, while annual growth reached 3.8% in Q3, 2.2% in Q2, and 2.5% in Q1.

2. Moderate Economic Growth Projections

- STATEC Luxembourg forecasts a meager 1.5% growth for the full year of 2023, similar to the previous year.

- The European Commission predicts a slightly higher growth rate of 1.6% for Luxembourg, while the IMF offers a more pessimistic projection of 1.1%.

3. Impact of Increasing Mortgage Interest Rates

- The European Central Bank's decision to raise its key interest rate to curb inflationary pressures has led to a rapid rise in mortgage interest rates in Luxembourg.

- The average interest rate for outstanding housing loans increased to 2.68% in May 2023, compared to 1.58% in the same period last year.

- Variable-rate mortgages, which make up the majority in Luxembourg, leave borrowers particularly vulnerable to interest rate fluctuations.

Shrinking Mortgage Market

1. Declining New Housing Loans

- Due to the surge in interest rates, the value of new housing contracts with floating rates and initial rate fixation (IRF) decreased significantly in May 2023.

- Contracts with IRF of up to 1 year fell by nearly 30% y-o-y to €216 million, while contracts with IRF of 1 to 5 years and 5 to 10 years declin

ed by 5% and 63.4%, respectively.

- Loans with IRF of more than 10 years experienced a plunge of 36.6% y-o-y to €227 million.

2. Minimal Growth in Outstanding Housing Loans

- The total amount of housing loans outstanding only rose by 0.9% y-o-y to €41.46 billion in June 2023.

- This growth pales in comparison to the annual increases of 5.1% in 2022, 9.1% in 2021, 9.9% in 2020, and 8.4% in 2019.

- Luxembourg's mortgage debt as a percentage of GDP stood at about 53.3% in 2022, a significant increase from 22.5% in 1999.

Challenges in Rental Market

1. Low Rental Yields

- Gross rental yields on apartments in Luxembourg range from 2.04% to 3.63%.

- This is a notable decline from an average rental yield of 5% five years ago.

2. Surge in Residential Rents

- In Q1 2023, average apartment rents in Luxembourg increased by 11.6% y-o-y, while house rents experienced an 11.1% y-o-y increase.

- The nationwide average monthly rent for apartments reached €1,608, with Luxembourg City's rents even higher.

- The high cost of living in Luxembourg City, which accounts for the majority of rental market activity, poses a challenge for renters.

3. Growth in Construction Activity

- After a decline in the total number of dwellings with approved building permits in 2022, construction activity is now gradually increasing.

- In Q1 2023, the total number of dwellings in residential buildings with approved permits rose significantly by 39.3% y-o-y to 1,470 units.

- The introduction of the Housing Pact 2.0 aims to develop affordable and sustainable housing options and improve the quality of residential dwellings.

Luxembourg's residential property market is currently experiencing a sharp decline in prices, primarily driven by rising interest rates. The decrease in apartment transactions and sales value is emblematic of the dropping demand for properties. Additionally, the overall economic slump adds to the challenges faced in the housing market. As mortgage interest rates continue to rise, the mortgage market is exhibiting signs of shrinkage. Low rental yields and increasing residential rents pose further difficulties for aspiring homeowners and tenants. While construction activity is showing signs of improvement, it remains to be seen how the implementation of the Housing Pact 2.0 will help alleviate the current crisis. With ongoing economic uncertainties, Luxembourg's housing market is likely to face further declines in the upcoming months.