«Defining characteristics The bulk of residential mortgage loans in Luxembourg is granted by a limited number of credit institutions. The market has ...»
The Luxembourg market for housing finance
The bulk of residential mortgage loans in Luxembourg is granted by a limited number of credit
institutions. The market has been characterised by a high degree of stability as few new competitors
have entered. In addition to the “traditional” credit institutions, the “Bausparkassen” and the “Caisse de
pension des employés privés” are also present.
Most institutions providing housing finance are incorporated as banks under Luxembourg law. It should be noted that two of the most important actors in housing finance are owned by foreign banks.
Less than 6% of outstanding loans were granted to borrowers residing in other euro area countries.
Anecdotal evidence suggests that institutions abroad account for very little housing finance in Luxembourg.
The commonest mortgage contract is at a variable rate. However, this does not necessarily represent a risk for the overall stability of financial institutions. Fixed rate products seem to have gained in importance recently. This could also be linked to the currently very low level of interest rates.
The standard maturity for mortgage loans is 20 to 25 years, while some banks grant credits for up to 40 years.
One of the banks with the largest market shares is state-owned. However, in practice it operates under the same legal conditions as any other commercial bank. The state subsidises households’ mortgage interest payments.
Main developments and trends over the past 10-15 years Residential property price inflation has followed an upward trend since 1993, which marked the end of a period of declining house price inflation. The latest available data, for 2003, show that nominal house prices increased by 11.9%.
House price inflation was slightly outpaced by estimated growth in per capita disposable income.
Affordability, as measured by the ratio of per capita disposable income to house prices, deteriorated between 1985 and 1990 and has recovered since then. However, it deteriorated markedly in 2003.
The increase in house prices depends to a large extent on the price of land available for construction purposes. Land is a scarce resource, so its cost increases with the growing number of households and with higher per capita disposable income. Local planning rules limit the land available for construction purposes.
The state took fiscal measures in 2002 to increase the supply of both housing and land for construction purposes. The impact of these measures on prices is still unclear.
Demand for loans for house purchase continued expanding in 2004 (11.4% growth on average) and in 2005 (11.3%), while moderating compared to 2003 (more than 20% growth). The increase in home loans may have contributed to strong house price dynamics in Luxembourg. The question is to what extent the strong credit growth could become a source of unsustainable price increases in property markets.
Rent increases were much more moderate than house price hikes. However, the residential rental sector is heavily regulated.
1.1. Developments over the last 10 years in house prices, rent levels, disposable income, household debt and wealth Residential property price changes have followed an upward trend since 1993. The annual rate of house price changes moderated from almost 20% in 1989 to –1.3% in 1993. The latest available data, for 2003, show that house prices increased by 11.9%. Partial evidence from a survey of newspaper and internet advertisements suggests that house prices increased by 7.2% in 2004, while apartment prices increased by 12.5%.
Growth in per capita disposable income1 was outpaced by house price inflation (see graph). In fact, house price increases averaged 8.3% since 1986, while nominal disposable income grew at an average of 6.4% over the same period. Affordability, as measured by the ratio of per capita disposable income to house prices, deteriorated between 1985 and 1990 and has recovered since then.
However, it deteriorated markedly in 2003.
Yearly nominal house price fluctuations were volatile in Luxembourg over the period from 1985 to 2003, ranging between –1.3% and 19.7%. However, price changes are part of the normal functioning of the housing market and need not necessarily indicate “bubbles”. Since the supply of new housing cannot respond rapidly to demand shocks, house prices may deviate from their fundamental/equilibrium value for prolonged periods of time.
The increase in house prices depends to a large extent on the price of land available for construction purposes. Land is a scarce resource, so its price increases with the growing number of households and increasing per capita disposable income. As local planning rules limit the land available for Household disposable income is not published in Luxembourg’s national accounts. Here it is approximated by compensation of employees plus government transfers to households minus social contributions and direct taxes paid by households.
Figures are adjusted for the significant number of non-residents in employment.
construction purposes, they have an impact on house prices. Some local authorities are reluctant to make land available for construction as new housing increases infrastructure costs (eg schools, roads, etc). The state took fiscal measures in 2002 to increase the supply of both housing and land for construction purposes (see point 1.3 below on registration taxes, capital gains taxes, real estate taxes and VAT). The impact of these measures on prices is still unclear in the absence of house price statistics for 2004 but partial evidence from a survey of newspaper and internet advertisements suggests that house prices have continued on their upward trend in 2004. However, government policy to provide housing at “affordable” prices does not seem to have triggered a significant decline in house price inflation.
Demand for housing loans continued expanding in 2004 (11.4% growth on average), while moderating compared to 2003, when these loans increased by more than 20%. The increase in housing loans may have contributed to strong house price dynamics in Luxembourg. The question is to what extent strong credit growth could become a source of unsustainable price increases in property markets. The very low level of interest rates is also likely to have fuelled recent demand for housing loans.
Rent increases were much more moderate than house price hikes, averaging 3.2% per year since
1986. However, the residential rental sector is heavily regulated.
The transformation of dwellings into commercial/office buildings has had a negative impact on the
housing stock in some areas, particularly in Luxembourg City. This development has been driven by:
(i) the fact that rents in the commercial sector are not regulated; and (ii) a gradual increase in the demand for office space in line with economic development in general and growth in the services sector in particular.
1.2. The extent of government influence in the housing market The state aid regime enacted in 1979 distinguishes between individual and collective aid.
Individual aid is granted to households buying primary residences. A distinction can be made between capital grants, which are designed to help households accumulate sufficient starting capital (ie construction grants, home improvement grants, home purchase grants and savings premiums), and subsidies aimed at reducing monthly mortgage interest rate payments (ie interest allowance and interest subsidy). These subsidies are based on the income and family situation of the beneficiary and on the size of the dwelling. Some local authorities also grant public aid in addition to that from the central government.
Luxembourg authorities are active in supplying social housing, which is provided indirectly by public developers. The Eighth programme for the Subsidised Building of Housing Blocks involves the construction of 10,822 subsidised dwellings for both rental and sale.
The main public developers are the “Fonds pour le développement du logement et de l’habitat”, the “Société Nationale des Habitations à Bon Marché” (SNHBM), the “Fonds d’assainissement de la Cité Syrdall” and local authorities. The central government allocates funds to these public developers.
1.3. Regulation (tax laws, owner occupancy requirements, etc) The law of 30 July 2002 enacts several tax measures which aim to reduce the shortage of building
land and housing. The four most significant measures are:
• Registration tax (“droits d’enregistrement”) is payable when real estate property is bought.
The tax base is the value of the transaction (or the “normal” market value in case of a significant difference from the transaction value), and the rate is 6% in most cases. However, a “taxe de transcription” equal to 1% of the value is also collected, which means that the effective rate is 7%. In addition, a special surcharge of 50% of the registration tax is applied for buildings sold in Luxembourg City (unless the building has been occupied for 10 years or more). This tax is likely to have penalised investment in housing compared to alternative assets like government bonds. It favours investment in dwellings under construction or in building sites as opposed to the acquisition of existing houses since the tax is calculated on the transaction value (which comprises the existing construction) at the time of the acquisition. In order to reduce the auxiliary costs associated with buying a dwelling, the law of 30 July 2002 introduced a tax credit on registration duties and fees for all persons wishing to acquire real estate property intended for dwelling purposes; this tax credit is set at EUR 20,000 for single persons and at EUR 40,000 for couples, independent of the amount of registration taxes. Any balance of the tax credit can be carried forward to a future acquisition.
• Value added tax: the 2002 law introduced the direct application of the “super-reduced” VAT rate (3%) on construction and renovation work; the former VAT repayment system is still applicable for those taxpayers who are not eligible for the direct application of the “superreduced” VAT rate.
• Capital gains taxes on real estate. Only secondary residences are taxed. A favourable tax treatment is applied when real estate assets have been owned for more than two years. A tax allowance of EUR 49,600 is available for non-speculative capital gains on immovable assets. However, only one such allowance can be used by the taxpayer over a 10-year period. In 2002, the government reduced the tax rate applicable to capital gains realised on the sale of real estate from 50% to 25% of the average tax rate (the reduction also applies to the sale of land situated in a housing estate and to operations carried out by property developers). This measure is effective only from 2002 to 2007.
• Income tax: rents received are taxed at the marginal tax rate (rents paid are not deductible from personal taxable income). The 2002 law raised the accelerated amortisation rate on rented buildings from 4% to 6%. This accelerated rate is available for new buildings or renovation costs during the first five years. The depreciation allowance for dwellings older than 60 years is 3%. Interest paid on mortgage loans is considered costs related to rent income and can therefore be deducted in full from rent received. All other costs incurred in relation with rent income, such as “real estate management costs”, can also be deducted from rent income. It should be noted that a negative rent income is offset against all other kinds of positive income, thereby moderating the overall tax due.
Other relevant features of the taxation framework are:
• Imputed rents for owner-occupied housing are also taxed at the marginal tax rate. However, the tax base is equal to 4% or 6% of the so-called “unit value” of the dwelling, which is much lower than the market value. Mortgage interest paid by owner-occupiers is deductible from their taxable income up to a certain threshold. The yearly ceiling for tax deduction amounts to EUR 1,500 per person living in the household for the first six years after moving in. This deduction is progressively reduced to EUR 750 for dwellings occupied for 12 years or longer.
Mortgage interest on secondary homes is not tax-deductible.
• Real estate tax (“impôt foncier”). This tax is collected at the local level. Some properties are exempted from the tax, for instance: (i) properties owned by the state or by local authorities which are used to provide public services; (ii) properties owned by non-profit organisations;
(iii) hospitals or buildings owned by religious orders when they are used for medical or educational purposes; (iv) properties such as the railway system. The taxation base is the unit value of the properties, which is based on a scale that dates back to 1941, multiplied by a coefficient that ranges between 0.7 and 1% depending on the nature of the property. Local municipalities fix the tax rate applied to this base. It varies considerably, from 90 to 800% of the base, depending on the type of property and the city where the property is located.
1.4. Transfer and enforcement of ownership/collateral rights According to article 879 of the “Nouveau code de procédure civile”, the lender can have the residential property sold by a notary public in case of the debtor’s default without applying the legal procedures normally applicable to seizure of property, provided that the interested parties have agreed to this simplified procedure by means of a prior notarial act. Five months are usually required for payment to creditors under this simplified procedure. In the absence of a prior agreement to apply the simplified procedure laid down in article 879, the lender will use a procedure involving the court (enacted in the said code from article 809 onwards).
See also points 4.1 and 4.2 below.
1.5. Structure of housing tenure (rental/ownership, etc) The great majority of households are owner-occupiers (about 70% in 2003). This share has increased in recent decades.
2. Borrowing and contract types 2.1. The relative importance of fixed and floating rate borrowing Most mortgage contracts are at a variable rate, representing over 83% of new lending in 2003 and