The buy-to-let dilemma for Luxembourg property investors

In a rising property market, buy-to-let investment can have considerable appeal. Investors receive a regular income that tends to rise in line with inflation, while at the same time the capital value of the property should also increase. This had been the case in Luxembourg for many years. However, the environment has changed, and potential investors will need to reconsider their strategy.

Buy-to-let has been a popular investment option over more than a decade. It constitutes diversification away from equity and bond markets, provides a stable income, and has delivered extremely satisfactory returns in recent years. Luxembourg has seen an extraordinary rise in property market valuations, with the average square-metre price increasing from €4,896 in 2016 to €9,511 at its peak in April 2022.

It has also provided a useful route to less costly participation in what is otherwise a relatively expensive housing market. Investors who did not want to buy a large family home, or only intended to be resident for a few years, could buy a smaller home and let it out if they were no longer occupying it. This freed up capital for use elsewhere, while retaining exposure to growth in the property market.

However, decision-making on buy-to-let investment has become more complicated. The past few years have seen the market’s long bull run come to an end, with prices averaging €8,382 per square metre as of August 2024. Most housing markets across Europe have experienced declines over the past few years, but Luxembourg has been an outlier, having further to fall from its recent peak. According to Eurostat, it saw the largest fall in the EU over the 12 months to the first quarter of 2024 (10.9%), significantly more than in France (4.8%) and Germany (5.9%). For Luxembourg, this decrease was only 5.1% over the 12 months preceding the 3^rd quarter of 2024.

Elevated borrowing costs

That partly reflects the fact that borrowing costs have risen. Whereas investors had been able to secure relatively attractive buy-to-let mortgage loans while interest rates were low, rates have risen significantly since 2022. Although interest rates have started to decline again in the second half of 2024, borrowing remains significantly more expensive than during the past decade of rock-bottom rates, which are unlikely to return again in the foreseeable future.

Higher borrowing costs and weakening home prices have complicated decisions on buy-to-let investing.

Higher borrowing costs and weakening home prices have complicated decisions on buy-to-let investing. Depending on the investor’s point of view, this may be a problem or an opportunity. It may be enable them to pick up Luxembourg property with valuable long-term potential at lower prices, but it might equally be symptomatic of a longer-term decline in the grand duchy’s property market.

However, for now it may be more important for buy-to-let investors to consider the evolution of rental prices. If purchase prices are falling and rental income is rising, buy-to-let becomes a more compelling strategy for new investors. Here the news is better, since rents have continued to increase in Luxembourg – from €24.15 per square metre per month in August 2021 to €28.10 three years later. Asking prices for rental properties are growing at between 7.5% and 8% a year.

There are also longer-term factors that point to future growth in Luxembourg rental market prices. The country has a significant itinerant population of individuals on one- or two-year assignments. The proportion of the resident population that does not have Luxembourg nationality stood at 47.3% at the beginning of 2024, drawn from 170 nationalities. This all contributes to a strong rental market, with many people preferring short-term accommodation as a natural response to their circumstances.

Purchase costs and ongoing expenses

A buy-to-let investor needs to consider not just the buoyancy of the property purchase and rental markets, but also the costs they can expect to incur. Buy-to-let investment entails upfront costs, including real estate transfer tax, notary’s fees and legal charges, which can add more than 10% to the overall spend on a property purchase.

Buy-to-let investment entails upfront costs, including real estate transfer tax, notary’s fees and legal charges, which can add more than 10% to the overall spend on a property purchase.

There are also ongoing costs that landlords may be expected to absorb. They may have to repay a mortgage loan that varies over time as interest rates evolve. While utility bills are usually paid by tenants, there are ongoing maintenance costs, such as fixing leaks, getting equipment repaired and replacing faulty appliances. These costs can be significant and influence the type of property a buy-to-let investor chooses – for example, a low-maintenance new-build residence rather than an older property.

There may also be costs involved in securing a tenant. While some landlords are willing to put their property on popular rental sites and hope for the best, others prefer the security of operating through an agent. This can give some protection if a tenant doesn’t pay the rent or provides other problems, and can act as a channel of communication. Some agencies offer an ongoing management service alongside finding tenants. This costs more, but can be useful if landlords are living in another country.

Aspiring buy-to-let investors should also consider how the rental income will affect their tax position. In Luxembourg, income from rent is subject to taxation at the owner’s marginal rate, the highest level of tax they pay on different slices of income. While various deductions are available, including for estate agents’ fees, repairs and interest on borrowing to purchase the property – there will still be a portion of the rental income on which tax must be paid. And buy-to-let investors who sell their rental property at a profit will probably be liable to pay capital gains tax on the difference.

Consider the market

It is important to consider any buy-to-let investment through the perspective of the tenant, identifying the natural market for the property – which might be students, young professionals, families or expatriates. Expats may need family accommodation, and might prefer a house with a garden, while students tend to be looking for more basic and attractively-priced accommodation, but may prefer a central location or good public transport connections.

Void periods tend to the biggest problem for any buy-to-let property owner. Every month where an investor is repaying a loan but has no rental income coming in is a drain on their overall return. So holding out for the highest possible price may be a good strategy when selling, but for buy-to-let business the best may be the enemy of the good. At the same time, taking steps to keep tenants happy and retain them for longer are usually worthwhile.

The decision-making process relating to buy-to-let investing in Luxembourg has changed. Investors had grown accustomed to constantly rising home prices and steady growth in rental income. However, weakness in the housing market and higher borrowing costs have made calculations more complex. Still, with the European Central Bank starting to reduce interest rates, it may be a good time to look again at buy-to-let property.

If purchase prices are falling and rental income is rising, buy-to-let becomes a more compelling strategy for new investors.