REREF – Regulation of real estate finance

About

Offering affordable housing is a key policy challenge in developed economies in general and in Luxembourg in particular. A myriad of policies are in place to support homeowners acquire and finance their homes. Most if not all of these policies are well intended by policy makers and consume substantial amounts of financial means, Yet, relatively little is known about the impact of these policies and potentially unintended implications. To gauge the importance of subsidies for the real estate market in Luxembourg, it is worth noting that roughly 3% of GDP is spent on house purchase subsidies.
In this project, we look at two aspects. First, we ask the following question: Are subsidies to buy homes beneficial for homeowners or will they merely act as a price driver and lead to price increases? This would make home sellers (i.e. sitting homeowners) better off but not alleviate the affordability crisis. Second, we look at the impact of tax deductibility of mortgage interest rate payments. Does the allocation of loan amounts take tax deductibility?
Turning to our first point, a subsidy to purchase a home is individually beneficial to every homebuyer, yet a market-wide distribution of such a subsidy may drive prices up. Each potential homebuyer has a larger budget due to the subsidy and hence the competition for each potential house or apartment becomes stiffer. It is thus not clear whether a subsidy to purchase your home is favourable for potential buyers.
In this project, we empirically investigate the extent to which subsidies have an impact on house prices. This exercise – while relatively simple in theory – is rather difficult to pursue. We need to have information on the supply of houses as well as on the demand for houses. We combine two particular subsidies, the Bellegen act at the point of purchase of a house and the reduced VAT for house construction to learn about the demand and the supply curves of houses.
We find the following: i) The number of transactions strongly react to the existence of the Bellegen act. ii) The extend of contruction and renovation work respond strongly to the reduced VAT. iii) Finally and most importantly, the benefits from the subsidies for home ownership are split across buyers and sellers: each Euro of subsidy for homeownership (in the form of tax credit in the Bellegen act) leads to a 27 cent increase of house prices and thereby ends in the pockets of sellers while the remaining 73 cents benefit home buyers.
Turning to our second point of analysis, we investigate how the take up of mortgages are affected by the tax deductibility of mortgage interest payments. Here again, we are able to benefit from specificities of the Luxembourgish tax system, namely the limits on tax deductibility (€2000 per person and year). We find evidence that there are more mortgages just to the left of the tax deductibility limit. Unfortunately, we face a power issue and it is hard if not impossible to derive statistically valid answers in our second setting.