In a report published on Tuesday, Sara Ferreira Filipe found that high residential real estate prices have led to an expansion of mortage credit, “which in turn triggers a further price increase”.

This, coupled with a limited supply and high demand from positive migration, “only partly explains the price dynamics of the residential real estate market in Luxembourg,” she wrote.

The tipping point was a “moderate but continued overvaluation of property prices”. Ferreira Filipe estimated the overvaluation at on average 6.85% over the five year period between 2012 and 2017, but says the trend decreased over the last few quarters.

The economist further says that a correction of this overvaluation has been slower in Luxembourg than in other countries “at an average rate of 2.2% of the overvaluation each quarter.”

This, she states, means it will take 31.5 quarters (7.8 years) to reset half of the deviation from the fundamental value.

“In comparison correcting the deviation of mortgage credit from its own fundamentals takes only about a quarter,” the economist wrote, adding: “In sum, the results suggest that an imbalance in the mortgage market is corrected faster than in the real estate market.”

Residential real estate prices rose by 40% in Luxembourg from 2006 to 2016. Latest figures on house prices in Luxembourg recorded a 4.9% increase from the third trimester of 2016 to the third trimester of 2017. A joint report from Statec and Liser found that the average price of a family house reached €649,425, an existing flat €5,002/sqm (+4.7%) and a new flat €6,316/sqm (+6.1%).

Updated, 14 February: The time period of the study was updated.