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The Peak Has Passed – But It is Too Early to Sound the All-Clear

Credit Suisse Publishes Its 2014 Study on the Swiss Real Estate Market

It is becoming increasingly clear that the real estate cycle in Switzerland has passed its peak, almost without anyone noticing. It is true that prices are still rising in some market segments, but the momentum has slowed. The situation varies in each of the individual markets. High prices for residential property are increasingly acting as a brake because the bar has been raised in terms of capital requirements and affordability in the wake of more stringent regulation. The market for office space is heading for an increasing oversupply which is likely to result in more rent reductions and valuation corrections in the course of this year. In contrast, the residential rental sector can count on a further year of robust demand, but is moving in the wrong direction in planning terms, as Credit Suisse economists point out. While demand is concentrated in the urban centers, too much capital is being directed into residential housing in rural areas – not least because of a lack of opportunities in the major centers. The real estate markets may be becoming more challenging, but they still offer new opportunities and investment niches for investors – in logistics for instance. While the pressure from online shopping negatively impacts retail space, logistics real estate is becoming more and more important.

Investors in the Swiss real estate market are becoming increasingly cautious. The dynamic market segments were and are being held in check by more stringent regulation. As a result, price growth in owner-occupied property and the associated lending volumes have begun to stagnate. High prices as such are tending to act as a brake and are leading to a transfer of demand to regions where prices are lower. Other market segments, such as top-range residential property and the market for office space, are already experiencing falling prices and rents. The unexpected approval of the initiative against mass-immigration will also limit potential demand in the rental market in the medium term. The turnaround in interest rates is also contributing to a market cool-off which has so far proceeded perfectly to plan. However, the path to a soft landing for the real estate market remains precarious. On the one hand, it is too soon to sound the all-clear because the fundamental factors driving the high demand for living space remain unchanged. On the other, unexpected economic shocks, heavy-handed regulation or rising interest rates could still lead to major price or value slumps.

Unsolved Problems in the Housing Market
Despite the approval of the initiative against mass-immigration, net immigration this year is likely to remain at around the same level as last year. As the analysis by Credit Suisse economists shows, jobs are primarily being created in the urban centers. Demand for housing therefore continues to focus on these regions, and the markets have consequently dried up. At the same time oversupply of residential property in rural areas increases, leading to increased internal migration. Just how sustainable this is remains questionable. Traffic jams, spiraling infrastructure costs and growing urban sprawl are the consequences which reveal the delivery gap in urban and regional planning. The unexpected approval of the initiative against mass-immigration by rural populations can also be interpreted as a further protest against the unchecked growth of housing developments in country areas. This is due partly to sustained resistance to increased population densities and partly to the over-regulation of the housing market in towns and cities. Credit Suisse economists cite the example of Geneva to show the unintended consequences of intervention in the price structure of the housing market, i.e. exploding prices in the unregulated sectors of the market, growing public dissatisfaction with the housing situation, and falling locational quality. The aim of the interventions was to keep residential space affordable. This objective was not, however, achieved because the implications of a lack of incentives to create residential space were not adequately considered.

This imbalance in supply and demand is likely to result in ongoing shortages of residential space and rising rents in the urban centers in the short term combined with increasing vacancy rates and problems with the absorption of rental apartments in peripheral areas. Against the backdrop of the approval of the initiative against mass-immigration, the likelihood of oversupply in the future has therefore increased. Because the absorption rate for apartments depends to a large extent on immigration, it is important to keep an eye on this latent risk. In this kind of environment, with real estate markets becoming increasingly challenging, locational quality is regaining importance. Based on an analysis of the regional hotspots for transport accessibility, Credit Suisse economists have concluded that accessibility in an increasingly mobile society is a key factor in locational quality, and largely explains the major price differential between town and country. In the battle for scarce space, businesses much prefer locations with excellent transport links. Households, in contrast, are prepared to accept compromises on the accessibility front as long as the price is right.

Over-Production Based on Low Interest Rates Likely to Lead to Lean Years in the Office Space Market
The current low interest rates are still leading to a relatively large number of new developments. The result is a rise in vacancy rates. As a rule, this does not affect those investing in new developments. Instead the impact is felt by the owners of comparatively expensive or now less desirable pre-existing properties, which means that the vicious circle is strengthened, and more and more new developments are planned. Credit Suisse economists estimate that overcapacity will exceed 1 million square meters by 2015. The problem is made worse by the fact that demand for office space is unusually flat. In contrast to earlier economic cycles, the financial services industry is practically non-existent at present as a demand factor. In an environment with record levels of supply, rising vacancy rates and growing bargaining power of tenants, the fact that the development pipeline is full is surprising. In the meantime, however, even some major projects are having problems moving towards the implementation phase because they cannot achieve an adequate level of pre-lettings. Despite impressive economic growth, businesses have remained cautious because of the uncertainties in the global economy. The market is therefore beginning to regulate itself. The burgeoning oversupply should increasingly lead to valuation corrections and falling rents in the coming quarters. Only the very best locations are likely to buck this trend.

Online Shopping – a Challenge for Retail Space, an Opportunity for Logistics Real Estate
On top of the challenges currently facing the retail trade (e.g. saturation, "shopping tourism", discounting) there is one other key factor that specifically affects retail space: online shopping. This technological revolution of shopping ruthlessly exposes inadequate retailing ideas and inferior locations. Credit Suisse economists have also detected a trend for the retail business to be dominated by chain stores, which highlights the growing difficulties faced by individual retailers. Online shopping is forcing retailers to invest both in the electronic channel and in the comparative advantages of stationary trading (e.g. advice, shopping experience). Consequently they no longer have the spare cash to expand their retail space. Future demand for retail space will also be hit by the simple fact that less retail space is needed in a world where people shop online. However, the same factors that represent a mortal threat to retailers can deliver real opportunities in logistics real estate. Since there is a growing direct link between the quality of logistics services and consumer purchasing decisions, logistics real estate is becoming much more important.