The renewed rise in vacancy rates in the Swiss real estate market is driven by the negative interest rate policy of central banks. Following the reversal of monetary policy in the US, a normalization of interest rates is off the table for now – and possibly for years to come. Real estate has therefore once again become the asset class of the moment due to the exceptionally attractive returns it offers. High valuations are likely to persist in the current market environment and to increase even further. This also applies to vacancy rates, which rose for the tenth time in succession and are becoming a chronic problem for the real estate market. Regulators are consequently back in the frame, with calls to stem the growing risks in the real estate and credit market through self-regulatory measures on the part of the banks.

Hopes for a normalization of conditions in the capital markets were dashed again by the sudden policy reversal by the US Federal Reserve (Fed) last November. Investors and savers are likely to be faced with zero and negative interest rates for years to come, along with their positive and negative side-effects. These include record-low costs for mortgage borrowers and substantial capital gains for real estate investors. However, with prices increasingly decoupling from the fundamentals, the risks have likewise grown once again. At the same time, the risk of a change in interest rates has receded further into the future.

Negative interest rates are fueling a high level of vacancies
Negative interest rates were originally viewed as a temporary phenomenon but there are still no signs of normalization four and a half years after they were introduced. Quite the reverse in fact, with the volume of bonds and loans offering negative interest rates having multiplied further in recent months. For the Swiss real estate market, that means ‘more of the same’. More and more capital is flowing into the real estate sector, driving prices further upwards. It is therefore to be expected that positive capital growth rates can be added to comparatively attractive net cash flow yields (Figure 1) over the next few years. The supercycle in the real estate market is therefore entering another extended period. Given this background, residential construction activity remains at a high level and excess production in the rental apartments market is continuing apace – ultimately resulting in unrestrained growth in vacancy levels.

Vacancies becoming a chronic problem
Vacancy rates for apartments have risen again in 2019, despite strong economic momentum over the past year. The number of vacant apartments has increased by 3,029 units to a current figure of 75,323. The renewed rise in the vacancy rate is entirely due to rental apartments. Within the space of a year, the vacancy rate for rented apartments has advanced from 2.55% to 2.64%. Over a ten-year period, it has more than doubled. Owner-occupied residential property, on the other hand, is unaffected by the vacancy problem. Indeed, a slight decline in vacant owner-occupied residential apartments was recorded for the first time since 2011 (–72 units), explaining the fall in the vacancy rate from 0.59% to 0.58%. The stable situation in owner-occupied housing is the result of a continuous reduction in construction activity in this segment in recent years. Record-low mortgage rates and a favorable economic situation are also likely to have boosted demand – notwithstanding the adverse effect of regulation and high prices.

At a regional level, the rise in the vacancy rate is no longer quite as broad-based as it was in 2018. A total of 47 of Switzerland's 110 economic regions posted an increase in the vacancy rate, 32 saw a reduction, while the remaining 31 regions were stable (Figure 2). Of the regions most at risk from oversupply, where vacancy rates were already above 2% in 2018, only a minority (18 out of 42 regions) were able to reduce their vacancies. This was achieved mainly in several regions of Valais and Aargau. In regions heavily affected by the supply overhang, such as the cantons of Solothurn, Thurgau, and Ticino, vacancy rates are over 3% in some cases – and significantly higher for rental apartments. On the other hand, vacancy rates have remained stable or even fallen in some regions in which no oversupply was observed in recent years. These include the Lake Geneva basin, the canton of Zurich, and large parts of Central Switzerland.

Ticino real estate market in trouble
The Ticino rental apartments market has run into difficulty following major investments in the construction of rental apartments in connection with improved access to the canton via the Gotthard and Ceneri base tunnels, as well as an attractive suburban rail network in the Bellinzona-Locarno-Lugano triangle. After a phase of above-average economic momentum between 2012 and 2015, the additional supply of housing coincided with a bout of economic weakness triggered mainly by the strong Swiss franc. The fact that the population has been shrinking for two years was also not conducive to the absorption of a roughly threefold rise in the production of rental apartments since 2015. The vacancy rate for rental apartments has therefore risen sharply, and now stands at 4.44%. The situation in the owner-occupied real estate market is more balanced. Although difficulties in key economic sectors such as finance and accountancy have hit the owner-occupied market, the recovery in employment growth this year seems to have caused prices in the owner-occupied residential market to start rising again.

Stricter regulations on investment property fail to calm market
The Swiss National Bank and the Swiss Financial Market Supervisory Authority (FINMA) are concerned about the rise in the price of multi-family dwellings – which have increased by more than 50% since fall 2008 – despite the growth in vacancies for rental apartments. They have therefore threatened the banks with an increase in risk weightings for high loan-to-value domestic residential investment properties, as part of a revision of the Capital Adequacy Ordinance (CAO). The banks subsequently agreed to introduce stricter self-regulatory measures for the debt financing of investment properties at the start of 2020 in order to avoid higher capital adequacy requirements. Specifically, the banks will reduce their lending limits and amortization periods. Both measures will significantly increase the hurdles for debt-financed investments in residential investment properties and lead to a slight decrease in demand, primarily among private investors and smaller real estate firms. Due to the continued negative interest rate environment, however, these measures are highly unlikely to lead to a significant calming of the market given that the latest record-low interest rates will more than offset the dampening effect.

The complete study ‘Real Estate Monitor Switzerland Q3 2019’ is available online in English, French, German, and Italian at: credit-suisse.com/realestatemonitor