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Coronavirus reinforces trends in the real estate market

Credit Suisse publishes Real Estate Monitor Switzerland for Q3 2020

The rapid but still incomplete recovery from the economic slump caused by coronavirus in the first half of the year means that the immediate negative effects in the Swiss real estate market have been limited to smaller sub-segments. However, COVID-19 is likely to have more of an impact as a catalyst and accelerator of various trends in the longer term. For example, the extension of the low-interest phase in the wake of the crisis is reinforcing the overproduction of rented apartments, while residential property remains hard to find. For the time being, therefore, there is no end in sight to growing vacancy rates for rental apartments. More worrying for real estate investors are the changes in working patterns, which have been accelerated by the pandemic. What is certain is that working from home will become more important in the future and this will reduce the need for office space. Since the productivity levels and innovative capacity of people working from home are likely to decline over time, Credit Suisse economists expect to see a gradual adaptation to new working models, not a radical departure from office working.

COVID-19 slows down demand and causes more vacancies
It was already clear last year that the slight reduction in the number of additional empty apartments did not mark the beginning of a turnaround in the rising vacancy rates seen in recent years, but was simply the result of the positive economic trend in 2017 and 2018. If ever there was any doubt on this front, COVID-19 has cleared it up once and for all. Uncertainty about the consequences of the pandemic further reduced housing demand, which was already losing momentum. Contrary to expectations, however, net immigration has proved to be relatively robust, as the number of emigrants (both foreigners and Swiss citizens) has fallen more sharply than the number of immigrants. In the end, this has slightly accelerated the growth of vacancies again. The already record-high stock of vacant apartments rose again this year by 3,449 units to 78,832, after a rise of 3,029 last year. This means that the vacancy rate for rental apartments is now at a high level of 2.75%.

No end in sight for rising vacancy rates
Immigration in the coming year is likely to remain on a downward trend despite the continuing economic recovery. This contention is supported by recession-related negative employment growth, which will continue to hinder recovery in the labor market in the short term, and also means that fewer workers are being drawn to Switzerland from Europe and third countries. There has also been a lower amount of status changes for holders of short-term residence permits. Their numbers have fallen sharply this year, and this will eventually be reflected in reduced growth in annual permit holders. This means that the rental market will not have the strength to fully absorb the new apartments coming onto the market, not only this year, but also next year. The number of empty rental apartments is therefore also likely to rise again in 2021.

Construction activity largely unaffected by COVID-19
The continuation of the 11-year rise in vacancy rates is also due to the large amount of construction activity in the rental apartment sector. This remains at a high level despite the coronavirus crisis and falling demand for apartments. As a direct consequence of the coronavirus crisis and the lockdown, the number of building permits issued in March and April fell drastically by 21%. However, this decline was largely made good in the second quarter with growth of 15%. The dip in the first quarter is barely perceptible in the moving average over four quarters. Once again, the extremely low interest-rate environment and the resulting attractiveness of real estate returns are the decisive factor behind robust construction activity. Although growing vacancy rates mean increased risks for real estate owners and make marketing more difficult, at best they will only tend to reduce excessive rental apartment construction, not stop it.

Residential property in scarce supply
In contrast to the rental housing market, there is likely to be a decline in the construction of condominiums and single-family dwellings over the next one to two years. The four-quarter moving average for building permits has reached a new low, and the expected increase in the coming six to 18 months therefore remains at 0.8% of the residential housing stock. The latest figures for planning applications also show no sign of a trend reversal. As long as the negative interest-rate environment persists and demand for multi-family dwellings remains high, developers are likely to continue to prefer rental apartments over condominiums in many places as they are easier to sell. Short supply is leading to further price rises for owner-occupied homes. In other words, homeowners are unlikely to see any fall in the value of their property, but potential new buyers face increased financing hurdles.

Office market: Revolution or evolution?
Although COVID-19 has caused practically no immediate loss of rental income in the office real estate sector, investors are concerned about the lasting impact of increased home working. COVID-19 has made working from home acceptable and is accelerating the trend away from a culture in which individuals are required to work in a central office location. Various companies have announced that they will give their employees more freedom in their choice of work location in the future, while others continue to see the office as the central location for service provision. The impact on long-term demand for office space is therefore difficult to predict. Although productivity among home workers was surprisingly high at the beginning, Credit Suisse economists expect it to decline over the medium to long term. Moreover, innovative capacity is likely to suffer in the future if there is too much home working. Consequently, many companies are likely to stick with the central office paradigm in the medium term.

The demand for office space is therefore likely to decline less sharply over the long term than is currently indicated by the share prices of real estate companies with a focus on commercial space. Nonetheless, the pandemic has helped the idea of working from home to achieve a breakthrough. Home working is likely to become a fixed component of many people's working lives. For this reason, Credit Suisse economists expect to see a noticeable long-term reduction of around 15% in demand for office space. However, as other trends (e.g. digitalization, the tertiarization of industry, and economic growth) will continue to have a positive impact on the demand for office space, demand is expected to remain more or less constant (i.e. stagnate) over a longer period. For the time being, however, the recession and the associated reduction in employment are likely to result in a slump in the demand for office space.

Structural changes in the housing market: An extreme scenario
If the coronavirus persists, long-term changes in the housing market are also conceivable. Assuming that the virus remains with us for another four to five years, micro-locational factors (e.g. natural light, tranquility, available infrastructure) would become significantly more important factors when choosing a place to live. Likewise, the characteristics of a dwelling, especially the quality of its layout and external space, are likely to gain in importance. Residential locations on the periphery would suddenly become more attractive, as many employees would no longer have to commute to the office every day. There would be increased demand for low-tax locations, while pressure on the major centers would ease somewhat. As a result, the currently very pronounced urban/rural price differential would also be reduced to some extent.

Figure: Eleven years of rising vacancy rates for rental apartments
Vacancy rate by segment, as a percentage of the respective type of housing stock

Source: Swiss Federal Statistical Office, Credit Suisse

The full version of the Real Estate Monitor Switzerland Q3 2020 study is available online in English, German, French, and Italian: credit-suisse.com/realestatemonitor