International real estate investments with potential
Swiss investors still rely almost exclusively on the domestic market when it comes to real estate investments. However, this is an opportune moment for looking beyond the Swiss borders. After all, real estate investments abroad not only promise further potential, but are also a good way to successfully diversify your portfolio.
The increasingly international orientation of institutional and private investors' real estate investment portfolios is a global trend. For instance, in 2017, Chinese investors were the most important customer segment in London. By contrast, European investors are diversifying into US real estate. And Canadian and US investors have been active in the European real estate markets for years.
Swiss real estate portfolios still have great potential for diversification
Swiss investors have been lagging behind this trend until now, and continue to exhibit an above-average inclination for the domestic market in their real estate portfolios. According to Credit Suisse's Swiss Pension Fund Index, international real estate investments still make up less than 2% of its total investments, while more than 20% of assets are invested in Swiss real estate. Furthermore, many Swiss pension funds have no investments in foreign real estate, although up to 10% of the investments would be permissible in regulatory terms. By contrast, these funds have built up their equity portfolios with a higher proportion abroad than in Switzerland. However, our analyses show that international diversification makes sense specifically in the case of real estate. While equity portfolios have correlations of over 0.8 between the different countries, we are observing significantly lower correlations in the area of real estate.
Figure 1 illustrates the development of total returns from real estate investments held by institutional investors in Switzerland, Germany, and on a global basis. Since 2003, investors have generated a total return per annum of 7.7% in Switzerland, approximately 4.6% in Germany, and 8.9% worldwide. The correlation between total returns from Swiss real estate investments and global real estate portfolios was only 0.1 between 2002 and 2016. In other words, there was only a weak correlation in practice between the two real estate segments over a prolonged period.
German real estate market on the rise
The different performances in the various markets arise from differences in local factors, such as vacancy rates, tenant structures and economic development. The interest rate cycle and investors' heterogeneous asset needs can also be factors that influence performance. The easiest way to identify this is by comparing the Swiss and German markets. Both markets are similar in character. Due to the geographical proximity and economic interdependence of the two countries, the correlation amounts to 0.5 here. However, it turns out that Swiss and German real estate are in different cycles. For a long time, German real estate was plagued by high vacancy rates, for example in the early 2000s. At the same time, Swiss and global real estate portfolios have performed above expectations. Since 2014 however, we have been seeing the opposite. German real estate is experiencing lower vacancy rates, rising rents and a high level of demand. Transaction prices and rents have simultaneously remained at a relatively low level, and we expect this market to perform robustly in the coming years.
Prospects for rental markets remain good in global terms
The situation remains positive in many other rental markets around the world. Figure 2 shows the downward trend for vacancy rates at selected global locations. This is the result of the local supply and demand situation. On the one hand, we are observing improved economic momentum here, leading to a higher demand for rental properties. On the other hand, few large-scale construction projects have been started in recent years, which means that the level of completions continues to be low. The recovery of the housing markets has also led to the conversion of redundant office space into modern residential properties, for example in Amsterdam, Frankfurt, Paris, and Sydney.
The examples mentioned – in Vancouver, Stuttgart, and Düsseldorf – are all outside Switzerland. Does this indicate that you are increasingly concentrating on the international market?
In global terms, Japan saw the most significant decline in vacancy rates after Germany. The Netherlands, which experienced a long period of high vacancy rates, as did regional cities in the UK, are also showing significant signs of improvement. In Australia and the US, the national trend is concealing large regional differences: Sydney and Melbourne in Australia, and also Boston in the US, have vacancy rates at record lows, while cities that are strongly impacted by the commodities cycle such as Houston (US), Perth and Brisbane (both AUS), are recovering more slowly. The drop in vacancy rates, low levels of construction completions that continue to be anticipated, and synchronous global economic acceleration offer grounds for further optimism in 2018 for real estate investors. We expect European real estate markets to have the best prospects by global standards. However, we also see opportunities outside of Europe. In Australia, we expect vacancy rates to recede and rents to start increasing again in Brisbane, while the strong market in Sydney may lose some of its momentum. In Japan, we are seeing regional office markets, especially Osaka, on the rebound. On the other hand, the US real estate markets may ease off slightly, as construction volumes are somewhat greater there and the interest rate cycle is more advanced. But here too, some differences will apply. Gateway cities such as New York and San Francisco are likely to slow, while Washington D.C., Los Angeles and Seattle promise further potential.
Accordingly, global investment solutions remain a good opportunity for Swiss investors, enabling them to achieve a higher level of diversification in their portfolios. This improves the robustness of their portfolio, particularly given the current economic environment and the uptrend in interest rates. Investments in Germany are recommended for investors who do not yet want to invest globally, but would like to dip their toes into foreign waters. These have characteristics that are similar to Swiss "core" real estate investments, but are supported by a very positive rental markets environment.