Banished from Paradise
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Banished from Paradise

For more than ten years now, the Swiss real estate markets have enjoyed parameters that can only be described as a kind of paradise – continuous rises in prices and rents, booming demand, and low vacancy rates against a backdrop of low interest rates. But in recent years, there has been an accumulation of indications that other, less favorable times lie ahead. Because real estate investors are no longer able to source easy returns just like that. In the future, investors will increasingly have to rely on their own services in order to generate the hoped-for returns in real estate markets.

Negative interest rates provided another powerful, and possibly final, boost for valuations of real estate in 2015. Due to low interest rates, discount rates fell by a further 20-30 basis points, which resulted in strong revaluation gains for investors. But the brighter the picture in the rear-view mirror, the more challenging the road ahead for the real estate market. The handsome gains in the real estate investment market stand in stark contrast to signs of growing imbalances in user markets. In the rental apartment market, for example, vacancy rates have been rising by more than 4000 apartments a year since 2014, despite robust demand. Marketing is becoming an increasing challenge, as is reflected in the increase in days-on-market of the average rental apartment, namely by four days to 28 days. Despite this development, the attractiveness of real estate returns as compared to returns on alternative forms of investment is triggering strong investment activity. Accordingly, the expansion of available floor space continues to increase unchecked. This year, a further 24,000 rental apartments are expected to be completed. Given the unbroken momentum of construction planning applications, it appears unlikely that this surge of construction activity will abate any time soon. In 2016, the significant planned expansion of rental apartments should once again increase the number of vacant apartments by more than 4000. As a result, the upward pressure on rental prices in Switzerland can be expected to virtually evaporate in 2016.

Significant yield advantage of real estate investments spurs construction activity

Significant yield advantage of real estate investments spurs construction activity

Spread between distribution yields of real estate funds and government bonds, together with planning applications for rental apartments (right-hand axis)

Source: Credit Suisse, Datastream, most recent annual report of real estate funds, "Baublatt" magazine

Refugees Prop Up Residential Rental Demand – But Only in Lowest Price Segment

The key driver of the anticipated end to rental price growth is the decline in the rate of immigration of workers on the demand side. The number of workers moving to Switzerland declined by some 10 percent in 2015, and we are anticipating an even greater fall in this influx of working adults in 2016, as employment growth is expected to slump this year. Viewed in terms of numbers alone, however, the decline in working immigrants is likely to be more than offset by the influx of refugees. The latter appear in the official data for Switzerland's permanent residential population either only partially (recognized refugees only in the data of the State Secretariat for Migration) or following a time lag of a year (as per the data of the Swiss Federal Statistical Office). The increase in the influx of refugees by 17,000 in 2015 according to the State Secretariat for Migration and the equally large influx expected in 2016 will therefore only be picked up hazily or following a certain delay. The additional demand for rental accommodation from refugees will primarily put pressure on demand in the lowest price segment, which is already fierce.

Overall picture of net immigration of foreign residential population

Overall picture of net immigration of foreign residential population

Moving 12-month total, including register corrections

Source: Secretary of State for Migration, Credit Suisse

Commercial Real Estate Markets Hit by Digital Revolution

Floorspace demand in the office property market is likely to be extremely weak. While key players such as financial service providers are struggling with structural change in their industries, the entire services sector is exposed to new challenges as a result of the digital revolution. The outsourcing of administrative support functions to low-wage countries (offshoring) is much simpler nowadays thanks to digitalization. After a stabilization in oversupply last year, a planned expansion of supply that exceeds historical averages will unquestionably intensify imbalances in the office market once again in 2016. No reversal should therefore be expected in the trends of increasing vacancy rates and declining rents over the next few quarters.

The retail premises market continues to be heavily exposed to the trend of digitalization and is being pressed hard by online trading. The upheaval in this market segment appears to have only just begun, as, compared to other countries, online trading in Switzerland is still at an early stage of development, with a market share of just under 6 percent. A gradual rise to a market share of 10 percent, as is standard in countries with a similar internet infrastructure, is likely to put retail space productivity under even greater pressure in the area of brick-and-mortar retailing, thereby reducing floorspace demand accordingly. Even as things stand, rising vacancy rates, a record-high level of space supply, and declining rental rates indicate that tenant activity is very subdued. The extent of the uncertainty over the future role of brick-and-mortar retailing in an increasingly digital world is clearly apparent in the planning of new retail premises, which is at an extraordinarily low level, despite the favorable interest environment.

Growing Generational Gap in Residential Property

Only in the residential property market do demand and supply appear to be largely in a state of equilibrium. Low interest rates and moderate increases in real income provide a basically positive backdrop for residential property demand. The desire of many recently arrived immigrants to purchase real estate is an additional supporting factor on the demand side. By contrast, the (self-) regulatory measures in the area of mortgage lending and the associated increase in financial requirements for the acquisition of residential property are having a significant dampening effect. In 2016, the calming of the residential property market is likely to continue. Across Switzerland as a whole, this is likely to result in positive but weak price growth of less than 1 percent. The price correction in French-speaking Switzerland is set to continue, but should not intensify further. This is because the conditions for residential property are still attractive.

Demand is increasingly being driven by people in the second half of their lives. The average Swiss property owner today is 57 years old. As the financially well-placed baby boomer generation gets older and lives longer, it will increasingly be older households that dominate the residential ownership market. By contrast, young households will remain longer in rented accommodation, as they are confronted by high ownership costs and more rigorous regulation. Accordingly, there will be a growing gulf between the generations. As a consequence, the residential ownership market will be subject to a stress test – and at the latest when the less populous demographic segments succeed the baby boomers. From 2018 onward, a demographically-driven weakening in demand is to be expected, which after a few years could be up to a third lower than it is today.

Number of home owners by age

Number of home owners by age

Number of households, by age of the surveyed person in the household

Source: Swiss Federal Statistical Office, Credit Suisse