UBS Chief Investment Office WM publishes UBS Real Estate Focus 2015

The current high price level, increased building activity and stricter regulation have cooled the Swiss homeownership market further in 2014. The 2.5% price increase for condominiums and 1.5% increase for single-family houses were well below the average growth rate over the past 15 years. Given robust economic conditions and the gradual slowdown in the rise in real estate prices, the current price level is regularly considered as sustainable. This perception overlooks two factors, however. First, price movements that can be fundamentally explained often present a false sense of security, and second, the real estate boom in Switzerland also rests partly on speculation.

Over the past five years, owner-occupied home prices have risen some 30% on an inflation-adjusted basis. In this period, the strong increase in population drove prices higher, and the drop in long-term interest rates since 2011 spurred the additional increase in prices. Nevertheless, this is neither the entire story nor reassuring. Especially since the financial crisis, many investors have fled into real estate, lending a speculative impetus to the rise in owner-occupied home prices. We believe that about one-third of the rise in prices since 2009 has been due to speculative investments.

Speculative price components are unstable. Even if conditions remain favorable, a price correction of around 10% could occur at any time. If interest and vacancy rates also surge, then even price rises that are fundamentally justified can retreat like snow in full sunlight. The argument that the real estate market has entered a safe haven fails to perceive the extant market imbalances.

Imbalances may abide for now, as the factors driving prices higher remain robust. For 2015, we expect price increases in Switzerland of only 0.5% for single-family houses and 1.5% for condominiums. We foresee higher price increases only in the large urban areas. Regulatory officials will, however, pull out all stops to prevent renewed price acceleration.

Assessing the sustainability of current prices by comparing them to alternative investments such as government bonds suggests that multi-family dwellings in prime locations in Switzerland’s largest cities are fairly valued. If real interest rates remain low, the top returns could even fall modestly this year and slip below the 3% level. But if the 10-year Swiss government bond yield were to rise to 4% in four years from the current 0.3%, the price of multi-family dwellings could plunge by as much as 25%. This means that buyers of multi-family dwellings are betting that the status quo will not change. In fact, real estate is a good investment only for believers that low interest rates are here to stay for a long time.

The top returns from direct investments in office space, however, are rising modestly, as the four-year downtrend for returns has been broken. The sharp drop in interest rates last year clearly shows the higher risks. Quoted rents have also begun to drop somewhat. The silver lining is that the number of construction permit requests has been falling, indicating a strong reduction in investment volumes starting in 2017. For the current year, we believe that vacancy rates will rise by 0.5 percentage points, while rents will continue inching lower throughout Switzerland.

UBS Real Estate Focus 2015 is available here: www.ubs.com/realestatefocus-en.