Credit Suisse (2015) Swiss Real Estate Market 2015 En

8/8/2019 Credit Suisse (2015) Swiss Real Estate Market 2015 En

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Economic Research

Swiss Issues Real EstateMarch 2015

Real Estate Market 2015

Structures and Prospects


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Credit Suisse Economic Research

Swiss Issues Real Estate – Real Estate Market 2015

Publishing Details

Publisher

Giles Keating

Head of Research and Deputy Global CIO

+41 44 332 22 33

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Fredy Hasenmaile

Head Real Estate & Regional Research+41 44 333 89 17

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Authors

Denise Fries

Fredy Hasenmaile

Philippe Kaufmann

Dr. Christian Kraft

Sarah Leissner

Thomas Rieder

Daniel Steffen

Dr. Fabian Waltert

Contribution

Andreas Bröhl

Thomas Schatzmann


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Swiss Issues Real Estate – Real Estate Market 2015 3

Table of Contents

Management Summary 4

FX Shock: Impact on Swiss Real Estate Market 6

Owner-Occupied Housing 8

Demand 8Supply 11Market Outcome 14Residential Property as an Investment 18Outlook for Owner-Occupied Housing in 2015 21

Residential Property in Regulators' Sights Across

the Globe 22

Rental Apartments 26

Demand 26Supply 29Market Outcome 31Outlook for Rental Apartments in 2015 34

Driverless Cars: The Next Stage of Mobility 35

Office Property 37

Demand 37Supply 39Market Outcome 41The 15 Largest Office Property Markets at a Glance 43The Five Largest Office Property Markets in Detail 43

Zurich 44Geneva 46Berne 48Basel 50Lausanne 52

Outlook for Office Property in 2015 54

Retail Property 55

Demand 55Supply 58Market Outcome 59Outlook for Retail Property in 2015 62

Student Housing: Yields Despite Low Willingness to

Pay? 63

Real Estate as an Investment 67

Direct Real Estate Investments 67Indirect Real Estate Investments 72Outlook for Real Estate as an Investment in 2015 77

Factsheets: Regional Real Estate Markets at a

Glance 78


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Management Summary

Return of the cycle

The Swiss franc shock accelerates a development that has long been in evidence on the Swissreal estate market, which is that the lengthy period of stability is drawing to a close. The tradi-tional real estate cycle, in which excess supply replaces the long phase of rising prices, is re-turning. This process is likely to accelerate, firstly because the domestic economy is also beingdragged down by the Swiss franc shock, thus reducing the demand for floor space, and sec-ondly because even more capital is now flowing into the real estate markets. This is becausenegative interest rates are driving investors into the real estate market, increasing the invest-ment in new developments and therefore further expanding the supply of space.

Braking and accelerating forces in equilibrium

Were it not for regulatory measures and the dampening effect of repeated warnings about aprice bubble, the residential property market would be overheating due to ultra-low mortgage

interest rates. Based on data for two cantons, it is possible to show how high prices and an un-equal distribution of assets, in combination with regulation, are limiting demand. Thus the mar-ket – figuratively speaking – has one foot on the scorching hot plate and the other in the freez-er. This "cohabitation" between hot and cold is by and large working. But whereas the high-price segment continues to suffer, the home ownership boom in the lower-priced segments iscontinuing apace. Developers have become cautious, however. Demand for owner-occupiedproperty is showing saturation tendencies; on the other hand, home ownership presents an in-creasingly important investment opportunity at a time of low interest rates.

Switzerland is not the only country seeking to calm its housing market

Some countries are currently showing a tendency toward overheating. The range of regulatorymeasures deployed around the world is as wide as it is uncharted. Switzerland has already im-

plemented a comparatively large number of measures. This is not entirely without some initialsuccess, which may have something to do with the typically Swiss sport of self-regulation.However, regulation is not without its costs and requires considerable judgment as well as goodtiming.

Gradual transition from landlord's to tenant's market Complaints about a lack of housing are widespread, despite the fact that vacancies for rentalapartments are at their highest level since 2001. With demand having peaked, this easing ofthe situation is likely to be the subject of increasing awareness in future. Though down by morethan 10%, immigration is once again more or less likely to ensure the sale of newly built apart-ments this year. That is unlikely to be the case going forward, however; we therefore examine ingreater detail which regions would be most affected by a continued decline in immigration. Thecurrent easing of the situation is primarily due to the high level of apartment construction. Be-cause developments are continuing at a very rapid pace, the greater number of days on themarket and weaker growth in rents offered – both of which we are seeing at the moment – areunlikely to be a flash in the pan. They are early signs of decreasing pressure on rents. A broad-based fall in rents is not yet expected over the coming quarters. The market is only slowly turn-ing. But provided there is no tightening of supply, that is indeed likely to become a reality.

Driverless vehicles take mobility to the next level

Driverless cars are on everyone's lips, but as yet very little is known about how this new tech-nology will alter people's behavior and their needs. The new technology is already being testedin the real world and will determine our everyday lives in the not-too-distant future. We thereforegive some thought to what this could mean for the real estate market.

No light at the end of the tunnelDespite solid five-year economic growth in the 1–2% range, an oversupply of office space hasbuilt up in Zurich and Geneva in particular. The primary reason is the fact that the developmentof the economy was dominated by domestic growth in the period after 2009. Momentum

Consequences of the

Swiss Franc Shock

Page 6

Owner-occupied housing

Page 8

Special focus:

Residential property in

regulators' sights across

the globePage 22

Rental apartments

Page 26

Special focus:

Driverless vehicles – the

next game-changer

Page 35

Office propertyPage 37


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among traditional users, such as banks, insurance companies and consultancy firms, hasslowed considerably and even gone into reverse in places. An increased requirement for officespace has developed among real estate and construction service providers, public administra-tion, educational institutions, healthcare and providers of services to the high-tech industry, onthe other hand, though with a lower willingness to pay and/or different floor space require-

ments. Because the absorption of new properties was effortless for a long period of time, themarket failed to respond quickly enough to changing demand requirements. The result is excesssupply, although this varies considerably from one location to another. Prime sites such as railway locations in the major centers should continue to do well. There is a major risk of an in-crease in excess supply, however. The fact is that even if production has peaked, constructionactivity will remain at too high a level due to the dearth of investment opportunities – a situationthat is likely to be amplified further by the introduction of negative interest rates.

Oversupply more clearly in evidence In-depth analysis of the major office property markets centers on the question of where adver-tised floor space is concentrated in location terms. Extensive supply currently exists in the cen-tral business districts (CBDs) of Geneva and Zurich in particular, mostly comprising small-scale

properties. Bern and Basel are comparatively unaffected; here it is above all individual projectsin the outer business districts that are looking for new tenants. Lausanne is positioned some- where between the two extremes.

No end to the challenges

The retail property market has demonstrated an astonishingly high degree of stability in recentyears. Supply and demand have never been far apart. However, there are now growing signsthat the spate of development that occurred in the period up to 2011 is set to take its toll on themarket. Although a few projects are still awaiting completion, it seems there are virtually no newprojects in the planning phase. This speaks volumes: the uncertainty on the part of investorsand tenants alike as to how the market can cope with the imminent challenges due to thegrowth of online sales is tangible. Bricks and mortar retailing has still to find its new role in adigitized omni-channel world. What's more, this is in a business environment that is now even

more challenging following the Swiss franc's appreciation.

A niche with growth potential

Affordable housing for students is a scarce resource at many university locations. First, low in-comes mean many students have minimal willingness to pay; this severely restricts the choice ofpotential accommodation. Second, reurbanization and immigration have made housing increas-ingly scarce in the urban centers, where educational institutions are located, and driven rentssharply higher. Supply is particularly scarce in the major university cities. Consequently, there ismajor demand for additional housing for students. At the same time, in an environment of con-tinuously falling yields the question of alternative investment opportunities is becoming an in-creasingly pressing one for real estate investors. Niche markets such as student housing areone of these alternatives and are also perfectly suited to diversification.

No way real estate investments can be avoided at the momentSwiss real estate investments benefited from extraordinary circumstances on the capital mar-kets last year. This trend is likely to continue in the current year, though presumably not with thesame dazzling results. We anticipate that short and long-term interest rates will remain at lowlevels this year. The gap between dividend yields on real estate investments and safer bondyields is therefore set to remain huge, meaning there is virtually no way real estate investmentscan be avoided. We also show that funds are less heavily exposed to the growing absorptionrisk. It will not be possible to prevent initial yields on direct Swiss real estate investments fromfalling again, however, since the development of prices and rents on residential and mixed-useinvestment properties is continuing to diverge.

Regional real estate markets at a glance We explore the influence of regional factors and characteristics on the structure and develop-ment of real estate markets in even greater detail in the form of informative electronic factsheets for all 110 of Switzerland's economic regions. These regional fact sheets serve as anonline reference tool, enabling private and professional real estate investors to compare regionalsub-markets and discover the key features of the local real estate markets.

The five largest office prop-

erty markets in detail

Page 43

Retail property

Page 55

Special focus:

Student housing

Page 63

Real estate as an

investment

Page 67

Regional analysis

Page 78


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FX Shock: Impact on Swiss Real Estate Market

The Swiss National Bank's abandonment of the euro exchange rate floor caught many marketparticipants totally unprepared. Although this thunderbolt has not fundamentally altered theSwiss economy's starting position, the scale and urgency of the new challenge should not beunderestimated. Following an initial stock-taking, we have halved our growth forecast for grossdomestic product this year to 0.8% and expect a sharp fall in employment growth. The mainvictims of the SNB's decision are the export sectors. They include not only the export-dependent industrial segments but also key elements of the Swiss financial center as well astourism and retailing. As the real estate and construction sectors with few exceptions have adistinctly domestic bias, the direct consequences are more or less negligible. Since the Swissfranc shock nevertheless has a negative effect on the domestic economy, Swiss real estatemarkets will very probably feel the consequences of the decision via second-round effects.

The abandonment of the euro exchange rate floor is an economic shock that will cause a slump

in demand for Swiss products. However, it also means a need for structural adjustment has builtup – literally overnight. The pressure for adjustment will require a rapid response that – after aslight time lag – will ultimately spread to the furthest reaches of the economy through varioustransmission channels. Companies will have to rethink their strategic business areas and beforced to adapt to the new situation. This will lead to the relocation of production processes,abandonment of entire business areas and concentration on new, high-value areas of activity.However, all cost factors will be scrutinized. These include the cost of premises, with the resultthat many of the companies affected are looking for ways to increase floor space efficiency andnegotiate more favorable rents per square meter. Real estate players therefore have to expectreductions in demand.

Although the fundamentals were negatively affected by the Swiss franc shock, interest in real

estate investments is likely to increase further still. There are four reasons for this: first, yieldspreads between real estate investments and alternative investments are at a record level fol-lowing the renewed reduction in interest rates by the National Bank. Second, the fear of nega-tive interest rates and shortage of alternatives are driving investors into real estate. Third, thereare no signs of a rapid change in the situation. There is no threat of a sharp rise in interest ratesor excessive slump in demand. Fourth, a greater home bias can be expected given that domes-tic investors are once again attaching greater weight to exchange-rate risk. Following a brief dipon the day of SNB's decision, price gains on listed Swiss real estate investments confirm theheightened interest among investors.

The yield gap in favor of real estate is likely to cause prices of the latter to go on rising, regard-less of the trend to excess supply and declining yields. Both rising prices and growing vacanciesare putting yields under pressure. Falling yields therefore continue to characterize the real estatemarket, where prices and fundamentals are becoming increasingly decoupled.

Impact on individual segments of the real estate market

The expected softening of economic activity comes at an inopportune moment for the officeproperty market. Floor space expansion continues to put a strain on the market and is causing arise in vacancies. The existing oversupply is now likely to accentuate even further. Having al-ready been slack to date, demand this year is likely to suffer from companies' response to theexchange-rate shock. In a single stroke, production costs in Switzerland also became substan-tially more expensive for foreign companies. The recent exceptionally low success rate in at-tracting foreign businesses (see page 37) is unlikely to recover quickly following the SNB's de-cision. On the contrary, consultants and locational development chiefs state that interest inSwitzerland among foreign firms is dwindling; hence the further fall in the number of new busi-nesses attracted in recent months. Growing uncertainty about the political framework in light ofthe many anti-business proposals is now accompanied by a jump in costs. We expect additionaldemand of less than 200'000 m² for 2015, which is only around one-eighth of the record de-

Need for structural adjust-

ment and cost pressureswill reduce demand for

floor space

Negative interest rates in-

creasing the attractivenessof real estate yields …

… and driving investors into

real estate

Commercial property

market worst affected


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mand seen in 2007. More efficient use of floor space is one option for firms wanting to cutcosts and maintain margins. This creates opportunities for new or refurbished properties, pro-vided they can offer companies efficient use of space. In overall terms, however, the markettrend means an acceleration in vacancies and even more pressure on rents. In the major centersof Zurich and Geneva in particular, we expect an unbroken rise in vacancies. That said, the situ-

ation may vary considerably at local level. Prime sites such as railway locations in the major cen-ters should continue to do very well, including in the case of new properties. Smaller office mar-kets are also likely to be less significantly affected by the supply overhang.

The abandonment of the euro exchange rate floor has a serious effect on the retail propertymarket, especially in border areas. The business environment in retailing – not that it had im-proved in any case – will continue to become more depressed as a result of the currency appre-ciation shock. Shopping tourism will get another boost and consumer enthusiasm will remainsubdued, while retail prices fall more sharply again. We consequently expect a noticeable, nom-inal decrease in sales in 2015. Investors and tenants had already been unsettled by online com-petition prior to the Swiss franc shock. Thus any boost to the demand for space is only likely tocome from population growth and foreign retail chains, whose interest in Switzerland as a busi-

ness location has increased due to the sharp jump in the Swiss franc's purchasing power. Arapid rise in surplus capacity is unlikely in future, however, given that expected construction out-put has also slumped. Vacancies will nevertheless continue to rise, while the supply of property will remain at a high level at least.

The super-cycle in the domestic economy is beginning to lose steam. This development is beingaccelerated by the abandonment of the euro exchange rate floor. Unlike the owner-occupiedmarket, which is being curbed by regulatory intervention, the rental apartments market is onlyseeing a minimal loss of momentum whether on the demand or the supply side. For 2015,however, we expect slightly weaker immigration from abroad of around 70'000 persons as wellas more cautious demand given that tenants are among the main victims of the expected job-shedding. The regulatory induced reduction in demand for owner-occupied housing will never-theless continue to have a supportive effect. Significantly lower employment growth and a con-

sequent decrease in the flow of immigrants will have a greater impact on demand in the mediumterm. On the supply side, production of rental apartments meanwhile continues unabated or isactually being stimulated further by the increasingly pressing dearth of investment opportunities.We therefore expect another marked increase in vacancies of around 4000 apartments in2015. As a result, the rental apartments market is gradually moving toward a situation of excesssupply and is likely to evolve into a tenant's market. It will be a slow process, however. This willtemporarily result in a slight easing in the urban centers, which are characterized by a shortageof housing. Long-term, the decline in demand is likely to be observed above all outside the major cities.

The more subdued economy, which is likely to become more noticeable to households duringthe summer months, will ensure a continuation of the weakening trend for owner-occupied

housing and keep the market on track for the hoped-for soft landing. Meanwhile, segment-specific differences are likely to become more accentuated. The high-price segment is exposedto persistently weak demand, which will become more acute due to the exchange-rate shock.Switzerland's price/performance ratio is simply no longer acceptable to foreign buyers, and this will also hit sales of second homes. The number of vacant owner-occupied properties is there-fore likely to increase again this year. We do not expect higher vacancies medium-term, howev-er, as output of owner-occupied housing has already been declining for years and is thereforeadjusting to waning demand. This year, for instance, construction of owner-occupied properties will reach its lowest level since 2001. This is likely to have a stabilizing influence on the marketshould the second-round effects of the exchange rate shock weaken demand somewhat morestrongly in 2016.

Retail property: sites near

border at risk

Rental apartments market:

return of the cycle

Owner-occupied housing:

High-price segment worst

affected


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Owner-Occupied Housing

Without regulatory measures and the dampening effect of repeated warnings of a price bubble,the residential property market would overheat due to the extremely low interest rates. Meta-phorically speaking, the market therefore has one leg on the glowing hotplate and the other inthe freezer. All in all this therefore results in a pleasant feeling. But will this "cohabitation" be-tween hot and cold continue to keep the market on course? In order to answer this question it ishelpful to know where the market is currently standing and how it can be expected to develop inthe next few quarters.

Demand: Marked Effects of (Self-) Regulation

Mortgage interest rates and consequently the financing of residential property were more favor-able than at any time within living memory at the start of 2015. Mortgage interest rates are at

their lowest technically feasible level well into the medium-term duration segment; in other words, the mortgage holder is only paying the margins of the lending institutions that the latterrequire to cover the handling and risk costs. Interest rates should remain at an extremely lowlevel on a historical comparison over the rest of the year. In principle this represents ideal breed-ing ground for strong demand for owner-occupied housing. However, demand can only benefitfrom the low mortgage interest rates to a limited extent: On the one hand the constant rise inproperty prices means that the number of households that can afford residential property is de-creasing. At the same time, the regulatory measures introduced so far, the impact of which we will address below, have additionally increased the obstacles. Although the desire for owner-occupied housing remains high due to very low mortgage interest rates, it is something thatfewer and fewer households are able to realize.

A comparison between the maximum price that according to conservative affordability guidelines

an average household is able to afford and the market price of a newly constructed condomini-um illustrates vividly how the price level achieved and the regulatory measures are curbing de-mand (see Figure 1). A property of this kind cost CHF 450'000 back in 2000. An averagehousehold would even have been able to afford a property for CHF 664'000 back then, i.e. it was not merely able to buy property but could even afford some extra space or a property in abetter location. The maximum affordable purchase price at the end of 2014 was CHF 734'000.The small increase in purchasing power is partly attributable to the fact that the higher paybackrequirements serve to neutralize some of the growth in income. Over the same period the pricefor an average property rose to almost CHF 800'000, which is no longer affordable for an aver-age household. Figure 1 illustrates this disproportionate development of market prices and thepurchasing power of the broad population.

Figure 1

Gulf between price and maximum affordability

Comparison in CHF for average household and medium-sized condominium

Source: Credit Suisse, Wüest & Partner

Figure 2

Imputed affordability (average household)

Imputed costs for residential property as % of income

Source: Credit Suisse

0

100'000

200'000

300'000

400'000

500'000

600'000

700'000

800'000

2000 2002 2004 2006 2008 2010 2012 2014

Market price of condominiums

Maximum affordable price of condominiums0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2001 2003 2005 2007 2009 2011 2013

Maintenance 1% of property value5% mortgage interest for 80% loan capitalRepayment costs from 80% to 66%

Golden rule of financing

Low mortgage interest

rates only exerting a limited

effect due to regulation

What is an average house-

hold still able to afford?


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If affordability is calculated at an imputed interest rate of 5%, an average household no longerfulfilled the imputed affordability criteria1 for the purchase of a new standard condominium at theend of 2014. 36% of household income would have to be spent on interest and repayments as well as maintenance, which is above the generally recognized affordability threshold of 33.3%(see Figure 2). Affordability is not only becoming a growing financing hurdle in the high-price

regions surrounding Lake Geneva, Zurich and Zug, but is now also affecting comparatively in-expensive regions such as St. Gallen/Rorschach and La Gruyère. The recent significant in-crease in prices in these regions alongside comparatively moderate simultaneous growth in in-come has pushed up the imputed living costs to 35% and 37% respectively (see Figure 5).

Alongside the continuous price increases, the regulatory measures gradually introduced by thesupervisory authorities in the past few years and the self-regulation of Swiss banks were themain reason for the growing difficulties of households in meeting the affordability requirements.The maximum repayment period for mortgage loans (up to 66.6% of the lending value) was re-duced to 20 years in July 2012 and a further reduction to 15 years followed in September2014. The shorter repayment periods resulted in an abrupt rise in annual repayments (see Fig-ure 2). Because the latter are included in affordability calculations, the imputed living costs of

the average household are increased. Without the two regulatory measures the living costs would today lie at 33.8% instead of 36.0%.

Even stronger than via the affordability channel regulatory measures unfolded their effect byaffecting capital requirements. Owing to the hefty property prices the capital requirements todaypose the greatest obstacle on the path to home ownership for broad sections of the population. According to our Housing Affordability Index (HAI), at the end of 2014 an average Swisshousehold had to spend 6.1 times its annual income on a new medium-sized condominium (seeFigure 3). The cost of a single-family dwelling amounts to 7.7 annual incomes. In the UK, where real estate is not exactly cheap, only 5.0 annual incomes are required for the purchase ofresidential property. Thanks to the option of an advance withdrawal of retirement assets, thegrowing capital requirements for a long time did not pose any major obstacle. However, thetightened equity requirements introduced in the summer of 2012 according to which a home

buyer has to contribute 10% of the lending value in the form of common equity that is not takenfrom pension fund assets were then deliberately radical. Because many households are eithernot able or not prepared to accumulate savings outside mandatory occupational retirement ben-efits, this clear provision has increased the entry obstacles. According to our estimates, the reg-ulatory measures introduced so far have curbed the growth of mortgage volumes over the pastfew quarters by 1.0 to 1.5 percentage points.

To determine how drastic these equity requirements are, we have carried out a detailed analysisof wealth data from the cantons of Aargau and Zurich. According to the most recently availablefigures from 2011, only 38.9% of taxpayers in the canton of Zurich are able to supply the 10%of common equity required for the purchase of an average newly built condominium in the can-ton from their own assets (see Figure 4). At 42.0%, somewhat more taxpayers fulfil this criteri-

on in the canton of Aargau, where a new condominium costs almost a third less. Assets in thecanton of Aargau are generally lower so that as a rule fewer households and taxpayers are ableto supply the capital for an equally expensive home. However, because house prices in the can-ton of Aargau are significantly lower, altogether more households are able to overcome the eq-uity obstacle.

The assessment of wealth distribution also shows what effect could be expected from a furtherincrease of the obstacle concerning common equity. A tightening of this requirement from 10%to 15% or 20% would reduce the share of taxpayers in the canton of Zurich with sufficientcapital for a newly built condominium from 34.2% to 29.8%. In the canton of Aargau, 37.2% or33.6% of taxpayers would remain as potential buyers of residential property.2 In some cases therequisite funds can also be procured via family or friends. However, this has a negative effect on

1 Loan to value ratio: 80%; imputed mortgage interest rate: 5%; maintenance: 1%; reduction of debt from 80% to 66.6% of lending value within 15 years.

2 Because funds from the third pillar are not included in the wealth data but can be allocated to common equity, the actual shares will in fact be somewhat higher. On theother hand, the continued rise in prices for residential property of 10.5% since 2011 that the wealth data is based on has reduced these shares again.

Imputed affordability no

longer guaranteed for

average households

Significant effects of

self-regulation

Capital requirements the

greatest obstacle

Distribution of wealth

increasingly determining

the potential demand

What would be the effect

on demand of a further

tightening of

equity provisions?


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affordability unless the money is lent without interest. Our results show that for each tighteningof the common equity requirements by five percentage points a fall in demand of over 10%compared with the existing potential demand can be expected.

Figure 3Housing affordability index: condominiums

Required annual income for the purchase of average residential property

(shown as minimum required equity and loan capital)


Figure 4Taxpayers with sufficient assets

X axis: share of taxpayers with sufficient assets; Y axis: required equity; data

from 2011

Source: Cantonal statistical offices, Credit Suisse

Regionally there are very different ratios in terms of the households still capable of fulfilling thedream of home ownership within the scope of their financial resources. The Housing Affordabil-ity Index drawn up for the first time on a regional basis clearly illustrates these differences re-garding the capital requirement obstacle (see Figure 6). To purchase a condominium costs 9.0annual incomes and more along virtually the entire shore of Lake Geneva. The front runners areGeneva at 14.6 and Lausanne at 11.1. The situation around Lake Zurich is similar, although notquite so extreme. The front runner here is the city of Zurich with 11.1 required annual incomes,followed by the Pfannenstiel region with 9.7. The situation in many parts of the Swiss Plateau isvery different: For instance, 5.1 annual incomes are sufficient in both the Thurtal region and Aarau.

A very similar regional picture emerges for imputed affordability that has long since ceased onlyto be difficult to uphold in the high-price regions (see Figure 5). For this reason a shift in de-mand can currently be observed to regions with lower land and property prices. Those who nev-ertheless do not wish to give up the dream of their own four walls at central localities are todaybeing obliged to switch to smaller-sized properties and if necessary also to make concessions interms of features.

The additional self-regulation measures for banks introduced in September 2014 (tightenedrepayment guidelines, lowest value principle) that ultimately serve to increase both the afforda-bility and the equity obstacle had only partially taken effect in the second half of 2014. Wetherefore expect the demand for owner-occupied housing to continue to fall in the current yeardespite negative interest. Because many potential buyers already own residential property, thepositive momentum arising from the extraordinarily low mortgage interest rates will not only beneutralized but overcompensated by the reduction in potential demand due to regulatory rea-sons.

0

1

2

3

4

5

6

7

2001 2003 2005 2007 2009 2011 2013

Common equity

Other equity

Loan capital

ZH 20%

ZH 15%

ZH 10%

AG 20%

AG 15%

AG 10%

0

25'000

50'000

75'000

100'000

125'000

150'000

175'000

200'000

20% 25% 30% 35% 40% 45%

Canton Zurich

Canton Aargau

Share of requiredcommon equity

Major regional differences

in terms of capital require-

ments and affordability

Demand switching to less

expensive regions or small-

er properties

Further downturn of

growth in demand in 2015

due to regulatory reasons


11/84



Figure 5

Imputed affordability (average household)

5% interest, 1% maintenance, 80% loan to value ratio, repayment on 67% in

15 years

Source: Credit Suisse, Geostat

Figure 6

Capital requirements (housing affordability index)

Required annual incomes for the purchase of average residential property.


Supply: Falling Number of Planned Owner-Occupied Properties

Housing production is so far barely showing any signs of fatigue and remains at a high level. Weexpect the completion of 47'000 residential units in 2015 (see Figure 7) which is only marginal-ly below the level of the past two years. Structurally, however, the mix of housing has beenchanging for years in favor of rental apartments. The construction of single-family dwellings hasbeen declining for over ten years. For the first time less than 10'000 new single-family dwell-ings were approved in 2013. By contrast, the number of approved condominiums remained at alevel of over 20'000 units until mid-2011. However, constructions in this segment have sincethen also entered a downward trend that was only temporarily halted by a wave of second homeapprovals following the acceptance of the second home initiative. We expect around 15'000condominiums and 8000 single-family dwellings to be built in the current year – a decline of12% on the previous year. Altogether the construction of residential property has decreased bya quarter since 2011. Residential property construction is at its lowest level since 2001.

It is expected that this development will continue in 2016. There are currently no signs of atrend reversal in terms of either building permits or planning applications. The decline in produc-tion can at best be expected to slow down for condominiums. In view of the situation outlinedabove with an ongoing downturn in demand for owner-occupied housing, the anticipated fall insupply is to be welcomed. This should reduce the risk of a growing oversupply.

The interesting question now is where less residential property is being planned. Is constructionactivity also shifting in line with demand from the high-price regions to the surrounding areas where purchasing one's own four walls is more affordable? In order to analyze this, we base ourassessment of building permits on regional aggregates that reflect the differing price momentum(see Figure 8). It can be seen that approvals in the high-price regions on Lakes Geneva, Zurichand Zug already dropped significantly at the start of 2012 and since then have more or lessmanaged to maintain the current annual level of 4300 approved units. This corresponds to adecline of 25% since mid-2011 when the local maximum of the past six years was recorded.The decline in the urban centers outside the high-price regions and in the growth regions closeto the urban centers is less marked (–22% since mid-2011). However, the downward trendthere has not yet come to a halt. Although the price level in these regions is not as high as in

the high-price regions, the continuous price rises are also posing a burden there for more andmore households. Meanwhile, the Alpine regions have sustained the sharpest fall with a virtualhalving of owner-occupied projects (–46% since mid-2011) because following acceptance ofthe second home initiative condominiums not used as a first home may only be built to a verylimited extent.

51 – 88%41 – 50%

34 – 40%

31 – 33%

26 – 30%

21 – 25%

15 – 20%

10 – 158 – 10

7 – 8

6 – 7

5 – 6

4 – 5

2 – 4

Continued shift of

construction activity

from residential property

to rental apartments

Production of new residen-

tial property will also fall in

2016

Noticeable decline in

owner-occupied projects

in high-price regions …


12/84



Figure 7

Net addition by SegmentIn residential units, 2014/2015: Credit Suisse estimate/forecast

Source: Credit Suisse, Baublatt, Swiss Federal Statistical Office

Figure 8

Owner-occupied housing building permitsGeographical aggregates, number of residential units, total over 12 months

The residential units approved in 2012 can no longer be constructed due toobjections upheld by the Federal Supreme Court.

Source: Baublatt, Credit Suisse

The least loss of momentum was recorded for the construction of residential property in otherparts of the Swiss Plateau and the Jura (see Figure 8). With 9800 approved condominiums andsingle-family dwellings in the last 12 months, permits are 17% down compared with mid-2011.The less marked decline will be attributable primarily to movements on the demand side fromthe high-price regions to regions still offering affordable housing. No change to this geograph-ical shift is to be expected in the immediate future.

Figure 9

Planned expansion of residential property As % of stock of residential property (condominiums and single-family dwellings)

Source: Credit Suisse, Baublatt, Geostat

0

10'000

20'000

30'000

40'000

50'000

60'000

2001 2003 2005 2007 2009 2011 2013 2015

Single-fami ly dwell ings Condominiums Rental apartments

0

2'000

4'000

6'000

8'000

10'000

12'000

14'000

2002 2004 2006 2008 2010 2012 2014

High-price regions (hotspots)Urban centers outside the hotspots and growth regions close to the urban centers

Other parts of Swiss Plateau and Jura Alpine regions

> 2.5%

2.0 – 2.5%

1.5 – 2.0%

1.0 – 1.5%

0.75 – 1.0%

0.5 – 0.75%

< 0.5%

Versus five-year average

Sharp increase

Moderate increase

Sideways movement

Slight decrease

Sharp decrease

… but less loss of momen-

tum in other parts of the

Swiss Plateau and the Jura


13/84



Major regional differences can arise within the geographical aggregates. Our overview mapshows how much the stock of residential property in the individual regions is expected to expandin 2015 (see Figure 9). It confirms the impression that the focus of construction activity is in-creasingly coming to lie outside the high-price regions. The highest growth in 2015 can be ex-pected in the regions of La Gruyère, Glâne/Veveyse, Erlach/Seeland, Sursee/Seetal and the

Limmattal and Knonaueramt. However, what is astonishing is that the momentum east of Zurichis only well above the national average in the Thurgau regions of Thurtal and Untersee/Rhein.

Not only is less residential property being built but the projects are generally also smaller (seeFigure 10). Projects with 25 homes or fewer now account for 68% of all approved condomini-ums. This primarily comes at the expense of projects with 26 to 50 homes. However, projects with over 100 homes are also rare and can today be counted on the fingers of one hand. Thedecrease in project size will at least partially be attributable to the fact that a greater share ofresidential property is being constructed outside the densely populated high-price regions wherethe volume of demand is limited. However, the decrease in project size also shows that suppli-ers have become more cautious and are avoiding cluster risks. In times of falling demand,smaller properties are more likely to achieve sufficiently high advance sales figures and hence

greater chances of realization.

Real estate investors also appear to be deciding increasingly later whether to construct rentalapartments or condominiums. The number of multi-family dwelling projects without specificationof use has therefore risen sharply. It is now the case for 34% of all planned homes in multi-family dwelling projects that no information is at hand as to whether rental apartments or con-dominiums are under construction (see Figure 11). There are two reasons for the lack of usagespecification – diversification and scope for manoeuver. On the one hand major projects are in-creasingly serving both demand segments, which is among other things also down to thechanged structure of immigration and increased demand for rental apartments. Any changes tothe market situation in one segment can be absorbed better with this kind of diversification. Onthe other hand, usage is deliberately kept open for as long as possible in order to retain scopefor manoeuver. If the homes cannot be sold to private owners due to the ongoing fall in de-

mand, many investors will be tempted to let them out. However, this entails the risk that poten-tial future sales problems for residential property spread to the rental accommodation market, tosay nothing of the fact that a conversion of condominiums to rental apartments is not all thateasy – especially since the two market segments are increasingly drifting apart. At least the re-turns will be brought under pressure by such a change of housing type.

Figure 10

Residential property projects by project sizeShare of MFD building permits by project size (owner-occupied only)


Figure 11

Planned use of MFD projectsPercentage of building permits


0%

10%

20%

30%

40%

50%

60%

70%

80%90%

100%

2002 2004 2006 2008 2010 2012 2014

1 – 10 11 – 25 26 – 50 51 – 100 101 – 200 > 200

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Condominiums Rental apartments MFD, usage unknown

Major regional differences

Fewer major projects

Increasingly cautious

behavior of real estate

investors


14/84



Market Outcome: Continued Slowdown – No All-Clear

Until now it has been possible to keep the Swiss residential property market on course despiteexcessive growth momentum from time to time. There remains a good chance that the currentproperty cycle will end with a "soft landing", which is more the exception than the rule. The

regulatory measures introduced to date have significantly weakened demand despite abnormallylow mortgage interest rates. Thanks to the likewise reduced expansion of supply, a major mar-ket imbalance has so far been prevented. However, the challenges remain in place. It is to behoped that any further potential regulatory measures are implemented in a well thought out andsensitive manner.

Owing to the long period between the planning and completion of construction projects, supplyis responding with delay to the lower demand. There was therefore an increase in residentialproperty vacancies of 1565 residential units in the past year. As of 1 June 2014, 5215 condo-miniums and 4692 single-family dwellings were vacant. This is equivalent to a vacancy rate of0.91% for condominiums and 0.34% for single-family dwellings. These levels are not yet worry-ing but merely confirm the more challenging market environment for investors.

An analysis of vacancies according to the various geographical aggregates confirms that theproperty market is no longer running smoothly above all in the high-price regions (see Figure12). Since 2010 vacancies in the hotspots on Lakes Geneva, Zurich and Zug have almost dou-bled to 0.4%. This is roughly equivalent to the level in the urban centers outside the high-priceregions and in the growth regions close to the urban centers. The considerably less expensivesupply of owner-occupied housing in these regions has largely found buyers so that vacancieshere have only risen marginally in recent years. The upturn in the remaining parts of the SwissPlateau and Jura was also limited although the vacancy rate here is somewhat higher at 0.53%.The significant upturn in the Alpine regions is to a considerable extent due to statistical effectsas vacancies in many tourist regions were reported too low in the past. Figure 13 illustrates thecurrent vacancy rates of residential property in the individual regions. The map shows that par-ticularly in the regions of Morges and Chablais and in the canton of Appenzell Ausserrhoden too

many properties have been constructed recently that are proving difficult to sell.

Figure 12

Vacancies of residential property

As % of stock of residential property (single-family dwellings and condos)

Source: Credit Suisse, Swiss Federal Statistical Office

Figure 13

Regional vacancies of residential property in 2014

As % of stock of residential property (single-family dwellings and condos)

Source: Credit Suisse, Swiss Federal Statistical Office, Geostat

The fall in demand for owner-occupied housing is also reflected in the development of transac-tions (see Figure 14). These reached their peaks in the spring of 2011. Compared with these

peaks there has been a decrease in the number of transactions of 11.8% in the case of con-dominiums and 16.8% in the case of single-family dwellings. Altogether this represents a mod-erate downturn in changes of ownership that points towards continued attractive frameworkconditions for owner-occupied housing. However, the conditions are now no longer equally at-tractive for all market players. The renewed appreciation of the Swiss franc following the with-

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

2001 2003 2005 2007 2009 2011 2013

High-price regions (hotspots)Urban centers outside the hotspots and growth regions close to urban centersOther parts of Swiss Plateau and Jura Alpine regions

2014 property vacancies

1.21 – 1.53%

1.01 – 1.2%

0.81 – 1%

0.61 – 0.8%

0.41 – 0.6%

0.21 – 0.4%

0 – 0.2%

Change on 2013 – 2014Sharp increaseModerate increaseSideways movementSlight decreaseSharp decrease

The "soft landing" path is

narrow

Vacancies of residential

property increasing

Vacancies in the hotspots

almost doubled since 2010

Number of transactions

decreasing


15/84



drawal of the minimum exchange rate has made residential property for foreigners calculating inforeign currencies much more expensive. Prices already rose by a quarter due to exchange rateeffects back in 2010/2011. In the canton of Zurich the number of property purchases by for-eigners has been falling since 2011. Alongside the appreciation of the franc, these falling salesfigures can also be explained by the changed structure of immigration. Immigrants from South-

ern Europe have less income and capital and can be proven to purchase less expensive proper-ties. They will therefore be much more greatly affected by the tightened financing guidelines.

Newly built homes account for an extraordinarily large share of overall transactions in Switzer-land. In 2014, 21% of all changes of ownership were attributable to newly built homes (seeFigure 15). If in order also to take into account newly built homes that cannot be sold immedi-ately we also count one-year-old properties, the share of newly built homes rises to almost29%. This high share results from the growing significance of condominiums in Switzerland as well as the typically long period of residence of owners in their own four walls which significantlyreduces the market liquidity of older properties compared with other countries. However, oldproperties that we define as properties in excess of 30 years old are gaining popularity in partic-ular in the single-family dwellings segment. They are exerting a growing influence on the selling

market for owner-occupied properties.

Figure 14

Transactions by segment

Index: 2009 = 100; Credit Suisse estimate

Source: SRED, Credit Suisse

Figure 15

Transactions by age of property

Percentage of all transactions

Source: SRED, Credit Suisse

The prevailing fall in demand is not only making itself felt in increased vacancies but also in areduction of price momentum. The upsurge in prices has been receding for a good three years.In the medium-range segment the prices of condominiums rose by 2.5% in the fourth quarter of2014 compared with the prior-year quarter, while those of single-family dwellings went up by

3.2% (see Figure 16). A price fall was only observed in isolated regions in 2014. We expect acontinued downturn in price momentum although at a lower speed. The lower production of res-idential property and above all the extremely low mortgage interest rates suggest that the rise inresidential property prices in the current year is likely to remain close to the 2% threshold oreven above it.

The upsurge in prices has by far decreased the most in the high-price regions. At present thereis only weak year-on-year growth of 0.3% (see Figure 17). The first price falls on an annualbasis are even emerging in the Lake Geneva area. Prices are falling most sharply in the cantonof Geneva at –2.8% on an annual basis. A certain degree of correction to the excessively highproperty prices in Geneva has therefore started to set in. The times of marked price growth arealso over in the city of Zurich and along the Gold Coast. Although self-regulation is presumed to

have made the greatest contribution to this development, further reasons will also be responsi-ble: The structural change in the financial sector, a lower number of prosperous expats due tofewer settlements and generally lower foreign demand have particularly affected the high-pricesegment. As no rapid change in these factors is to be expected and an economic slowdown willnow also be added following the withdrawal of the minimum exchange rate, price momentum in

50

60

70

80

90

100

110

120

2009 2010 2011 2012 2013 2014

Condominiums Single-family dwellings

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2002 2004 2006 2008 2010 2012 2014

Newly built 1 2 – 5 6 – 10 11 – 20 21 – 30

31 – 40 41 – 50 51 – 75 76 – 100 > 100

Newly built homes account

for two fifths of transac-

tions but old properties

gaining popularity

Downturn in price momen-

tum losing strength

Price falls to be expected in

high-price regions in 2015


16/84



the high-price regions looks set to decrease further. We expect a fall in prices on an annual ba-sis for the first time in a long time in 2015.

Figure 16

Price growth in the residential property segment Annual growth rates in %

Source: Wüest & Partner, Credit Suisse

Figure 17

Growth of residential property prices – regionalGeographical aggregates (condominiums and single-family dwellings); annual

growth rates in %

Source: Wüest & Partner, Credit Suisse

The situation in the Alpine regions is difficult to interpret at present. A large number of secondhomes have been built due to the second home initiative. However, their sale is stalling consid-erably due to the uncertainty among buyers owing to the unclear legal situation. Statisticallythere are therefore only few observations available and price performance should accordingly betreated with caution. However, the upsurge in prices in the Alpine regions has until recently fall-en to a credibly similar degree to that in the high-price regions of the Swiss Plateau. By con-trast, price growth in the urban centers outside the high-price regions and in the growth regionsclose to the urban centers has evened out at a level of around 4% and is only displaying a verysmall further downward trend. This will be attributable to the geographical shifts in demand. Asexplained above, many households are now only able to afford owner-occupied housing in lessexpensive regions owing to the tightened financing guidelines.

Second homes – continued legal uncertainty

The second-homes act, or "Lex Weber", which market players hope will create legal cer-tainty, has yet to materialize. It has now been debated in the Council of States and is in-cluded in the agenda for the spring session of the National Council in March 2015. Buteven if the National Council were to go along with the toned-down draft legislation of the

Council of States, it is questionable whether implementation would be swift. The initiatorsof the second-homes initiative are threatening a referendum. This could give the Swisselectorate the final say, which would extend the legal uncertainty. The Building and Plan-ning Committee of the National Council therefore intends to declare the legislation urgent.That would mean it entering into force with immediate effect. Any referendum would followlater, and might result in the law being overturned again.

The ongoing legal uncertainty is toxic for a functioning market in the regions affected.Potential buyers are shying away from a purchase, and in many places it is difficult to sellproperty at present. This is compounded by the large number of new second homes insome tourist regions; these were planned and constructed at the last minute after the"yes" vote in the second-homes initiative. Following the lead verdict issued by the SwissFederal Court, stipulating that the rules on restricting second homes must apply from the

date of the referendum, the status of these properties has not been resolved. Will they betreated as equal to homes built under the old legislation, or should specific restrictionsapply to their use? The decision will have a key impact on price levels for these homes. No wonder, then, that sales are slow. In addition, the entire situation is exacerbated by the

0%

2%

4%

6%

8%

10%

1.Q 2011 1.Q 2012 1.Q 2013 1.Q 2014

Condominiums

Single-family dwellings

Average condominiums 2000–2014

Average single-family dwellings 2000–2014

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

2001 2003 2005 2007 2009 2011 2013

High-price regions (hotspots)Urban centers outside the hotspots and growth regions close to urban centersOther parts of Swiss Plateau and Jura

Alpine regions

Continued high price

growth outside the high-

price regions


17/84



overall economic situation – particularly in the euro zone. Poor economic prospects in theirhome countries, plus the strong Swiss franc, are currently deterring many foreign residentsfrom buying a second home in Switzerland. As a result, excess supply will continue to risein the short term.

Unfortunately the uncertainties will not be cleared up even after the law is passed. Thedraft legislation contains a number of passages interpretation of which will presumablyrequire final clarification by the Federal Court. Once the law is passed, a noticeable im-provement in the market situation is likely to begin for properties not subject to restrictionson their use (those covered by the old legislation) at least. However, the possible scaleand type of additional second homes that may be built in future as well as future prospectsfor the construction sector in the regions affected will be heavily dependent on the defini-tive form in which the second-homes act takes effect.

The decreasing price momentum has reduced the risk of a price bubble by preventing the realestate market from slipping into a development shaped by speculative purchases. However, this

does not mean that the question of the sustainability of the current price level has been re-solved. On the contrary, the residential property prices in various regions continued to rise moresharply than incomes over the last year. The imbalances have therefore increased in number butare no longer quite as extreme in some regions. We now consider the price performance in 55out of 106 regions no longer to be sustainable (see Figure 18). Price corrections must be ex-pected in these regions in the event of a normalization of the interest rate situation. However,the overvaluation in some regions is only very moderate and their price levels differ greatly fromthose in the high-price regions. This applies to most of the regions that are newly included inthis count. As before, we are talking only in the case of Geneva about a veritable price bubble.However, the imbalances were slightly reduced in 2014 in both Geneva and the other high-priceregions around Lakes Geneva and Zurich. Nevertheless, there is still a long way to go beforeregional property prices correspond better with local incomes again.

Figure 18

Regional valuation of residential property prices

Price performance of condos/single-family dwellings in relation to income


Figure 19

Criteria of a property price bubble


With a view to our checklist for the existence of a property price bubble, the situation is similarto that of the previous year (see Figure 19). As before, some criteria for the existence of aproperty bubble are not fulfilled. There can be no talk of either excessive construction activity or

generally poor credit checks by the mortgage loan institutions. Furthermore, because the growthof mortgage lending to private households has shrunk markedly to 3.3%, there can no longerbe any talk of excessive lending. On the other hand, we are placing more of a focus on specula-tive real estate transactions. Although the falling overall number of transactions (see Figure 14) is having a calming effect and does not support the conclusion that a large number of properties

1996 – 2014 ratio

> 1.6

1.5 – 1.6

1.4 – 1.5

1.3 – 1.4

1.2 – 1.3

1.1 – 1.2

1.0 – 1.1

< 1.0

YoY change

Deterioration

No change

Improvement

Agree ~ Insufficiently pronounced X Disagree

Excess liquidity

Excessive appetite for risk

Long period of rising real estate prices

Real estate prices decoupled from income

High level of speculative real estate transactions

High / excessive growth in mortgage volumes given marginpressure on mortgage lenders

Insufficient credit checks for mortgage approval (due to falseincentives)

Excessive construction activity and supply surplus

X

X

X

~

~

More – but less extreme –

imbalances

No property price bubble

despite overvaluation


18/84



are being acquired with the objective of a swift resale with profit, owing to the risk of an in-crease in "buy to let" transactions we are adjusting our assessment from "Does not apply" to"Not sufficiently pronounced".

The record low interest rates can tempt people into buying residential property for investment

reasons in the form of so-called "buy to let" transactions. Private buyers then purchase residen-tial property not for their own use but to let out. There are no nationwide figures available forthis phenomenon. Almost every fifth loan granted by the two big banks is for a "buy to let"transaction. In view of the extremely low borrowing costs, these kinds of transaction appear tobe very attractive investments – at least from a short-term perspective. However, viewed over alonger term it is not clear whether the profit currently achievable from letting will suffice to offsetfuture value adjustments due to a normalization on the interest rate front.

Letting is set to become more challenging in the next few years because oversupplies are tend-ing to accumulate on the rental accommodation market (see chapter on rental apartments). Ontop of this, many of these owners hardly have any experience in property management. In theabsence of specialist knowledge, the costs of maintenance are often underestimated and the

potential renewed rise in borrowing costs in the future are insufficiently anticipated. Markets withhigh shares of "buy to let" are generally considered to be more volatile because such propertiesare more hastily placed on the market in the event of a deterioration of the framework condi-tions and can trigger major price fluctuations. The first banks have therefore tightened the fi-nancing guidelines for such transactions, for instance in the form of higher repayments. Alt-hough these transactions do not pose any direct risk potential at present, there has been noincrease in their number at the big banks in the last two to three years.

There can still be no talk of a speculative property price bubble on the Swiss residential propertymarket. Despite the fall in demand and significantly weaker price growth, the price levels in themajority of regions continue to point towards overvaluation. This poses certain risks that can atbest be alleviated through the creation of capital buffers by all involved. However these do notmake value losses any less likely, they at least enable them to be absorbed better. There is at

any rate no call to sound the all-clear as long as interest rates remain at such low levels.

Residential Property as an Investment

The high price rises of the past few years have made residential property appear an ideal in-vestment. In the current negative interest environment in which private households are seekingopportunities to park their money with at least a minimum rate of return, this perception is gain-ing even more supporters. However, the price indices underlying the price rises reflect the per-formance of new construction projects and therefore blend out part of the investment calcula-tion, namely the depreciation resulting from structural and economic ageing. From an investorperspective it is imperative that this is included. In view of their differing performance, it makessense to consider the building and building land separately in the investment calculation. Thebuilding has its maximum value when new and loses value each year. The loss of value is takeninto account via depreciation. This contrasts with the building land, the value and future appreci-ation potential of which primarily depend on the attractiveness of the location and its further de-velopment as well as economic and property market-specific factors. Whether the home ownerlets out or lives in his property plays only a subordinate role in our consideration. In the formercase the home owner achieves a letting success and the latter is a question of consumption. Atthis stage we only consider the value over time of the property.

For the home owner to make appreciation gains, the increase in value of the building land mustexceed the depreciation on the building. Decisive in this regard is the share of the land in theoverall value of the property, also referred to as the land value share. The higher the land price,the greater the land value share. However, the maximum achievable plot ratio is barely relevant

as a decision-making criterion for the investment decision as it is included in the land price andincreases the value of the property irrespective of the planned building project. Although a sin-gle-family dwelling normally comprises more land per square meter of living space, this is alsogenerally worth less in single-family dwelling zones due to the low potential for construction

Seemingly attractive "buy to

let" transactions

Risk of increasing "buy to

let" transactions

Bottom line: Overvaluation

yes, bubble no

Distinction between build-

ing and building land

Land value share as a

decisive influencing factor


19/84



(lower plot ratio). A single-family dwelling with a large amount of land therefore does not neces-sarily have a higher land value share than a house with several condominiums. The decisive in-fluencing factor is hence the land value share and not the share of land. The greater the landvalue share of a property, the less weight is carried by the depreciation of the building so thatthere is a chance of appreciation gains. However, if a high land value share only arises because

the building land prices are so expensive, a more detailed examination should be carried out toestablish whether the building land still has any appreciation potential at this level. This is thecase if a future inflow of comparatively high-earning and prosperous inhabitants can be ex-pected who are able and willing to pay these building land prices or if there is potential for zoneexpansion.

In practice there is very little data available on land prices and hence also on land value shares.Thanks to estimates by IAZI we are able to illustrate the Swiss average development over time.Between 2000 and 2014 the land prices of single-family dwellings in Switzerland rose by 74%(see Figure 20). This is equivalent to an increase of 4% per year and will have more than offsetthe depreciation of the property in the majority of cases. This has also caused the land valueshare to rise from 36% to 42%. However, major differences emerge at the regional level (see

Figure 21) that reflect the attractiveness of the municipalities as places of residence. For exam-ple, today's land value share averages at a very high 74% in Lausanne and 76% in Meilen.However, the land value share in many parts of Switzerland lies at less than half, such as inSolothurn at 47%. The lowest land value shares can be found in very rural areas and in particu-lar in the canton of Jura where the land value share amounts to less than 20%.

Figure 20

Property prices, land prices and land value sharesIndexed single-family dwelling, land prices: 1978 = 100; land value share as %

Source: IAZI

Figure 21

2014 land value shares in Swiss municipalitiesShare of land value in overall value of single-family dwelling property as %

Source: IAZI

Residential property as an investment therefore primarily pays off in attractive residential loca-tions with high land value shares where the land prices are already high today and are also setto rise further in the future due to the attractiveness of the location. Residential property as aninvestment is much less attractive in many rural areas where the land value share is low and onlymarginal increases if any are to be expected in land prices as the depreciation over time carriestoo much weight. In these regions residential property is primarily a consumer asset and owneroccupancy stands in the foreground.

However, the potential risks must be pointed out with regard to residential property as an in-vestment. Although a high land value share is attractive from an investment perspective, it alsoposes higher risks in the form of a greater potential fall, particularly in view of the fact that the

price changes of residential property with high land value shares largely result from changedland prices. The development of land prices fluctuates even more strongly than that of propertyprices that already display a very cyclical nature (see Figure 20). Although at attractive locationsan increase in value can be expected in the long term, value losses are also possible here in theshort and medium term. For example, according to estimates by the Statistical Office of the

0%

10%

20%

30%

40%

50%

0

100

200

300

400

500

1978 1982 1986 1990 1994 1998 2002 2006 2010 2014

IAZI House Price Index (left-hand scale)

IAZI Land Price Index (left-hand scale)

IAZI Relative Land Value Share (right-hand scale)

Major regional

differences in land value

shares

Investment or consumer

asset

High land value share also

poses risks


20/84



Canton of Zurich, land prices in the city of Zurich fell by 13% between 1992 and 2004 and onlymade good this loss again in 2008. On top of this there is the location-based risk: In the eventof a sustained deterioration of the local framework conditions, e.g. in the form of higher taxes,the construction of a busy road or another form of emissions, a long-term decrease in the valueof the building land can result.


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Outlook for Owner-Occupied Housing in 2015

The residential property market remains on the narrow path toward a "soft landing". The slow-down in the upward pressure on prices has recently abated somewhat in the wake of a furtherfall in mortgage rates – in part, perhaps, because residential property is also seen as an attrac-

tive investment opportunity against a backdrop of negative interest rates. At any rate, the desirefor owner-occupied housing remains strong among large sections of the population. Due totighter regulation, however, this demand can to an increasing extent only be met in areas out-side the high-price regions, where price levels are to some extent still in tune with regionalhousehold incomes. In these regions, residential property prices will therefore continue to riseand at a relatively significant rate. Only the more subdued economy, which is likely to becomemore noticeable to households during the summer months, will ensure a continuation of the weakening trend for owner-occupied housing and keep the market on course for the hoped-forsoft landing. Meanwhile, segment-specific differences are likely to become more accentuated.The high-price segment is exposed to persistently weak demand, which will become more acutedue to the exchange-rate shock. Switzerland's price/performance ratio is simply no longer ac-ceptable to foreign buyers. The number of vacant properties is therefore likely to increase again

this year. We do not expect higher vacancies medium-term, however, as output of owner-occupied housing has already been declining for years and is therefore adjusting to waning de-mand. This year, for instance, construction of owner-occupied properties will reach its lowestlevel since 2001. No major supply overhang has emerged other than in the mountain regions, where regardless of demand as much as possible continued to be built before the second-homes initiative put a stop to it. This is likely to have a stabilizing influence on the market shouldthe second-round effects of the exchange rate shock weaken demand somewhat more stronglyin 2016.

Demand, supply and market outcome

Demand Background Outlook

Level of mortgage rates: Mortgage interest rates have reached their lower technical limit.

No further reductions are possible even in the case of lower negative interest rates,

unless the banks expose themselves to major cluster risk. The phase of falling mortgagerates is therefore likely to be replaced by a longer phase of sideways-trending interest

rates at an exceptionally low level.

Libor mortgage

Fix mortgage

Libor mortgage

/Fix mortgage

Regulation: The full effect of the reduced redemption period introduced in September

2014 and introduction of the lower-of-cost-or-market principle will only be felt in the

course of the year, when it will additionally dampen the demand for owner-occupied

housing.

Population trends: We expect immigration to decline by more than 10% in 2015 to a net

70'000 immigrants. This will have a dampening effect on the demand for owner-

occupied housing. In addition, the changed structure of immigration in terms of country

of origin (increasingly southern Europeans) will contribute to a slight decrease in the

demand for owner-occupied housing subject to a time lag.

Supply

Net addition of owner-occupied housing in 2015: With around 15'000 new condomini-

ums and 8000 single-family dwellings due to be constructed in 2015, production will fall

to its lowest level since 2001. The shift in new construction from the high-price regionsto regions with more sustainable price levels continues apace.

Medium-term expansion plans: Recently submitted planning applications for owner-

occupied projects suggests this development will continue in 2016.

Market outcome

Vacancies: We expect a further rise in vacancies for owner-occupied housing in 2015. In

the high-price regions in particular, supply is likely to meet comparatively weak demand.

Prices: Price momentum is likely to continue weakening in 2015, but should remain well

into positive territory in overall terms with a rise of around 2%. Medium-term, the more

subdued economic picture is likely to contribute to a marked softening of prices in the

peripheral regions as well. Except in the high-price regions, we do not expect prices to

fall as long as interest rates remain so low.

Sustainability of prices: The imbalances in the high-price regions are declining slowly,

though they remain substantial. Outside these regions, however, owner-occupied prices

are likely to rise much more strongly or at least in tandem with incomes; consequently,

the gap between prices and incomes is still not set to narrow. That means it is too early

to give the all-clear.


Stalled cooling off will pick

up momentum again


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Residential Property in Regulators' Sights Across the Globe

The overheating housing market and attendant risks to households and the financial system is ahotly debated subject not just in Switzerland. Relaxed monetary policy in various countries hasled to signs of overheating, which governments have sought to counter in recent years. Pricemomentum has now weakened considerably in Switzerland and there is no need for furthermeasures to cool the situation. It is nevertheless worth taking a look beyond the country's bor-ders at other countries' experience with the use of various instruments.

Price increases alone are still not a threat

Persistent, sharp price increases alone are not necessarily problematic for the stability of ahousing market. It is only in combination with excessive growth in credit and a high level ofhousehold debt that a risky situation can arise in which house price momentum diverges from

the economic fundamentals. For example, studies show a potentially dangerous positive correla-tion between default rates and the level of indebtedness.3

There are two reasons why the development of bubbles on real estate markets can cause po-tentially greater harm than bubbles on other types of investment market. First, owner-occupiedhousing accounts for a substantial share of national wealth in many countries. A slump in realestate prices accordingly affects private households in greater number and to a greater extentthan, say, a sharp fall on equity markets. Consumption consequently suffers a more considera-ble slump, as a result of which the growth in gross domestic product is more adversely affected.Second, mortgages account for a large portion of bank portfolios in many countries. A sharp fallin real estate prices can seriously impair the viability of mortgages and trigger banking crises, which in turn impacts very negatively on the level of economic activity.

In general terms, worldwide housing markets cannot be regarded as overvalued at present. Theequally weighted global house price index of the International Monetary Fund (IMF), whichshows the development of house prices in more than 50 industrialized and emerging-marketcountries, has been rising since mid-2009; measured in terms of economic growth, however, ithas risen by a comparatively modest 3.2%. On the other hand, some countries have recordedvery strong real growth rates in the past. Recovery movements can be seen in the likes of Ire-land (+18.1% since the low point at the start of 2013) and the US (+21% since the start of2012). Since 2000, real house prices have also risen strongly in Australia (+34%), Switzerland(+52%), the UK (68%) and most of all Sweden (+120%). Momentum in Germany was consid-erably weaker at around 7% (see Figure 22). The growth in credit volumes is trending higher,as are price levels in relation to incomes and rent levels. In terms of affordability, Sweden, theUK and Australia stand out in particular. There, house prices are already well above their long-

term average compared with incomes and rents.

Apart from the problem of differentiating between a potentially dangerous overvaluation andnormal price increases, legislators and regulators face the challenge of implementing appropri-ate measures (see Figure 23). The most obvious tool for keeping lending and consequently realestate prices in check is a restrictive monetary policy. As this measure has a braking effect notonly on the real estate market but also on the economy as a whole, it is not an appropriate in-strument in the current environment of tentative growth because it is disproportionate.

3 See Crowe et al. (2013): How to deal with real estate booms: Lessons from country experiences, Journal of Financial Stability, pp. 301–302.

Price increases only prob-

lematic in combination with

sharply rising debt

Real estate bubbles can

potentially be more dan-

gerous than other price

bubbles

No worldwide overvalua-

tion, but sharp price in-

creases in some countries

More restrictive monetary

policy frequently not an

option


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Figure 22

Real-term house price indices in selected countries

Index: Q1 2000 = 100

Source: Credit Suisse, Datastream, Wüest & Partner, BIS

Figure 23

Four groups of regulatory measures

Schematic view of the measures


Two real-life examples also show that monetary policy alone is often not enough to curb anoverheating real estate market. In Australia and Sweden, interest rates were deliberately in-creased with aim of preventing an impending bubble on the real estate market. Interest rates in Australia were raised by 300 basis points between 2002 and 2008, and in Sweden by a total of325 basis points between the end of 2005 and 2008. Real house prices nonetheless increasedby 21% (Australia) and 81% (Sweden) between 2000 and 2007. To exert a dampening effecton the housing market, the hike in interest rates would therefore have to be too large from theperspective of the economy as a whole and would consequently involve too much collateraldamage.

Broad arsenal of fiscal policy and macroprudential measures

Targeted regulatory intervention can be taken in relation to households as well as the banks.Intervention falls into the category of fiscal policy measures and primarily affects the tax treat-ment of real estate purchase, ownership and method of financing. This includes transactiontaxes, which increase the cost of purchasing owner-occupied housing. Their role is to makespeculative real estate investment – which can be reflected in a large number of transactions ina relatively short period – more expensive and therefore more difficult. In reality, the effect oftransaction taxes is mixed. In a comparison of transfer and capital gains tax across the Swisscantons, no evidence of a dampening effect could be found.4 By contrast, the US experienceshows that wealth taxes reduce the attractiveness of owner-occupied housing (see again Croweet al., 2013). Fiscal policy instruments also include the abolition of tax breaks in relation to own-

er-occupied housing and debt interest.

By contrast, macroprudential regulatory measures are aimed at the degree of indebtedness ofbanks and households. Higher capital requirements on banks through an increase in risk weightings and rules on greater r isk provisioning in the good times not only have a dampeningeffect on credit growth but are also helpful in terms of building up reserves for possible futurelosses. On the borrower side, upper limits for loan-to-value ratios and the level of indebtedness,i.e. the ratio of debt to income, can reduce the vulnerability of household balance sheets to fluc-tuations in real estate prices and interest rates.

In practice, various combinations and variations on the aforementioned measures are used fromcountry to country. Two interesting examples are Singapore and Hong Kong, where the real

estate markets are already at a very far advanced stage in their cycle and a series of measureshas been implemented. Following real growth in prices of 34% between mid-2009 and mid-

4 See Aregger/Brown/Rossi (2013): Transaction Taxes, Capital Gains Taxes and House Prices, SNB Working Paper.

60

80

100

120

140

160

180

200

220

2000 2002 2004 2006 2008 2010 2012 2014

SwedenSingapore

Australia

Switzerland

UK

Monetary policy

More restrictive monetary policy:Hike in interest rates

Macroprudential regulation

Banking sector: higher capitalrequirements

Private households: upper limitsfor loan-to-value ratios and

degree of indebtedness

Microprudential measures

Supervision at individualinstitution level

Fiscal policy measures

Transaction taxes

Wealth taxes

Reduced tax deductibility ofmortgage interest

Higher interest rates don't

always have the desired

effect in practice

Action can be taken in

relation to banks as

well as households

Macroprudential measures

focus on higher capital

buffer

In practice, many legisla-

tors focus on a combination

of different measures


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2010, sellers' stamp duty (SSD) was introduced in Singapore with the a

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