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RF_Real_estate_en.inddCommercial real estate Quality more important than ever
Listed real estate Last years performance hard to beat
The real estate market in Switzerland 2011
UBS real estate focus Research Switzerland
January 2011
Content
This report has been prepared by UBS AG.
Please see the important disclaimer at the
end of the document. Past performance is
not an indication of future returns. The
market prices provided are closing prices on
the respective principal stock exchange.
Publisher
Editor in chief
Authors
Gunnar Herm*, Caesar Lack,
Achim Peijan, Claudio Saputelli,
Niklaus Scheerer*, Christian Unternährer*,
Thomas Veraguth, Markus Wagemann*
Languages
Contact
[email protected]
*These authors are from units outside Wealth Manage- ment Research. These units are not subject to all legal provisions governing the independence of fi nancial research. The “Directives on the Independence of Financial Research”, issued by the Board of Directors of the Swiss Bankers Association (SBA), do not apply.
SAP No. 83518E-1101
Infl ation and interest rates ......................................................................... 7
Population and employment ...................................................................... 8
Residential real estate
In focus
Imputed rental values – a violation of classic tax theory ......................... 13
Occupational pension withdrawals – a dangerous game ....................... 15
Full-service living – a hot new trend ...................................................... 17
Commercial real estate and special uses
Offi ce properties – separating the wheat from the chaff ........................ 20
Retail space – zero growth expected ...................................................... 22
Overview of commercial properties .......................................................... 22
In focus
Hospital real estate in upheaval ............................................................ 25
Global real estate investments – diversifi cation
opportunities abound ........................................................................... 27
Real estate equities – on solid ground ................................................... 30
Real estate funds – an attractive addition to portfolios .......................... 31
Overview of listed real estate ................................................................... 32
In focus
Trend watch – exchange-traded real estate funds ................................. 35
Property investment groups of investment
foundations – on the advance .............................................................. 37
Our services
Selection of research publications ............................................................ 42
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UBS real estate focus January 2011 3
Editorial
Daniel Kalt
Claudio Saputelli
Dear reader,
“Real estate is at the core of almost every business,” claims US real estate mogul
Donald Trump. He is right – to an extent. It is true that real estate dominates the
workdays of the authors of this new publication, UBS real estate focus. What really
matters for our business, however, is our clients. They get us involved in a variety of
issues, from basic advisory services on property transactions to complex fi nancing
deals for large PPP projects.
Besides serving clients, UBS’s real estate teams also gain insights by sharing ideas
and supporting one another in an internal network. Over the years, they have ac-
quired a broad and deep base of real estate expertise. We share this expertise with
you in UBS real estate focus, our new in-depth annual study of the real estate mar-
ket. Every year brings new insights. In our quest to fi nd client-specifi c real estate
solutions, we continue to challenge ourselves, explore new disciplines and develop
innovative ideas.
UBS real estate focus consists of four chapters. The fi rst chapter, “Market drivers,”
explains the main macroeconomic factors aff ecting the Swiss real estate market.
The next two chapters, “Residential property” and “Commercial property and spe-
cial uses,” focus on direct real estate investments. Chapter four looks at indirect real
estate investments – investment foundations and listed real estate. Each chapter
begins with a market overview, followed by three focus articles on the latest market
issues. This structure helps you quickly get up to speed on the topics we cover.
We hope that UBS real estate focus will help you make sound real estate decisions.
We have made our analyses more actionable by including boxes with recommenda-
tions in the focus articles. We do agree with Donald Trump in one regard: “In order
to build your wealth and improve your business smarts, you need to know about
real estate.”
We hope you enjoy reading this issue of UBS real estate focus.
Claudio Saputelli
At a glance
ward trend has not fl attened out as ex-
pected in previous quarters. The public is
increasingly worried about a real estate
bubble – with some justifi cation. Caution
is advised. Page 10
harbors upside potential. Prices for multi-
family dwellings have made commercial
properties increasingly attractive to inves-
tors. Page 12
The taxation of imputed rental values as
income is controversial. For years, there
have been heated discussions about this
issue. Last summer, the Federal Council
threw its hat in the ring, supporting a
total abolition of the tax in order to sim-
plify the tax code. Page 13
Occupational pension with -
been made from retirement accounts since
1995. The withdrawn capital is expected
to exceed 35 billion Swiss francs in 2010.
The possible impact on future retirement
benefi ts remains unknown, but the risks
should not be ignored. Page 15
Full-service living – a hot new trend
Full-service living is an innovative concept
that caters to urban residents’ demand
for greater comfort and higher living
standards. Already established abroad,
Switzerland. Page 17
through the global economic crisis in
relatively good shape. We expect price
pressure from tenants to widen the per-
formance gap between central and
peripheral locations. Page 20
alike but investment performance increas-
ingly hinges on property quality. Page 22
In focus
public-private partners have to do more
than just work together. They also need
to defi ne processes to structure their
relationship, allocate risk, award con-
tracts and lay down ground rules for
the partnership. Page 23
Switzerland’s hospital system is complex.
Its structure, buildings and fi nancing are
on the cusp of a radical transformation.
This change opens up attractive opportu-
nities for investors. Page 25
Global real estate investments –
diversifi cation opportunities abound
mented along national and regional lines,
o en making entrance into specifi c mar-
kets diffi cult. Direct and indirect real
estate investment products can overcome
these barriers and they off er attractive
diversifi cation opportunities in a global
economy. Page 27
foundations
2010 – partly due to their own merits,
and partly due to a favorable economic
environment. The coming year looks to
be much tougher, though. Page 30
Exchange-traded real estate funds appeal
to investors because they combine fea-
tures of stocks, bonds and real estate.
This mix is refl ected in the risk/return
profi les of funds, making them an attrac-
tive choice for mixed portfolios.
Page 31
In focus
ings. Despite their short histories and
rapid changes, Switzerland’s leading real
estate equities are good choices for de-
fensive long-term investors. Page 33
Trend watch – exchange-traded
real estate funds
darlings of private and institutional inves-
tors. Strong demand has given rise to
new products and improved transpar-
ency. More IPOs, rights issues and sec-
ondary off erings should keep market
momentum strong. Page 35
Property investment groups of
off er attractive product features. Pen-
sion funds’ property contributions make
a signifi cant contribution to fueling
growth. Page 37
Market drivers
UBS real estate focus January 20116
Market drivers
more than 2 percent in the next two years.
This is well above the historical average
and should boost real estate prices.
The Swiss economy has been on the rebound
since mid-2009. Its recession was much mild er
than in most other industrialized western coun-
tries. Indeed, the Swiss economy is not only
recovering faster than expected, it is recovering
faster than the rest of Europe. According to the
State Secretariat for Economic Aff airs (Seco), real
gross domestic product (GDP) has expanded an
average of 3 percent in terms of annualized
quarter-on-quarter growth since the recession
ended. It even broke above precrisis levels in the
third quarter of 2010.
balance sheets
the European Union on the free movement of
persons. Free movement stimulates economic
growth by making it easier for companies to
hire skilled staff . The resulting immigration also
supports consumption and construction invest-
ment and directly increases GDP. Plus, unlike
many other industrialized western countries,
Switzerland’s private- and public-sector balance
sheets are in rude health. Switzerland is one of
the few countries that did not live beyond its
means in the run-up to the crisis. Compared
to other countries, Switzerland as a whole
(governments, households and companies) has
relatively large holdings of net foreign assets
– over 100 percent of GDP. Switzerland is also
in an enviable position in terms of public fi -
nances: It has a nearly balanced budget and
gross debt ratio of around 40 percent. This
positions it to weather the current debt crisis
much better than the highly indebted majority
of industrialized western countries.
quarters, we expect economic growth to con-
tinue at robust, albeit lower levels. Growth will
be supported by continued immigration, a glo-
bal economic upturn and the Swiss National
Bank’s very expansive monetary policy. Specifi -
cally, we expect the economy to grow 2.3 per-
cent in 2011 and 2.1 percent in 2012. This is
signifi cantly higher than the average growth
rate of 1.7 percent over the last 30 years. Due
to the strong franc, domestic consumption will
probably drive growth, instead of exports as in
the precrisis years.
real estate
below 1. In other words, a 1 percent increase
in income leads to an increase in housing
spending of slightly less than 1 percent. The
expected growth rates, which are relatively
high in historical comparison, should lead to
a correspondingly high increase in housing
spending. While this spending will most likely
fuel the construction of new housing, it
should also drive up the prices of existing resi-
dential properties due to the scarcity of land
in Switzerland. Prices for commercial real es-
tate should also benefi t from the strong do-
mestic economy.
114 112
108 110
102 100
104 106
96 98
Strong Swiss economy
Inflation-adjusted GDP, 1st quarter 2005 = 100
Switzerland Germany
Spain France
Market drivers
Historically low interest rates about to end
Sources: Bloomberg; UBS WMR
4.5 4.0
3.0 3.5
1.5 1.0
2.0 2.5
0 0.5
10-year interest rates (swap)
low right now. We expect this to change in
2011. The domestic economy’s robust
growth, expected rise in infl ation and nec-
essary tightening of monetary policy all
point to higher interest rates.
Imports account for over one quarter of the
basket of goods used to track consumer price
infl ation – petroleum products alone make up
almost 5 percent. The strong franc has fueled
import price defl ation in recent months, which
has dragged year-on-year infl ation below 0.5
percent as measured by the national consumer
price index. Since we do not expect the franc
to appreciate further, we think exchange rates
should gradually lose their defl ationary power
this year. Commodity prices have also risen
sharply in recent months; together with the
elimination of the exchange rate eff ect, this
should drive up import prices during the year.
The persistent strength of the domestic econo-
my should also drive up the prices of domestic
goods. We expect infl ation to reach almost
1 percent in 2011 and to trend towards
2 percent in 2012.
half-year
higher infl ation than the Swiss National Bank
(SNB). The SNB surprisingly lowered its infl ation
forecast in its monetary policy assessment of
September 2010 and confi rmed its low infl a-
tion forecast in its monetary policy assessment
of December 2010. We expect the SNB to raise
its infl ation forecast again, and possibly hike
interest rates 0.25 percent in the fi rst half of
the year to prevent the domestic economy and
real estate markets from overheating.
Swiss Confederation bonds are benefi ting from
their status as an international safe haven.
Europe’s debt crisis and loose monetary policy
worldwide have driven investors into Swiss
government bonds and pushed yields down to
levels not seen since 1965.
We believe, however, that investors should
prepare themselves for rising interest rates and
bond yields in the medium term. The economic
recovery should continue, and loose monetary
policy should tighten up during the year. Bond
markets usually preempt monetary tightening
and raise yields in advance. Overall, higher in-
terest rates will probably be introduced gradu-
ally, and we expect interest rates to remain
historically low this year.
Financing terms remain attractive
for now, which will support real estate prices.
The mortgage reference interest rate used to
calculate residential rents will rise marginally,
but not until the second half of the year. Rent
increases on commercial properties will also be
limited: They are generally tied to infl ation,
which is currently low.
Achim Peijan
Market drivers
age in recent years, fueled mainly by an
exceptionally high infl ux of immigrants.
Employment has remained surprisingly
fi nancial crisis has barely le a mark on
the tertiary sector.
ously for the 33rd year in a row. Our extra-
polation, based on provisional monthly data
provided by the Federal Statistical Offi ce, pre-
dicts growth of 1.1 percent in 2010. Over the
last 40 years, Switzerland has only seen pop-
ulation growth exceed 1 percent seven times
– including four out of the last four years.
The free movement of persons from the EU-
17 and EFTA member states, instituted in
June 2007, has obviously le its mark. This
fi nding is borne out by a detailed analysis
of net migration. While net migration (in-
cluding status changes) accounted for about
50 percent of population growth in the
1980s and 1990s, it has recently contributed
80 percent and more (2007: 91 percent). The
cantons of Vaud, Obwalden, Fribourg, Ge-
neva, Aargau and Zurich likely experienced
above-average growth in 2010. Given the
positive economic prospects overall, we ex-
pect the population to grow around 1 per-
cent again in 2011.
terms of full-time equivalents (FTEs), employ-
ment climbed a record-breaking 8.4 percent
during the 2005–2008 boom period. In 2009,
however, total employment became sluggish for
several quarters. The slowdown was largely con-
centrated in manufacturing, although employ-
ment numbers went up again slightly in the third
quarter of 2010. This has also brightened senti-
ment in the secondary sector. The service sector,
by contrast, recorded overall growth of 0.7 per-
cent, even in the depths of the 2009 recession.
The commercial real estate market is mainly af-
fected by the offi ce and retail sectors. In the fi rst
three quarters of 2010, the offi ce sector saw a
negligible 0.2 percent year-on-year increase in
employment. Retail employment also managed
to grow during this period – by 1.2 percent.
Thus, retail more than compensated for the prior
year’s drop in employment.
Housing demand remains strong
ing demand strong. Prices will only so en – espe-
cially for privately owned homes – if residential
construction steps up. In the commercial real
estate market, demand for retail space is show-
ing signs of improvement. Demand for offi ce
space, by contrast, will most likely be driven by
space optimization.
Claudio Saputelli
Overview of property market drivers
Unless otherwise indicated, all fi gures refer to percentage growth over the previous year.
Business cycle and income 20111 20102 2009 2008 10 yrs.3
Real gross domestic product 2.3 2.7 –1.9 1.9 1.7
Real construction investment 1.3 3.4 3.0 0.0 1.1
Real wage growth 0.7 0.4 2.6 –0.4 0.7
Infl ation and interest rates
Average annual infl ation 0.9 0.7 –0.5 2.4 0.9
3-month Libor CHF4 1.2 0.2 0.3 0.7 1.0
Yield on 10-yr Swiss Federal bonds4 2.4 1.8 1.9 2.1 2.5
Population and employment
Employment, in FTE 1.2 0.7 –0.1 2.7 1.0
Unemployment rate 3.4 3.9 3.7 2.6 3.2
1 Forecast UBS WMR Sources: Seco; BFS; UBS WMR 2 Forecast or extrapolations from UBS WMR (as of January 3, 2011) 3 Average: 2001 to 2010 4 Year-end
The Swiss property market is not overheated overall, but vigilance is still warranted.
Homes – elevated threat level
ward trend has not fl attened out as ex-
pected in previous quarters. The public is
increasingly worried about a real estate
bubble – with some justifi cation. Caution
is advised.
Fog is “dense” when visibility is less than a
quarter of a mile. Gentle rain is a “drizzle” if
the water droplets have diameters between
0.2 and 0.5 millimeters. The sky is “overcast”
if clouds cover over nine-tenths of it, but only
“cloudy” if they cover seven-tenths. No won-
der economists o en envy meteorology for its
crisp terminology. Their fi eld is much fuzzier.
For example, no economist can identify the
exact criteria that defi ne a real estate bubble.
Experts agree that real estate is somehow
heavily overvalued in a bubble, but cannot say
how much or how long prices have to in-
crease before a hot market becomes a full-
blown bubble.
criterion, though, provides a tangible defi ni-
tion of a real estate bubble. Because bubbles
are not governed by any quantifi able criteria,
the public and even experts are far too quick
to label many buoyant markets “bubbles.”
This has been happening in Switzerland since
early last year a er a recent steep spike in
home prices. Let’s consider the facts. The
Swiss property market began its rise in 1998.
Condominium prices have climbed 56 percent
since then, while single-family home prices
have gained 37 percent, according to the
Wüest & Partner indexes. Is this sustainable?
To fi nd out, economists compare home prices
to three factors: rents, infl ation and income.
Condominiums less aff ordable
houses, thanks to Switzerland’s mature body
of landlord-tenant law, so excessive discrep-
ancies between the two price trends can indi-
cate market imbalances. In the past 12 years,
rents rose by roughly the same percentage as
prices for single-family houses. The diver-
gence, though visible, was insignifi cant given
the period of time and diff erences in quality:
Rental apartments tend to be older, lower-
cost properties, while the interior quality of
condominiums has recently improved dramati-
cally. As for the infl ation comparison, count-
less international studies have shown that
infl ation-adjusted property prices are stagnant
over the long term. This was certainly the case
in the Swiss house market between 1970 and
2000.
infl ation since 2000, though, leaving a worry-
ing gap between the two curves. Theoreti-
cally, the maximum potential drop in home
prices is the current diff erence between the
curves: 33 percent for condominiums and
26 percent for single-family houses. Another
well-regarded economic approach, by con-
trast, links the long-term home price trend to
disposable household income. This is called
“housing aff ordability.” If real estate prices
rise faster than disposable income, this ap-
proach says that homes are less aff ordable for
households. Demand weakens and prices fall.
Average disposable income in Switzerland has
risen by roughly 35 percent since 1998. So
while the aff ordability of single-family houses
in Switzerland has remained more or less
steady during this period, it has fallen consid-
erably for condominiums.
Large regional discrepancies
whole, but local real estate markets vary
widely. Average annual increases in condo-
250 275
175 150
200 225
100 125
98 04 06 080200 1080 82 84 86 88 90 92 94 96
House prices not overheated overall
Sources: BFS; Wüest & Partner; UBS WMR
House prices compared to rent and disposable income (1980 = 100)
Consumer prices House prices, Zurich reg.
House prices, Switzerl. Rental apt., Switzerland
House prices, Lake Geneva Disposable income
Claudio Saputelli
minium prices since 2000 range from 3 per-
cent for the Berne region to 8 percent for the
Lake Geneva region (Switzerland: 4.2 per-
cent). At these rates, real estate prices will
need 24 years to double in the Berne region,
but only nine years in the Lake Geneva region.
In fact, Lake Geneva prices would sextuple in
24 years if growth were to remain un-
changed. This simple calculation shows that
Lake Geneva’s trend is clearly unsustainable.
Housing prices are still skyrocketing, despite
the general desire for a slowdown. In the
third quarter of 2010, transaction prices rose
7.3 percent year-on-year for condominiums in
Switzerland (Lake Geneva: 10 percent; Zurich:
8.7 percent; Central Switzerland: 8.1 percent)
and 3 percent for single-family houses (Lake
Geneva: 5.7 percent; Zurich: 4.1 percent;
Central Switzerland: 4.7 percent). Prices failed
to decline in any metropolitan region.
Threat level: seven
trends: Home prices still largely refl ect the
long-term economic fundamentals for Swit-
zerland as a whole. At the same time, how-
ever, some regions are frothier than the Swiss
average, particularly the communities sur-
rounding Lake Geneva, Lake Zurich and Lake
Zug, and several high-end resort areas south
of the Alps. It would be irresponsible to treat
these territories as only isolated trouble spots
for the Swiss real estate market. History has
shown that price corrections can trigger un-
predictable domino eff ects across several re-
gions. Thus, the threat level should be raised
for the entire Swiss real estate market. Since
economics (still) has no threat levels for cat-
egorizing the severity of a real estate bubble,
we shall use the meteorological Beaufort
scale, which classifi es wind speed from 0
(calm) to 12 (hurricane). We would currently
set the metaphorical threat level at
seven: “high wind.” The description reads,
“Whole trees in motion. Eff ort needed to
walk against the wind.”
14 12
8 10
2 0
4 6
–4 –2
09 1187 89 91 93 95 97 99 01 03 05 07
Mortgage loan growth not excessive
Sources: SNB; BFS; UBS WMR
Change in ratio of mortgage volume to population/GDP, in percent
Mortgage volume / population Mortgage volume / GDP (nominal)
The rental apartment market is stable
and harbors upside potential. Prices for
multi-family dwellings have made com-
mercial properties increasingly attractive
housing demand. The number of apartments
under construction in Switzerland tapered off
marginally during the recession, but has not
reached a turning point by any means. Low
interest rates also supported construction in
2010. Over 70,000 apartments were under
construction at the end of the third quarter of
2010. This is a record, and almost 12 percent
higher than in 2009. The number of building
permits indicated that construction activity
will drop slightly in 2011. Given the recent
improvements in the economic environment,
no signifi cant increase in vacancy rates is ex-
pected. Switzerland has the lowest vacancy
rate in Europe at 0.9 percent.
Scarcity drives rent increases
ported the growth in rents. Switzerland as
a whole saw rents increase by an average of
2 percent in the fi rst three quarters of 2010,
although performance varied widely between
regions. Near Lake Geneva, nominal rents
rose nearly 7 percent; those in southern Swit-
zerland went up around 3.1 percent. In other
major regions, rents only increased by 0.8 to
1.6 percent during the same period. Rents will
probably increase further given the economic
environment, but each region should always
be analyzed separately. Despite continued
construction in Zurich, demographic trends
should soak up the additional supply. A swell-
ing population in the Geneva region is facing
a very scarce supply, which is driving up rents.
More rural regions, such as the Jura and parts
of Central Switzerland, will see rents fall.
Careful analysis of investments
ment demand. Many have focused on rental
apartments, and thus have raised prices for
existing multi-family dwellings. While the rent-
al apartment market does not appear over-
heated among professional investors, we still
recommend carefully analyzing prospective
appreciation return on multi-family dwellings
to remain on par with prior years. Since the
economy is expected to improve, we assume
rising rents will push up commercial property
valuations. This could enable commercial real
estate to outperform multi-family dwellings
in 2012.
Overview of residential properties
Residential construction and vacancies 20111 20102 2009 2008 10 yrs.3
Net increase in number of homes 45 000 42 000 38 977 44 717 38 255
Residential vacancy rate 1.0 0.9 0.9 1.0 1.0
Rental apartments
Asking prices for rental apartments 1.5 1.7 3.5 4.2 3.1
Asking prices for new rental apartments –1.5 –1.2 –4.5 1.5 3.8
Price index for passing rents 1.0 1.1 2.4 2.5 1.7
Mortgage reference interest rate 5 3.0 2.8 3.0 3.5 –
Number of vacant rental apartments 31 000 28 947 26 343 28 138 29 567
Performance on residential direct investment 5.0 5.0 5.3 6.1 5.64
Owner-occupied homes
Asking prices for single-family homes 2.5 4.7 5.0 2.7 3.0
Closing prices for single-family homes 1.5 2.3 0.4 3.8 2.7
Variable mortgage interest rate, all banks 5 3.0 2.7 2.7 2.8 3.3
Growth in mortgage loans, all banks 4.5 5.1 4.9 3.4 4.1
Number of vacant condominiums 8 000 7 766 8 418 8 980 7 938 1 Forecast UBS WMR Sources: Wüest & Partner; BFS; SNB; IPD; UBS WMR 2 Forecast or extrapolations from UBS WMR (as of January 3, 2011) 3 Average: 2001 to 2010 4 Average: 2006 to 2010 5 Year-end
Imputed rental values – a violation of classic tax theory
The taxation of imputed rental values as
income is controversial. For years, there
have been heated discussions about this
issue. Last summer, the Federal Council
threw its hat in the ring, supporting a
total abolition of the tax in order to sim-
plify the tax code.
tiative titled “Living Securely in Old Age.” The
Federal Council rejected the initiative and now
aims to abolish the tax on imputed rental val-
ues (IRV) by instituting an indirect counterpro-
posal. In exchange, it will eliminate tax deduc-
tions on private interest payments, with certain
exceptions. Maintenance costs will no longer
be tax-deductible, either, except for high-quali-
ty energy effi ciency and environmental protec-
tion measures.
rental values
taxes always links IRV to mortgage interest and
other tax-deductible expenses. They are treat-
ed as parts of one indivisible system. However,
we can best evaluate the system’s macroeco-
nomic eff ects by examining each component
separately. Let’s begin with IRV. It represents
the rent revenues that homeowners could the-
oretically earn if they rented out their home on
the open market. It is taxed as a form of invest-
ment income. This IRV tax allegedly puts ten-
ants and homeowners on an equal footing on
the premise that homeowners are better off
economically since they live rent-free.
This is a specious argument, in our view. First,
tenants, unlike homeowners, bear no invest-
ment risk for their home and no opportunity
costs for their assets (profi ts not earned on
assets tied up in real estate). Second, the gov-
ernment greatly benefi ts from homeowners’
risk-taking when properties are sold – it levies
a he y property gains tax on any capital gains.
Losses, by contrast, are fully borne by the
property seller. Third, the IRV tax does a poor
job of evening the odds between tenants and
homeowners. Simply consider how IRV are
determined. There are few comparable proper-
ties, particularly for single-family homes and
luxury properties, making it diffi cult or impos-
sible to calculate the market rents that underlie
the IRV. Finally, the cantons use diff erent and
sometimes quite complicated assessment
tax theory’s maxim that tax laws should be
both simple and transparent.
side of the coin
What about the fl ip side of the home tax sys-
tem, the deductions for mortgage interest and
maintenance expenses? As the law stands, the
tax on IRV automatically allows homeowners
to claim these deductions as “professional ex-
penses.” If IRV taxes were revoked, the govern-
ment could be more pragmatic about mort-
gage interest. There are three main reasons
why deductions for owner-occupied homes
should be eliminated, in our opinion, as the
Federal Council is essentially proposing to do.
First, the deductions give households an incen-
tive to take on too much debt. While this is not
necessarily bad in itself, it is still not something
the government should be expressly encourag-
ing. Second, allowing income tax deductions
for debt interest pushes part of the home buy-
er’s interest rate risk onto the government, and
thus the taxpayer. As interest rates rise, home-
owners can claim larger interest deductions,
thereby reducing their tax bills. Tenants, by
contrast, bear the full interest rate risk under
current tenant-landlord law through the refer-
ence mortgage interest rate. Third, it is unfair
to permit homeowners to claim deductions for
Current system for taxing home ownership is complicated
Source: UBS WMR
Taxable income WITHOUT home ownership
Taxable income WITH home ownership
+ Imputed rental value – Maintenance costs – Mortgage interest
Current system of taxes on home ownership
In focus Residential real estate
Claudio Saputelli
The leverage formula is decisive
Whenever taxes on home ownership change, homeowners wonder
whether they should pay down their mortgages. To answer this ques-
tion, it helps to consider the leverage formula (use of debt to improve
return on equity). If the return on a long-term investment exceeds the
current mortgage rate, it makes more sense to put money in long-term
investments than in extra mortgage payments. If mortgage rates ex-
ceed long-term returns, however, it might be better to pay down the
mortgage. If mortgage rates and long-term investment returns are
equal, homeowners cannot improve their fi nancial situation by tweak-
ing mortgage payments. Besides determining the ideal debt level, we
strongly recommend diversifying. Homeowners should not put all their
eggs in one basket, but rather assemble a widely diversifi ed portfolio.
Given the low correlation between direct real estate investments and
other asset classes, portfolio construction theory recommends not
concentrating all your assets in your home.
living expenses when tenants cannot deduct a
single cent.
constitutional mandate to encourage home
ownership by permitting fi rst-time home buy-
ers to claim mortgage interest deductions up
to a certain franc limit over 10 years. This
“fi rst-time buyer deduction” would also ben-
efi t high-income households, which obviously
misses the point and should therefore be re-
considered. Under the Federal Council’s indi-
rect counterproposal, taxpayers with interest
income could still off set mortgage interest
against the full amount of their interest in-
come. This is also a one-sided policy that large-
ly benefi ts homeowners who can deduct mort-
gage interest from their taxable interest and
securities income.
come tax deductions for maintenance costs as
well as private mortgage interest. This is a step
in the right direction. A er all, tenants do not
receive tax breaks on their living expenses.
However, the Federal Council is making excep-
tions to allow deductions on energy effi ciency
and environmental protection measures that
meet specifi c energy criteria. It would be very
labor-intensive and therefore expensive to reg-
ularly defi ne and review eligible measures for
each individual homeowner. A more effi cient
method would directly subsidize eco-friendly
energy systems and construction materials.
The tax on imputed rental values
should be abolished
sense, in our view. If it were abolished, there
would be no need for many deductions and
exceptions, which is why we think the govern-
ment should simplify the tax code by com-
pletely eliminating this tax on home ownership.
That way, homeowners can preserve both their
homes and their sanity around tax time.
In focus Residential real estate
Occupational pension withdrawals – a dangerous game
An estimated 520,000 withdrawals have
been made from retirement accounts since
1995. The withdrawn capital is expected
to exceed 35 billion Swiss francs in 2010.
The possible impact on future retirement
benefi ts remains unknown, but the risks
should not be ignored.
Home Ownership with Occupational Retire-
ment Assets” was published in the August
1992 Federal Gazette. It states, “The home
ownership rate in Switzerland is extremely
low compared to other countries. Raising it is
an urgent national and social priority.” Also,
policymakers tended to oversimplify the mat-
ter when they claimed the low home owner-
ship rate showed too little was being done to
reach the political goal of widespread home
ownership among the population.
The home ownership rate was 31 percent in
1990. By 2000, fi ve years a er a home own-
ership encouragement law began to allow
prospective home buyers to pledge and with-
draw pension assets, 34.6 percent of all per-
manently occupied homes were owner-occu-
pied. The Swiss Federal Housing Offi ce now
puts the home ownership rate at 39 percent.
In Germany, the rate is 42 percent, compared
to 57 percent in France and 70 percent in
Italy.
minium ownership was not introduced to
Switzerland until 1965. Second, the Swiss
rental apartment market is relatively effi cient
compared to other countries, which dulls the
incentive to own a home. So what caused
the spike in the home ownership rate in the
1990s? In that decade, home prices fell a er
the real estate bubble burst, declining sharply
relative to national income. Third, Switzer-
land’s “baby boomers” are now 40 and older
– the cohort where home ownership is most
common. Finally, people have been free to
pledge or withdraw occupational pension as-
sets for home purchases since 1995. However,
it is not clear whether this statutory option
has acted as a genuine incentive or only had a
bandwagon eff ect.
system – established in 1985 to supplement
the old age and survivors’ pension system
(AHV) – is to maintain a certain standard of
living when the policyholder retires, dies or
becomes disabled. As fully funded schemes,
occupational pensions represent the most
politically attractive pot of money for encour-
aging home ownership. Withdrawing pension
assets, however, does more than reduce
future retirement benefi ts. It can also lower
death and disability benefi ts if they depend
on the amount of built-up capital (defi ned
contribution plan). Thus, pension withdrawals
are a poor vehicle for encouraging home
ownership since they clearly undermine the
main purpose of occupational pensions: to
provide an annuity or lump-sum payout in
retirement age.
follows: “Encouraging home ownership serves
the purpose of occupational pensions because
living expenses represent one of the largest
costs for retirees.” But this claim rings hollow.
It ignores the need to distribute investment
risks and choose assets that off er security and
an adequate return – as stipulated by the Fed-
eral Act on Occupational Pensions. People
who withdraw pension assets are fully ex-
Thomas Veraguth
3,500 4,000 4,500
1,500 1,000
2,000 2,500
0 500
45,000 40,000
30,000 35,000
15,000 10,000
20,000 25,000
0 5000
0995 96 97 98 99 00 01 02 03 04 05 06 07 08
Pension withdrawals relatively constant since 2003
Sources: EDI; ESTV; UBS WMR
Total amount and number of withdrawals per year since 1995
Number of annual withdrawals (right-hand scale)
Total annual amount in CHF million
posed to the one-sided, non-diversifi able and
considerable risks of the real estate market for
years at a time.
The statistics tell a nuanced story of how
withdrawals are being used to fi nance home
purchases. The capital invested in occupatio n-
al pension schemes has nearly doubled since
1995, reaching 600 billion Swiss francs in
2009. The total increase was almost 290 bil-
lion francs, which dwarfs the 35 billion francs
withdrawn between 1995 and 2009. This rep-
resents just 12 percent of the capital growth in
occupational pension schemes over the past
15 years. On average, annual withdrawals ac-
count for around 0.5 percent of the total capi-
tal invested in occupational pensions. By com-
parison, Wüest & Partner estimates that all the
single-family homes and condominiums in
Switzerland had an aggregate market value of
1.24 trillion Swiss francs in 2010. Mortgages
taken out by private households amounted to
566 billion francs in September 2010.
The withdrawal statistics also harbor another
surprise: the continuity of the amounts with-
drawn. The average withdrawal has remained
within a tight corridor of 60,000 to 73,000
Swiss francs since 1995. The average peaked
in 2003 at 73,160 francs. This is not an exces-
sive amount: A typical Swiss home sells for
680,000 francs. In 1995, withdrawals ac-
counted for 6 percent of all expenses incurred
by Swiss occupational pensions, consisting of
annuities and lump-sum payments, and 16.7
percent of all the schemes’ lump-sum and
cash payments. The 2009 percentages were
roughly 6 and 22 percent, respectively.
Moderation is key
tial problems arise from the legislature’s deci-
sion to allow consumers to make early pen-
sion withdrawals for home purchases. Luckily,
consumers have exercised considerable self-
restraint, as indicated by the data on the
number of withdrawals and total money with-
drawn per year. Less than 1 percent of all
members of occupational pension schemes
make withdrawals each year. This is in part
due to restrictions inserted in the legislation
by lawmakers, such as a tax on withdrawals.
As a result, we are cautiously optimistic about
the future of home fi nancing, but recommend
pledges over withdrawals.
Weighing the pros and cons of withdrawals
Pension withdrawals have been allowed for home purchases since
1995. Home ownership is conventionally viewed as a sound way to
prepare for retirement. The reality is diff erent, in our view: Homes
make unattractive alternatives to capital investment, given their op-
portunity costs and loss in value due to aging. Pension assets are
nonetheless used in up to one fi h of all purchases of existing proper-
ties and one third of new ones. Withdrawals are particularly common
for “threshold households” (low income, low savings rate). However,
there are no current offi cial impact analyses. In 2004, written surveys
by Hornung revealed that withdrawals play an important role. Never-
theless, the question remains open as to whether less affl uent employ-
ees are cutting their future benefi ts too heavily by purchasing a home.
Impact analyses used to be the responsibility of the Federal Offi ce of
Social Insurance under Article 18 of the Home Ownership Encourage-
ment Ordinance – until this Article was abolished on 22 August 2007.
For these reasons, the pros and cons of a withdrawal must be weighed
carefully when purchasing a home.
Full-service living – a hot new trend
Full-service living is an innovative concept
that caters to urban residents’ demand for
greater comfort and higher living stand-
ards. Already established abroad, this
model is fast gaining adherents in Swit-
zerland.
number of small households are driving demand
for new models of living with integrated ser-
vices. This trend extends beyond wealthy te-
nants and senior citizens. The upper middle
class, including many “DINKs” – double income
no kids – is less willing to spend precious free
time on tedious errands or exhausting chores.
Even young families are increasingly discovering
the model’s benefi ts.
Growing importance of new models
of living
ing needs. Over the years, we have seen the
emergence of nursing homes, independent liv-
ing and assisted-living communities. There is
now an even richer, more diverse menu of
options ranging from boarding houses to full-
service living. While this latest model may re-
main a niche product for several years, we think
demand will stay strong for the foreseeable
future thanks to demographic change, growing
interest in support and services, and a greater
overall need for higher living standards. Of-
ferings need to be aligned with target group
needs and interests, though. Our experience
with the “James – Full-service Living” project
shows that models should be tailored to both
the target group and local conditions.
James – Full-service Living
brainchild of our real estate fund UBS (CH) Prop-
erty Fund – Swiss Mixed “Sima.” In 2007, the
fund opened the fi rst James apartment complex
in Zurich with around 280 apartments. In 2009,
the UBS Foundation for the Investment of Pen-
sion Fund Assets built a second James complex
in Lausanne, tailored to the local area. Thirty-
four of the 114 apartments were designed spe-
cifi cally for older or disabled residents. The third
James complex is under construction in Winter-
thur and will open its doors to tenants in mid-
2011. It conveniently combines living and shop-
ping thanks to a direct connection between the
roughly 150 apartments and a shopping center,
restaurants and a parking garage.
The James – Full-service Living concept refl ects
today’s needs and lifestyles. It embraces not
only modern communication technologies (In-
ternet, e-mail), but also direct personal interac-
tion (James is physically on the premises). At a
James complex, rent includes a wide array of
concierge services, such as receiving guests,
accepting packages and purchases, or reserving
concert tickets or tables at restaurants. Not to
mention a broad selection of à la carte services,
such as laundry service, apartment cleaning, pet
care, plant watering or vacation service. These
services are billed separately under a pay-as-
you-go scheme.
land. “Concierge” is a French word that origi-
nally described the castle gatekeeper. Today, it
mainly designates French superintendents or
caretakers of residential buildings. But “con-
cierge service” increasingly refers to comprehen-
sive personal services for tenants and visitors as
well. The word is commonly used in luxury ho-
tels, where a concierge’s duties extend far be-
yond receiving guests: Concierges are complete-
ly at the disposal of a discerning clientele. The
James concept embraces this principle. When
tenants and visitors enter a James apartment
complex, it should be readily apparent that this
is more than just a place to live. The James –
Full-service Living concept can also adapt to
Patric Caillat
Source: UBS GRE Switzerland
Living as a core service
Basic services included in rent
À la carte services
residents’ new and changing needs over time,
thanks to its extensive modular service off ering.
The program is based on three components:
residential use, integrated basic services, and
additional à la carte services.
The apartment is the core service and, as such,
must perfectly satisfy tenants’ requirements in
terms of location, infrastructure, amenities and
aesthetics. The rent must also include several
basic services that are important to the target
groups. This diff erentiates James from a regular
apartment complex. Residents can also use
many diff erent à la carte services. They simply
pick the services they need and pay for them
separately, which makes the apartment some-
thing like a hotel. To be successful, the concept
has to combine these elements intelligently
while taking local circumstances into account.
Other models on the market
Several models with slightly diff erent approach-
es have been launched in recent years. Besides
James – Full-service Living from UBS Global As-
set Management, other full-service models in-
clude “Living Services” from Credit Suisse’s Real
Estate Asset Management department and
“Bonacasa” from Bracher und Partner AG.
Combining services with attractive living can
give a property its own unique character and
ensure its long-term appeal. This fact helps
support intelligent real estate marketing. How-
ever, full-service living can only work if the
services benefi t users, operators and owners
alike. While Switzerland has no long-term ex-
perience with such models, it certainly has the
conditions and outlook needed to achieve a
win-win situation.
Added value at an attractive price
“Full-service living” seems to be a growing demand. For it to work,
users and operators will have to answer a crucial question: “What
value do the services provide?” They should off er tangible benefi ts to
tenants. And they should pay off for the landlord or operator: A er
all, they are not provided for free in any model. Either they are in-
cluded in the rent, or they are charged according to a pay-as-you-go
scheme. Several key questions have to be answered from the start:
Who is the target audience? What services do they want? While this
might seem trivial at fi rst glance, experience shows that the venture’s
success or failure depends on precisely these issues and how they are
handled in practice. Over the long term, full-service living concepts
will only succeed if they provide tenants with added value at an at-
tractive price. The program must also be able to adapt to residents’
changing needs.
The market separates the wheat from the chaff .
Offi ce properties – separating the wheat from the chaff
The Swiss offi ce property market came
through the global economic crisis in rela-
tively good shape. We expect price pres-
sure from tenants to widen the perform-
ance gap between central and peripheral
locations.
the Swiss commercial real estate market. The
commercial property market was estimated
to be worth 68 billion Swiss francs at the end
of 2009, according to Investment Property
Databank (IPD). Some 58.8 percent of this
total was offi ce space, while retail properties
made up 37.7 percent and industrial real es-
tate 3.5 percent.
Stable demand factors
ture, even though 17 and 10 percent of the
total offi ce space lies in the fi nancial centers of
Zurich and Geneva, respectively. Financial and
business services represent over 18 percent of
total employment in Switzerland – a high per-
centage compared to other countries. The
Swiss fi nancial industry, unlike its peers else-
where, exited the global fi nancial crisis rela-
tively unscathed. While the EU’s fi nancial sec-
tor shed jobs at a rapid rate, Switzerland’s
growth rate merely slackened in 2009, but still
remained positive. Part-time employment is
also becoming more widespread in Switzer-
land. As elsewhere in Europe, Swiss companies
are focusing on boosting employee productiv-
ity. Future employment growth looks likely to
be moderate as a result.
Rising importance of quality
growth highlights the importance of analyzing
the supply of offi ce space. Offi ce vacancy rates
range from 2 to 6 percent in Swiss cities. This is
moderate compared to other countries and has
recently fueled growth in offi ce rental rates. In
crisis-stricken 2009, for example, IPD found
that Swiss offi ce rents rose 1 percent. Offi ce
completions have been much higher in Ger-
man-speaking Switzerland than western Swit-
zerland in recent years. In 2011/12, around
150,000 m² of new offi ce space will enter the
market in Zurich, compared to only 60,000 m²
in Geneva. It is important to diff erentiate the
various kinds of offi ce space on the market. For
example, we are skeptical about the medium-
term prospects of non-integrated offi ce prop-
erties (poor access to transportation and low
availability of services) on the periphery of cit-
ies and urban agglomerations, given the bur-
geoning interest in environmental sustainabil-
ity. Even if immigration infl ows continue to be
strong, expanding the labor market, companies
still need to provide attractive workplaces for
their employees. Easily accessible, central offi ce
locations will gain even more importance. Un-
der these pressures, the offi ce market should
start to more clearly separate the wheat from
the chaff . Downtown locations, where offi ce
space is scarce, should perform well, while
non-integrated offi ce properties will struggle
to attract tenants. Rents for these peripheral
locations will be squeezed, since they are main-
ly used for extremely cost-sensitive back-offi ce
functions. Through renovation or new con-
structions, in contrast, downtown locations
should see further appreciation and attractive
returns. For this reason, we think rents for
high-end offi ce space should rise further.
Positive appreciation rate
bond yields, initial yields in the institutional
offi ce segment have hardly budged, according
to IPD: They were 5.8 percent in 2008 and
2009. In contrast to many European real estate
markets, the appreciation rate is still positively
5
Forecast
Employment growth in financial and business services, in percent
Switzerland EU15
Gunnar Herm
correlated with the rental growth rate in the
Swiss offi ce property market. The percentage
increase in the granting of commercial mort-
gages has not exceeded the Swiss infl ation
rate, either. Both these factors mean the Swiss
commercial property market is on solid ground.
The fall in government bond yields has height-
ened the relative appeal of commercial proper-
ties, driving investment demand for this asset
class. Nevertheless, for 2011, we recommend
that offi ce real estate investors review carefully
the risk/return profi le for each property and
refuse to compromise on their investment cri-
teria. Most buyers are using their own funds at
present, and can easily tap capital markets for
their debt fi nancing needs. Unlike in previous
years, few highly geared investors are active in
the Swiss property market.
global crisis and is helping to drive European
economic growth. Rising interest rates would
not, however, automatically trigger property
devaluation in the commercial institutional
real estate market. Interest rates also refl ect
prevailing economic growth. Fast growth
tends to raise rent revenues and thus prop-
erty valuations. While this is not necessarily
an automatic reaction, investors with proper-
ties in sustainable locations should not worry
if interest rates rise from the current historic
lows.
market to deliver steady performance in 2011,
driven by stable returns, while property values
should appreciate only modestly. Appreciation
rates are based on expected rental growth due
to an improving economic environment, and
not on speculative changes in appreciation
returns. As such, the Swiss offi ce property
market refl ects the country’s sound economic
fundamentals.
8
4
6
0
2
Forecast
Slight potential for appreciation expected
Sources: IPD; UBS GRE Past performance is no indication for future performance.
Performance of Swiss office market, % p.a.
Net cash flow yield Appreciation return
Consumer confi dence is stronger in Swit-
zerland than in many other countries. This
benefi ts retailers and real estate investors
alike, but investment performance in-
creasingly hinges on property quality.
While its consumers did not escape the global
economic crisis entirely unscathed, the Swiss
retail sector seems relatively unfazed. Infl a-
tion-adjusted retail revenues still rose by
around 0.5 percent in 2009 despite the cycli-
cal weakness, compared with up to 4.3 per-
cent in the boom years. Rising unemployment
fanned uncertainty in 2009, but unemploy-
ment started falling again in February 2010
and consumers regained confi dence. This
should support retail revenue. The retail sec-
tor is expected to see real revenue growth in
excess of 2 percent for 2010 and in the cur-
rent year.
Concentration continues
European neighbors has encouraged many
foreign retailers to set up business here. In the
fi rst stage of expansion, they are focusing on
downtown shopping districts and prime shop-
ping centers. This means lower-quality loca-
tions and shopping centers will have an uphill
battle. Restoring competitiveness o en re-
quires costly, extensive work. The Swiss retail
property sector signifi cantly outperformed the
overall Swiss real estate market in 2009, log-
ging an overall rise of 6.3 percent. Mean-
while, rents increased by more than 3 percent
in 2009 and 2010, according to Wüest & Part-
ner. This is largely due to changing quality
diff erences between property categories.
Performance diff erentiation
more important to retailers’ siting decisions
and the success of retail property invest-
ments. That is why we expect to see even
greater discrepancies in retail property per-
formance. Construction has been proceeding
at a rapid pace in some regions recently, and
older, outdated shopping centers have been
renovated. This has fueled competition for
tenants, leaving little leeway for rent increases
in the retail market in 2011. The overall mar-
ket should thus see zero growth. Only high-
end locations and well-managed properties
should rise above the fl at rental trend. We
also expect property appreciation rates to
settle at between 1 and 2 percent in the
years ahead.
Gunnar Herm
Overview of commercial properties
Employment revenue and sentiment 20111 20102 2009 2008 10 yrs.3
Employment, offi ce, in FTE 0.5 0.3 1.7 4.2 2.0
Employment, retail, in FTE 0.5 1.2 –0.9 1.8 0.3
Real retail revenue, working day-adjusted 2.5 2.8 0.5 3.3 1.9
Consumer sentiment index, average – –5.8 –33.3 –7.0 –8.8
Offi ce space
Asking rents for offi ce space 0.0 0.7 4.0 0.8 1.2
Vacancy rate for offi ce space 4.8 4.5 4.3 4.3 –
Net cash fl ow yield 4.9 4.9 4.9 4.8 4.84
Appreciation return 0.8 0.8 0.4 1.0 1.04
Performance on offi ce direct investment 5.7 5.7 5.3 5.9 5.84
Retail space
Asking rents for retail space 0.5 3.6 3.4 0.6 1.4
Net cash fl ow yield 4.9 4.8 4.8 5.0 4.94
Appreciation return 0.4 0.5 1.5 1.4 2.24
Performance on retail direct investment 5.3 5.3 6.3 6.5 7.14
1 Forecast UBS WMR Sources: Wüest & Partner; Colliers; IPD; BFS; Seco; UBS WMR 2 Forecast or extrapolations from UBS WMR (as of January 3, 2011) 3 Average: 2001 to 2010 4 Average: 2006 to 2010
Public-private partnership – more than a buzzword
Governments and companies have a long
history of collaboration. However, public-
private partners have to do more than just
work together. They also need to defi ne
processes to structure their relationship,
allocate risk, award contracts and lay
down ground rules for the partnership.
Operating, maintaining and repairing a build-
ing over a 25- to 30-year period costs about as
much as constructing it in the fi rst place (ex-
cluding fi nance costs). Even a er accounting
for the time value of money, only two thirds of
the total budget go toward the initial construc-
tion, with one third consumed by operating
costs over 25 to 30 years. Planning for any
construction project should thus consider the
subsequent operational phase. This is one of
the strengths of public-private partnerships
(PPPs).
seeking a way out of fi nancial predicaments,
today one of the PPP model’s major virtues is
the fact that bidders already have to consider
the operational phase when they make their
bids. PPP does not do half-measures, either.
Besides addressing operating costs directly, the
bidders are also free to design a building and/
or infrastructure that minimizes operating
costs. PPP thus integrates the building’s future
operator in the bidding consortium from the
start, thereby improving long-term planning,
design and construction.
The core of every PPP project is a contract be-
tween a public-sector entity and a project com-
pany with a clearly defi ned scope of services.
The long contract terms (generally 20 to 30
years) show that PPPs cover the property’s en-
tire lifecycle, not just construction and fi nance.
Successful PPP projects utilize well-designed
tendering procedures that integrate planning,
design, construction, fi nance, and operation
into the bids and encourage competition for
each stage of the project.
Some government clients hold architecture
competitions, and then solicit bids from com-
panies to build and operate the property. This
is not true PPP. The problem: Since the archi-
tecture has already been determined, the
private service provider has little leeway to
optimize construction and/or operation in its
proposal. And so, while planning and opera-
tion may be more effi cient, these gains are
swallowed up by the company’s higher fi nanc-
ing costs compared to its government client.
The typical PPP tendering procedure can de-
liver signifi cant savings – for both the project
company and the public-sector client. Numer-
ous analyses of PPP projects in neighboring
countries have documented effi ciency gains of
15 to 20 percent, not to mention shorter build-
ing periods in many cases. In Switzerland, the
effi ciency gains for above-ground projects
should range from 5 to 10 percent.
Higher fi nancing costs:
vices to private providers o en argue that
companies have higher fi nancing costs than
governments. Unfortunately, they ignore the
fundamental diff erences between the public
sector’s risks in a PPP project as versus projects
where the building is constructed by govern-
Typical structure of a PPP project
Source: UBS Real Estate Advisory
Contract
Supervisory authority
Investors/ banks
Christian Unternährer
Wealth Management &
ment entities. In a PPP project, the private
contractor assumes construction and opera-
tion risks, while government construction
places some or all of these risks on the public
sector’s shoulders.
course to debt guarantees from taxpayers is
hard to justify, though, especially when the
risks and services could easily be offl oaded to
the private sector. Risk allocation becomes dis-
torted by a kind of circular logic: The taxpayers
are essentially guaranteeing their own debts as
the indirect project initiators. Since this struc-
ture ignores the eff ective project risk in all fi -
nancing deliberations, capital allocation is fre-
quently suboptimal.
them to whomever can best judge and bear
them. The private sector provides the project
fi nance, although the government client is still
able or required to furnish greater or lesser
guarantees. If guarantees are furnished, how-
ever, they are tied to a risk event so that the
client can manage the risks properly.
Many potential areas of application
PPP projects are ideal for building transporta-
tion infrastructure. They have also proven
their value over the last ten years in health-
care, education, criminal justice and national
defense, particularly outside of Switzerland.
Within Switzerland, PPP models will probably
play the largest role in hospital fi nancing in
the near future. Indeed, the hospital fi nancing
reform slated for early 2012 (see “Hospital
property market in upheaval” on page 25)
was motivated by a desire to create a level
playing fi eld for public- and private-sector
operators of acute care hospitals. Having gov-
ernments build and operate hospitals would
not have been conducive to achieving this
goal. This does not mean, however, that the
public sector has pulled out of the hospital
sector. Instead, it should assume a new role,
as envisioned by the PPP paradigm. Public and
private partners have unlimited scope for cre-
ativity in determining how they will share the
work. It is important, though, for work alloca-
tion arrangements to be clearly structured
and consistently implemented by both part-
ners from the beginning. PPP is not a game of
“hot potato” between the public and private
sectors.
Intelligent risk allocation with PPP
PPP models are a viable form of fi nancing projects in Switzerland, as
illustrated by the canton of Berne’s new Neumatt Administrative
Center in Burgdorf. The government is receiving a new piece of infra-
structure that it probably could not have built and fi nanced itself –
and the project is on schedule and on budget. Debt-to-equity ratios
vary in PPP projects depending on the area of application and risk
structure. Ten to 20 percent of project costs is the standard equity
ratio for above-ground projects where the private partner bears little
to no market risk. This low ratio – which is only possible thanks to
the clear risk allocation of PPP projects – can deliver an attractive
return on equity, and also optimizes overall fi nancing costs. And that
protects government coff ers. Large real estate investors would do
well to familiarize themselves with PPP, since Switzerland is expected
to see many PPP projects in the future. It makes sense to learn as
much as possible early on.
In focus Commercial real estate and special uses
Hospital real estate in upheaval
Switzerland’s hospital system is complex.
Its structure, buildings and fi nancing are
on the cusp of a radical transformation.
This change opens up attractive opportu-
nities for investors.
heaval. Not only do the properties (largely
built in the 1970s and 1980s) need signifi cant
renovations, but the hospital structure in many
cantons is outdated and balkanized. Plus, the
widespread shi from inpatient to outpatient
treatment is creating new demands on space
that the current hospital infrastructure is un-
able to meet adequately or cost-eff ectively.
New hospital fi nancing as of
January 1, 2012
Insurance Act (Krankenversicherungsgesetz,
is to improve effi ciency and transparency. The
reform applies a system of “diagnosis-related
groups” (DRGs) for the treatment of patients.
Patients are assigned to DRGs based on criteria
such as the main diagnosis, additional diag-
noses, treatment and severity. The DRG assign-
ment determines the fl at fee paid to the hospi-
tal for treating the patient. This contrasts with
the existing system, where hospitals receive
payment retrospectively, with defi cit guaran-
tees or global budgets. DRG rates are set using
the least expensive hospitals as a baseline and
are regularly updated. They are defi ned on a
national level by SwissDRG AG, an organiza-
tion set up specifi cally for this purpose. Part of
the DRG fee goes toward capital expenses that
used to be fi nanced by the cantons. Special
provisions have been instituted during the tran-
sition from the old to the new system of hospi-
tal fi nancing. The new system, however, does
not cover outpatient services, which continue
to be paid using the Tarmed tariff system.
Unpredictable regulator
the legislature, hospitals will fail if they cannot
provide services at or below the DRG rates.
Only time will tell if policymakers will stand by
and watch this happen, as the cantons are re-
quired to ensure an adequate supply of inpa-
tient hospital services. Thus, the market will
probably not be given a free hand to reform
Switzerland’s hospital system quite as radically
as envisaged in the amended KVG.
Cantons will have to decide whether to prop
up hospitals as long as they continue to wear
several confl icting hats: Not only do they stipu-
late what services hospitals have to provide as
part of the hospital planning process (this
“service mandate” is necessary for hospitals to
appear on the Hospital List), but they also di-
rectly or indirectly own and operate many hos-
pitals themselves.
Financial assessment
sessed based on the hospital operator’s cred-
itworthiness, not the canton’s. That means
hospital fi nancing will increasingly use the
standard assessment criteria for corporate
fi nance. The reason: The competition-distort-
ing eff ects of public guarantees would run
counter to the new system’s goals. As a re-
sult, investors will have to carefully review
each hospital’s prospects and viability before
providing equity or debt capital.
Hospitals with a strong cost/quality profi le
and attractive catchment areas ought to be
able to easily raise capital for future operations,
despite the various hurdles such as ensuring
adequate capitalization. Poorly positioned,
Source: UBS Corporate Finance Switzerland, Project & Product Development
Illustrated by an example
Canton
Hospital Ltd. or other legal structure
Hospital
Management contract
Markus Wagemann
Wealth Management &
ineffi cient hospitals, by contrast, will run into
diffi culties. The cantons have promised to lend
funds at market rates if private investors do not
provide enough backing. This inherent contra-
diction of the future fi nancing system should
be addressed, however, to prevent the emer-
gence of other structures that distort competi-
tion. It is legitimate to assume, a er all, that all
viable hospitals should be able to fi nd private
investors if they pay market interest rates that
refl ect the risk exposure. This government in-
tervention in the Swiss hospital system will
make it diffi cult for investors and lenders to
evaluate a particular hospital’s competitive po-
sition and market appeal. As a result, all pri-
vately fi nanced hospitals will probably have to
pay a non-transparency premium.
investors
of the Swiss hospital system, we believe this
market off ers attractive opportunities for real
estate investors. If a hospital can tailor its infra-
structure to the medical processes and diff er-
ent space requirements of in- and outpatient
treatment, it can become a cost leader and
achieve superior profi t margins. Not to men-
tion other favorable factors, such as the health-
care sector’s overall growth momentum and
the high entry barriers for new providers due
largely to heavy regulation. Investors, however,
should familiarize themselves with the com-
plexities of the Swiss hospital system and ac-
cept fi nancial models other than the typical
renting model. In this special segment of the
real estate market, other characteristics of suc-
cessful investors include openness and creativ-
ity in providing services that go beyond merely
providing rooms. Investors who put in the
work will be rewarded with the prospect of
attractive cash fl ow yields.
Some key aspects of due diligence
The underlying structure of the Swiss hospital system began to
change years ago. While the number of general hospitals has
dropped sharply, the number of specialty hospitals has stayed steady.
Both segments, however, now treat far more cases with signifi cantly
fewer beds. These concentration and specialization trends should be
considered when investing in hospital real estate. Also, the govern-
ment’s role, its room to maneuver and its future obligations should
be clearly identifi ed. Of course, the Hospital Lists and service man-
dates of the cantons are the main criteria for assessing a hospital’s
market position. Special attention should be paid to how cantons
handle real estate properties. Furthermore, investors should expect
hospitals to focus more on outpatient treatment as they avoid the
cost trap created by diff erences in how Tarmed and SwissDRG rates
pay hospitals for capital expenditures. Nor should hospitals fall below
the critical 100-bed threshold since that would prevent them from
providing their services effi ciently.
Global real estate investments – diversifi cation opportunities abound
The global real estate market is frag-
mented along national and regional lines,
o en making entrance into specifi c mar-
kets diffi cult. Direct and indirect real
estate investment products can overcome
these barriers and they off er attractive
diversifi cation opportunities in a global
economy.
estate accounted for 10 trillion US dollars in
global investment volume at the end of 2009.
Of this very large pie, 39 percent was in North
America, 32 in Europe, and 29 in Asia/Pacifi c.
Besides their relative size, these regional mar-
kets diff er in other ways, too. Each off ers its
own unique blend of liquidity, investable sec-
tors and expected risks and returns. While resi-
dential real estate is the king of the Swiss, Ger-
man and US markets, commercial properties
play a key role in most European countries with
high home ownership rates. Landlord-tenant
laws and leases also vary considerably from
country to country. Leases tend to be shorter
in Continental Europe than in the UK. British
and Irish leases also contain “upward-only
lease review” clauses, which allow rent hikes
to be imposed in periods of economic
strength, but prohibit reductions when times
are tough. In Continental Europe, by contrast,
rents are o en indexed, typically to consumer
price indexes. While this prevents landlords
from maximizing rent revenue in strong mar-
kets, it also protects them against infl ation
over the lease term.
tionally not only can reduce portfolio risk, but
also boost returns. Diversifi cation in general
reduces risk. If investors also wish to increase
returns, they can incorporate other sectors
and stages of investment into their global
real estate strategy. In short, there are many
ways to exploit the diversifi cation potential of
international real estate investments. The
graphic compares 82 country/sector combina-
tions of real estate investments (for example,
French offi ce buildings and German residen-
tial real estate) along with maximum and
minimum total returns between 1995 and
today. The crisis year of 2008 saw the largest
gap between the best and worst performers:
60 percent. In this asset class, unfortunately,
investors cannot move quickly and easily be-
tween countries and sectors. That makes it
especially important for them to be prudent
and farsighted with their tactical and strate-
gic asset allocations.
on the private market or in unlisted funds or
funds of funds. Second, indirect investments
can be made in real estate funds or real estate
corporations that are listed on an exchange.
Direct real estate investments
increase in open-ended, unlisted real estate
funds that regularly issue and redeem shares.
This has led investors to overestimate this vehi-
cle’s liquidity. It should not be overlooked that,
since unlisted funds own real properties, they
are as illiquid as their holdings. On the positive
side for investors, fund units are denominated
and traded in much smaller amounts than ac-
tual properties and so are much easier to buy
and sell. The investment vehicle can only boost
liquidity by holding cash or other liquid instru-
ments, which may dilute the performance of
its real estate portfolio.
Global range of performance opens up diversification opportunities
Sources: IPD; UBS GRE Past performance is not an indication of future returns.
Global range of returns by country/sector, in percent
Global minimum Global maximum
Gunnar Herm
Indirect investments
because they seem more liquid than direct in-
vestments. This is a tempting way to circumvent
real estate’s fundamental liquidity problem, but
it does exact a cost, namely greater volatility. If
the real estate strategy allocates a large share
of assets to listed real estate investments, the
portfolio’s performance may suddenly plummet
as market prices fall. Even though the market
for listed real estate investments is about as
effi cient as global equity markets, it remains
diffi cult, if not impossible, to predict and hedge
against market corrections.
real estate investments, a er adjusting for the
cost of debt fi nancing and the eff ect of setting
prices through an exchange. Unlisted funds gen-
erally fall within these two extremes in terms of
risk and return.
Trends and outlook
lower valuations, however, signifi cantly wid-
ened the gap between real estate returns and
low-yielding government bonds. These gaps
even reached historical highs in some cases,
which, beginning in the second half of 2009,
heartened investors to move back into real
estate, stabilizing property valuations. While
acknowledging the fragile economic environ-
ment in most Western property markets, we
are cautiously optimistic about the future. In
2011, global investment strategies should focus
on maintaining current returns. We do not ex-
pect valuations to rise as sharply as they did
before the global fi nancial crisis. While a minor
correction in the UK is not unlikely in 2011, we
see opportunities in the US and most Eurozone
countries. The focus in most Asian markets is
on value-added and opportunistic investment
strategies. The macrotrend in emerging coun-
tries remains intact, but only sophisticated in-
vestors with strong risk appetites should seek
exposure to these regions, in our view.
Continental Europe appeals
investment’s structure can signifi cantly impact liquidity and short-
term performance. Diversifi cation can be achieved by capitalizing on
the growing “de-synchronization” among global real estate markets.
In other words, diff erent countries are in diff erent stages of the per-
formance cycle. We thus expect commercial real estate markets to
grow at diff erent rates from region to region. The US and Continen-
tal European markets currently off er attractive risk/return profi les.
Asian markets are growing rapidly, but investors there must be will-
ing to take on more risk. Finally, investors who concentrate their real
estate portfolios in Switzerland are shutting themselves off from
nearly 99 percent of the global investment volume in real estate. His-
tory teaches us that diversifying across various Swiss regions is not a
very promising strategy. The reason: Cash fl ows from these regions
are subject to the same macroeconomic parameters such as income,
infl ation and interest rates.
Listed real estate and investment foundations
Indirect Swiss real estate investments are among the winners of recent years.
Real estate equities – on solid ground
Real estate equities performed well in
2010 – partly due to their own merits, and
partly due to a favorable economic envi-
ronment. The coming year looks to be
much tougher, though.
environment of 2010: no overheated markets,
a rapid economic recovery, robust demand and
falling interest rates. Companies also invested
further in their properties, which buoyed per-
formance. Several made up for the corrections
from late 2008 and early 2009 and even
reached all-time highs. Among them were Swit-
zerland’s two leading property stocks: Swiss
Prime Site (SPS) and PSP Swiss Property.
Moderate potential for NAV appreciation
A er strong relative and absolute performance
in 2010, the remaining upside is moderate due
to fair valuations and limited potential for appre-
ciation of net asset value. Long-term investors
can still hold these shares for their attractive
dividend yields, which we expect to remain high
for some time to come. The leading real estate
companies are paying dividends as a return of
share capital that incurs no withholding tax. Our
overall assessment for Swiss real estate equities
is slightly more cautious. Investors should capi-
talize on price dips by adding to their positions.
Real estate is a late-cyclical sector. That means
real estate prices should fall somewhat over the
next two years. However, long residual lease
terms should so en and contain the fallout for
leading real estate fi rms like SPS and PSP: The
average term is four to fi ve years for PSP and an
impressive 11 years for Jelmoli, which SPS ac-
quired in 2009. The largest fi rms’ vacancy rates
of 3.5 to 8 percent should rise slightly in the
upcoming two years.
niches among Switzerland’s large real estate
companies. Allreal generates around one quar-
ter of its earnings by designing and building
properties. We expect it to see more moderate
demand given the decline in real estate prices
and long-term rise in interest rates. However,
Allreal has a large order backlog of 1.7 billion
Swiss francs, or roughly three-and-a-half times
the division’s annual revenue.
Attractive niches
airport infrastructure with robust cash fl ow.
Even with the recession, passenger volumes at
Zurich Airport only dropped 1 percent in 2009.
We expect passenger volumes to grow 5 per-
cent in 2010, and 3 to 4 percent in 2011. In the
short term, recovering global demand for air
travel will drive growth. In the medium term, it
will be fueled by increased retail space at Zu-
rich Airport. The airport has also launched
“The Circle,” a one billion franc property de-
velopment project with attractive long-term
growth prospects, located next to the airport.
With its healthy profi t outlook, Flughafen
Zürich is one of the more attractive real estate
shares in Switzerland.
400
2008 2009 20102001 2002 2003 2004 2005 2006 2007
Spectacular performance likely to settle down Gains including dividends over the last 10 years (2001 = 100)
SPS PSP
Flughafen Zürich Allreal
Sources: Reuters; UBS WMR Past performance is not an indication of future returns.
Stefan R. Meyer
Wealth Management Research
UBS AG
The above does not constitute investment research, a sales prospectus, an off er or a solicitation of an off er for investment transactions.
Listed real estate and investment foundations
170
Positive trend in various markets
Sources: UBS GAM; SXI Real Estate Funds Index; Thomson Reuters; Real estate funds closing accounts Past performance is not an indication of future returns.
Performance of listed Swiss real estate funds (2003 = 100)
SXI Real Estate Funds Index (performance, indexed) Net asset value of market (indexed)
Premium to net asset value, in percent (right-hand scale)
Exchange-traded real estate funds appeal
to investors because they combine fea-
tures of stocks, bonds, and real estate.
This mix is refl ected in the risk/return pro-
fi les of funds, making them an attractive
choice for mixed portfolios.
50 years, in some cases. O en considered bor-
ing and opaque, they have recently experienced
a boom. Investors have included exchange-trad-
ed Swiss real estate funds in their portfolios for
a variety of reasons. Generally, they off er stable
and interesting returns, attractive dividends, in-
vestor protection, regional and sectoral diversifi -
cation, an attractive risk/return profi le and, in
some cases, good protection against infl ation.
Together, these traits enable real estate funds to
trade at a premium (the diff erence between the
trading price and net asset value) in almost any
market.
protect investors. First, funds can only change
the number of units outstanding under special
circumstances, such as secondary off erings. Real
estate funds are regulated by the Swiss Collec-
tive Investment Schemes Act and the Swiss Fi-
nancial Market Supervisory Authority (FINMA).
The funds

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