Real Estate Outlook – Switzerland, Edition May 2024

The high demand on the housing market, the resulting rental growth and the reference interest rate mechanism have supported capital values on the Swiss real estate market in the higher interest rate environment. The recovery in risk premiums and (further expected) interest rate cut(s) should help the market regain momentum.

Kerstin Hansen, Research Analyst – Real Estate DACH

SNB initiates interest rate turnaround, brightening of economic conditions expected in 2H24

After the Swiss economy grew at an above-average rate of 2.7% in 2022 due to pandemic-related catch-up effects, significantly lower growth of 0.8% was recorded in 2023. This was mainly due to a weaker industry performance – driven also by the economic slowdown in neighboring European countries. The unemployment rate has gone up from the minimum of 1.9% in spring 2023 to a still low 2.3% in March 2024. Total employment still grew by 70,400 full-time equivalents.

Also, thanks to the solid employment situation, private consumption was stable in 2023, supporting particularly the services sector of the Swiss economy. The bifurcation of the economy remains evident in the current purchasing manager index (PMI) results. At the same time, the industry PMI at 41.4 points sits below the growth threshold of 50 points for five quarters now, the services PMI shows robustness at 55.6 points. With the service segment continuing to serve as the motor of the Swiss economy, growth is expected to be 1.3% in 2024 and 1.5% in 2025.

Inflation has come down significantly compared to the peak in the summer of 2022. In 2023, annual inflation was still 2.1% on average, but back in the Swiss National Bank’s (SNB) target range of 0 to 2% since June. In April 2024, headline inflation came in at 1.4% and core inflation at 1.2%. Since February 2024, the price of domestic goods has also dropped below the 2% threshold. In view of the strong decline in inflation numbers, the SNB initiated the interest rate turnaround on 21 March 2024 and lowered its key interest rate from 1.75% to 1.5%. Two further rate cuts of 25 basis points each are currently expected for the remainder of 2024 (see Figure 1).

Figure 1: Inflation, core inflation and SNB policy rate

Sources: Refinitiv; SNB; UBS CIO GWM, May 2024.

Higher risk premiums lead to more market momentum
Prior to the aforementioned turnaround, the increase in the key interest rate by a total of 250 basis points between September 2022 and June 2023 has changed the environment for real estate investment drastically. With some delay, prime yields on the real estate market have adjusted to the new conditions. For residential and office properties, by 4Q23, initial yields in the prime segment have increased by 65 basis points compared to their absolute minimum in 2Q22. The net initial yield on prime retail space, which recorded much less momentum in the years before the interest rate turnaround, rose by 50 basis points over the same period. As the 10-year government bond yield came down, the real estate risk premium rose back to around 150 basis points in 4Q23, approaching its 25-year average of 170 basis points.

With risk premiums rising, the transaction market is likely to pick up again too. Due to the disagreement between buyers and sellers regarding a reasonable price level, transactions had literally come to a standstill over the past two years. In the residential segment, which is supported by a very strong user market, the correction in yields has slowed significantly, pointing to a bottoming out. Even though portfolio valuations are lagging behind slightly, the combination of the bottoming out, the interest rate turnaround and decreasing denominator effects should help the real estate transaction market to gain momentum again.

Strong demand growth drives up asking rents
Demand on the Swiss rental housing market continues to rise sharply. With net immigration of 98,900 people, the 2023 figure was only slightly below the 2008 record level. In the first three months of 2024, net immigration already reached around 21,500. At the same time, supply expansion remains depressed. At just under 32,700 residential units, annual building permits in 2023 were around one third below the long-term average.

With 9,300 permits in the first quarter, the start of 2024 does not indicate a strong trend reversal either. As a result, vacancies continue to fall, which in turn drives up rents. In 1Q24, asking rents rose by 6.3% YoY across Switzerland (see Figure 2). Regions with exceptionally high demand such as eg, Zurich recorded double-digit rental growth. On top of that, in-contract rents have risen as a result of two 25 basis points steps in the mortgage reference rate each in June and December 2023 to now 1.75%. The mortgage reference rate links to the average of all interest rates applied to mortgages in Switzerland.

If this rises, residential property owners can adjust rents. A further increase in the reference interest rate is currently no longer expected. However, due to continued strong household growth and record low construction activity, the vacancy rate is expected to drop below 1% in 2024. Thus, rents should continue to grow strongly. The increasing shortage and high rental growth are likely to lead to a further increase in the number of policy initiatives aiming at regulating the rental housing market. While around 30% of the Swiss rental housing stock is already subject to some type of regulation (cost rent, right of first refusal or rent control), this share could increase to about 50% if all currently planned additional measures are put into force¹. This in turn would however further reduce the incentives to construct new housing and thus exacerbate the housing shortage.

Figure 2: Annual growth rates advertised rents (%, YoY)

Source: Wüest Partner, 1Q24.

Polarization of commercial real estate sector
While the rental housing market is characterized by scarcity more or less across the country, the situation of commercial real estate varies greatly depending on the location and quality of the property. Office space demand has changed significantly over the past four years due to home office and hybrid working models. Compared to other countries, Swiss companies have, however, a significantly higher office presence.

Moreover, the effects of the current economic slowdown stay within reason due to the stability of the labor market. As a result, the supply ratio only increased marginally from 4.5% in the previous year to 4.6% in 2023. However, the polarization observed on international office markets is also evident in Switzerland. Hybrid work models reduce the space needed per employee. For the space demanded, however, quality requirements are way up.

As companies want to attract and retain employees in times of a labor shortage, there is strong demand for easily accessible, modern and sustainable spaces. Secondary assets, on the contrary, increasingly experience difficulties in rental negotiations. This is also reflected in the development of rents: while prime rents (of top objects in prime locations in Zurich or Geneva) in the office sector rose by 5.9% YoY in 1Q24, average rents fell by 3.1%.

The picture in the market is similar for retail space: despite currently poor consumer sentiment and declining retail sales, retail spaces in central, well-frequented locations continue to record solid demand and rental price growth. The popularity of prime locations is supported also by the return of tourists: with 41.8 million overnight stays, 2023 was not only a further recovery from the Corona-related slump, but a new record high for the Swiss hospitality industry.

Positive rental prospects support property values
The rise in interest rates has also led to corrections in the Swiss real estate market in 2023. Compared to many international real estate markets, due to the lower rise in interest rates and solid fundamentals of the user markets, the value corrections of -1.7% across all segments in Switzerland were however very moderate. The situation on the rental market was particularly supportive for the residential segment. While residential real estate lost 0.9% in capital values in 2023, the correction in the office (-2.6%) and retail (-2.5%) segments was almost threefold.

The focus on user markets that characterizes the Swiss valuation system compared to systems which are strongly oriented towards transaction markets means that the value corrections are more moderate compared to other countries but are also likely to drag on for a little longer. In the commercial segment in particular, the corrections should therefore continue in 2024 with -1.8% for office spaces and -1% for retail spaces. The very positive prospects for rental growth on the residential market are likely to turn capital growth of residential real estate positive again already in 2024, with an appreciation expected to be almost neutral at +0.4%.

While capital value growth was elevated due to the high investment pressure during the negative interest rate period, this is currently no longer expected. Income return and with that active asset management ₋ especially when sustainability factors are taken into account ₋ are therefore clearly slipping to the center of investment management.

1 Details can be found in the publication UBS Real Estate Focus 2024.