Interpretation of the FPRE real estate meta-analysis for February 2023

References to FPRE graphics in our text are marked with ‘[1]’ etc.

17 February 2023

The Swiss real estate market seems to have put most of the turbulence of 2022 triggered by the war in Ukraine and the turnaround in interest rates behind it. Although investor behaviour continues to be marked by uncertainty, the trends towards normalisation that set in during the previous quarter are continuing. This applies in particular to the industries upstream of the real estate sector. In the last quarter, only the ending of China’s zero-Covid policy was registered as an unexpected demand shock on the energy markets. Furthermore, high net immigration, generated by labour shortages and continuing low unemployment levels, as well as by the admission of Ukrainian refugees, is putting pressure on residential real estate markets. While the demand situation in the office segment appears to be less easy for investors to gauge, a further jump in the policy rate will once again bump up expected yields and negatively impact market values. Home ownership is still in high demand. However, the first signs of a flattening in prices can be seen, particularly for owner-occupied apartments.

Trends towards normalisation continued in the fourth quarter of 2022

While the coronavirus crisis was still the dominant issue at the beginning of 2022, it seemed to have receded well into the distance by the end of the year. From spring 2022, economic trends were dominated by the energy price shock triggered by the war in Ukraine and by the interest rate turnaround necessitated by the rapidly rising inflation rate. Although the trends towards normalisation visible in the third quarter of 2022 continued in the fourth quarter, they were made even more complex to analyze by the cancellation of the zero-Covid policy in China.

With a figure of 3.5% in the second quarter of 2022, inflation peaked for the time being. Over the year as a whole, Switzerland recorded an inflation rate of 2.8%, which was gratifyingly low compared with other industrialised countries.1 Given a constant policy rate at 1.0%, the SNB forecasts inflation rates of 2.4% and 1.8% for 2023 and 2024 respectively. This means that inflation is expected to return to the target range of 0–2% in 2024 [11].2 Experts are forecasting modest GDP growth (in real terms) of 0.7% in 2023, while moderate growth of 1.8% (in real terms) is expected in 2024. In the euro zone, GDP is expected to grow in real terms by 0.6% and 1.1% in 2023 and 2024 respectively, with inflation of 6.2% and 2.6% forecast, according to the experts of Swiss Life. In the USA, inflation-adjusted economic growth of 0.4% and 0.8% for 2023 and 2024, respectively, is predicted. Inflation is expected to be 3.9% and 2.5% respectively [8, 73].3 The two largest Western domestic markets as well as Switzerland will thus have to cope with modest growth prospects in the next two years.

Continued normalisation of construction cost inflation

The production cost index continued on the strong downward trend of the previous quarters and is currently back in the pre-pandemic range of +/–4.0% per year. In the fourth quarter of 2022 the index for building and industrial construction showed a change of –8.5% compared to the previous quarter, which equates to an annualised index change of 2.8%. The inflation rates for stone and concrete construction for multi-family and single-family homes decreased by –3.7% and –3.9% respectively compared with the previous quarter. The index in this segment stands at an annual inflation rate of 3.6% and 3.5% respectively [18]. By contrast, the construction price index – which lags behind the production cost index – has not yet passed its peak, although the growth rate has slowed noticeably. In the second half of 2022 the index for multi-family units recorded a change of 3.4% against the previous half, while an annualised inflation rate of 8.2% was still to be observed. In the office segment, the annual inflation rate was still 9.5%. The change on a half-year basis stood at 3.7% [19]. In terms of construction activity, moderate growth of 0.7% and 1.4% respectively is still expected for the next two years [16].

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Further rise in residential rents due to the increase in the reference interest rate

Rents for new-build apartments rose by 0.6% in the last quarter, while rents for apartments in existing buildings fell by –0.3%. Taken together, residential rents held steady quarter on quarter with an increase of 0.1%. Over the past 12 months, the index for residential rents is at +0.9%. During this period, apartments in existing buildings (+1.4%) showed stronger growth than new-build apartments (+0.5%).4 In line with trends at the national level, the Zurich region saw rent increases flattening off. While growth of 2.3% was recorded over the last 12 months, rents rose by just 0.4% in the last three months. The same effect was seen in the eastern Switzerland region (quarter on quarter: 0.5% / year on year: 1.1%), the Alpine region (1.1%/1.3%) and the Mittelland region (0.0%/0.3%). In some regions the trend actually switched from positive growth to a reduction in rent levels. That is true of the Lake Geneva region (–0.3%/1.1%) and southern Switzerland (–2.4%/0.9%). In contrast, slight rent increases were observed in the Basel (0.4%/–2.1%) and Jura (0.6%/–1.9%) regions, compared with an overall fall in rents in the last 12 months [25]. A majority of market observers expect rents to rise in the coming months [30]. This is likely to be related not least to the increase in the reference interest rate expected in 2023. Forecasts from ZKB are for a first step from 1.25% to 1.50% to be made in the first half of 2023, which would mean an increase in rents of around 3% for rental contracts affected.5

Post-pandemic peak in office rents has passed

The negative trend in office rents that began in the third quarter of 2022 was accentuated in the fourth quarter of 2022 with a change of –3.1% (third quarter of 2022: –0.3%). Over the year as a whole, slight growth of 1.1% was recorded thanks to a strong first half. However, there are relatively significant regional differences. While the Lake Geneva region saw a –1.7% reduction in office rents in the last quarter, there was a significant 8.2% increase in rents over 2022 as a whole. The southern Switzerland region shows a similar trend, with –4.9% in the final quarter and 6.6% over 2022 as a whole. The Basel (–4.5%/–7.7%), eastern Switzerland (–4.4%/–1.1%) and Mittelland (3.1%/–0.2%) regions all reported declines both in the final quarter and over the last 12 months. The trend in the Zurich region (–3.0%/0.6%) showed similar stability to that in Switzerland as a whole, although the high level of mutual interaction should not be overlooked. No analysis was available for the Jura and Alpine regions [38].6 According to the FPRE analysis, a majority of the real estate investors surveyed expect a downturn in office rents over the next 12 months. Assessments are slightly gloomier than in the first half of 2022, but more optimistic than at any time since the beginning of the coronavirus crisis [48]. The reduction in vacant office space in Switzerland observed for the third quarter in succession appears somewhat contrary in this context [43].

The employment indicator, which is important for trends in the market for office space, showed stabilising tendencies towards the end of the year and at the beginning of the new year after a slight dampening effect in the third quarter of 2022, but is not yet back at the all-time high seen in the first half of 2022. The KOF Swiss Economic Institute business surveys revealed that a majority of companies consider the current number of employees to be too low. In addition, the proportion of companies planning to fill additional positions in the next quarter is higher than the proportion planning to shed jobs.7 In line with this, the State Secretariat for Economic Affairs (SECO) expects the unemployment rate to remain low at 2.3% in 2023 and to increase slightly to 2.4% in 2024 [8].8 The historically low number of construction projects is likely to have the effect of putting pressure on the market for office space. In the city of Zurich, for example, the construction volumes approved in the last 12 months, at CHF 112 million, are far below the long-term average of around CHF 320 million.9 This can be interpreted as a sign that investors currently see a high degree of uncertainty in their assessment of performance prospects in the office space segment.

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Continuing downward trend in the market value of investment properties

After the minimum discount rates increased significantly in the second and third quarters of 2022 in the context of the sharp rise in the policy rate over the course of 2022, this trend flattened out noticeably in the fourth quarter of 2022. For multi-family units in prime locations, expected yields increased from 1.86% in the previous quarter to the current rate of 1.91% (net, in real terms) [34, 35] according to leading valuation firms. However, market values for multi-family units are still on a downward trend. Compared with the previous quarter, negative growth of –2.8% was observed. Over the last 12 months, a downward trend in market values in the order of –4.5% has been recorded [27]. In the commercial sector, market values of office properties were down for the second quarter in a row with –4.6% in the fourth quarter of 2022 [40].10 These figures underpin the trend reversal from a seller’s market to a buyer’s market that has been the talk of the real estate sector recently.

The total return (based on an annual average net return and market value comparison to 2021) for multi-family units averaged 5.5% in 2022, the same level of return as in 2021. Thus, a year that started out strong and had some unexpected twists and turns was brought to a conciliatory close. As in 2021, the total return was divided roughly equally between the cash flow return and the return from appreciation in value, at 2.9% and 2.6% respectively. Regionally, the Zurich and Lake Geneva regions came out top in 2022 with total returns of 6.7% (2021: 6.8%) and 5.7 % (2021: 4.9%). The eastern Switzerland, Mittelland and Basel regions, with figures of 5.0 % (2021: 5.5%), 4.8% (2021: 4.9%) and 4.0% (2021: 5.1%) respectively, likewise recorded solid returns. A more sluggish performance can be seen in the Jura, Alpine and southern Switzerland regions at 2.9% (2021: 5.2%), 2.8% (2021: 3.4%) and 2.5% (2021: 2.8%) respectively.11

Due to a strong first half of the year the total return of office properties showed a strong performance of 12.1% last year (2021: 6.7%). This comprises a cash flow return of 3.6% (3.6%) and a return from appreciation of 8.5% (3.1%). The strong performance in the office segment was not limited to the commercial hubs of Lake Geneva and Zurich, which posted total returns of 17.1% (2.0%) and 12.8% (11.2%) respectively. Southern Switzerland, Mittelland and eastern Switzerland likewise posted strong growth in returns of 13.4% (9.1%), 10.1% (0.1%) and 8.4% (7.7%) respectively. By contrast, Switzerland’s third-largest commercial hub, the Basel region, recorded lower growth in 2022 at 4.0% (2.1%). No figures were available for the Jura and Alpine regions.12 According to FPRE, surveys of real estate investors show that the market values of office properties will remain under pressure in 2023, both in Switzerland as a whole and in all regions. Values are not expected to stabilise until 2024 [44, 45].

Prices for residential property continue to rise in all segments

Irrespective of trends on the financial markets, the volume of mortgage loans in Switzerland has been rising steadily for the past ten years, reaching a total volume of CHF 1,145 billion in November last year. This is around 3.9% higher than the previous year’s figure [24]. In contrast to the trend in the volume of mortgage lending, mortgage rates experienced the greatest turbulence of the past decade last year. As a result of the SNB’s sharp increases in its policy rate in 2022, the interest rate on a three-year fixed-rate mortgage shot up from 1.82% in mid-2022 to 2.46% in autumn 2022, before ending at 2.60% as per February 2023. For five-year and ten-year fixed-rate mortgages, rates jumped from 1.99% via 2.70% to 2.67% and from 2.40% via 3.08% to 2.86% respectively [23].

The overall development on the residential property market did not show any marked changes in the last quarter. While the price index for single-family homes rose by 1.5% in the penultimate quarter, it increased by another 0.9% in the last quarter. Overall, the price increase for single-family homes over the past 12 months was 5.2%, with the dynamics within the various price segments for single-family homes remaining unchanged compared with the previous quarter. The premium end of the market showed the highest year-on-year change, at +6.2%. This was followed by the mid-range and low-price segments, with figures of +4.2% and +4.0% respectively. Compared with the previous quarter, the price increase did not exceed +1.0% in any of the segments [58]. Despite a sharp rise in financing costs, there was (still) no trend reversal in the prices of single-family homes in 2022. However, an analysis of market participants’ price expectations for the next 12 months conducted by the HEV Switzerland and FPRE makes interesting reading. The share of answers, that expect rising prices over the course of the next twelve months, has sharply decreased [61].

Price momentum in the residential property market was even more pronounced in the owner-occupied apartment segment than in the single-family home segment. Across all segments, price growth reached 7.0% in 2022. The development in the individual segments is as follows: the premium segment is the top performer year on year (+8.4%). This is followed by the mid-range (+5.6%) and low-price (+5.5%) segments. However, a comparison with the previous quarter indicates a cooling growth trend. Price levels in the mid-range and low-price segments declined (–0.7% and –0.3% respectively), while the premium segment still showed positive growth of 0.9% [64]. In a similar way to the analysis in the single-family home category, market participants’ price expectations for the coming 12 months foresee less steep price increases for the first time in five quarters [67].

The steady rise in residential property prices, coupled with a significant change in the general conditions in 2022, supports the theory espoused by economists at Credit Suisse, which was noted in the last issue of PwC Immospektive, according to which only the demise of the baby boomer generation will ease the situation on the demand side of the owner-occupied housing market.13 From the current perspective, no easing on the supply side can be expected because of planning laws. An article by Swiss Life argues that a Switzerland of ten million inhabitants would still be feasible with the existing building zones. However, it is noted that single-family homes and terraced houses are likely to become scarcer and may tend to be replaced increasingly by multi-family units.14

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1Federal Bureau of Statistics, Press release / January 2023

2SNB, Monetary Policy Assessment / December 2022

3Swiss Life Asset Managers, Economic perspectives / February 2023

4FPRE, Market rent- und building land indices of investment properties for Switzerland (Data status: 31.12.2022)

5ZKB, Real Estate Now / November 2022

6FPRE, Market rent- und building land indices of investment properties for Switzerland (Data status: 31.12.2022)

7KOF, Employment indicator / February 2023

8SECO, Economic forecast / December 2022

9Credit Suisse, Office space market study 2023 / December 2022

10FPRE, Market indices for investment properties (Data status: 31.12.2022)

11FPRE, Market indices for investment properties (Data status: 31.12.2022)

12FPRE, Market indices for investment properties (Data status: 31.12.2022)

13Credit Suisse, Resilient property market / September 2022

14Swiss Life Asset Managers, Real Estate to go / January 2023

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Sebastian Zollinger

Sebastian Zollinger

Director, Head Real Estate Advisory, PwC Switzerland

Tel.: +41 58 792 28 87