PwC-Immospektive

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

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

17 November 2023

The Swiss National Bank’s decision not to raise its policy rate in September marked a hiatus in the battle against inflation that has gone on since mid-2022. Many market participants doubt that this heralds the end of the cycle of interest rate increases. In the office space and rental housing markets, the consequences of the high level of inflation over the last 18 months are only slowly becoming apparent, with rising income from existing rental contracts. A further increase in the reference interest rate is expected to come about in the next six months. In addition, rising net immigration is putting great pressure on the rental housing market, particularly in the urban centres, and this pressure cannot currently be relieved on the supply side. Although the production and construction cost indices are showing marked normalisation patterns, no growth is expected in the building construction segment over the next two years. These trends will cause rents to continue to rise sharply for the foreseeable future. The situation in the owner-occupied housing market remains unchanged. Short supply is causing prices to continue to rise steadily. Higher financing costs have so far depressed demand only slightly.

Deceptive stability in the inflation trend

On 21 September 2023, the Swiss National Bank (SNB) refrained from raising its policy rate any further, following five consecutive increases. and left the rate at 1.75% for the time being.¹ While some market observers welcomed the eagerly awaited decision and regard the cycle of interest rate increases as being at an end, others criticised the decision and saw it as inconsistent with regard to combating inflation.² The SNB is forecasting unchanged inflation of 2.2% for the current and coming year, while other central government agencies such as the Swiss State Secretariat for Economic Affairs (SECO) and the KOF Swiss Economic Institute at ETH are slightly more positive about inflation in 2024, putting it at 1.9% and 2.1% respectively [8]. The SNB does not become more optimistic about the situation until 2025 and has revised its forecast from 2.1% to 1.9% as against its assessment on 21 June 2023 [11]. That would bring inflation back within the target range of 0.0% to 2.0% by the end of the forecast period. The reasons given for the reduction in inflation expectations are cheaper imported products as a result of the stronger franc, and a general slowdown in the economy.³ The decision seems especially specific as the last increase was based on the expectation of second-round effects still to be anticipated and rising rents.⁴ The rising rent trend at least will gain momentum in the coming months and is likely to be increasingly reflected in the inflation figures as a driving factor. Economic growth is still expected to be moderately positive. The SNB, SECO and KOF are forecasting growth of 1% for the current year.⁵ While SECO expects growth of 1.6% for 2024, KOF estimates somewhat greater expansion at 1.9% [8]. The Swiss Life and UBS estimates for GDP growth are somewhat more negative than those of the state institutions, with both expecting 0.7% for 2023 and the two firms predicting 1.0% and 1.2% respectively for 2024 [73]. ^{6 7} The western economic blocs are moving from a phase of stagnation to a period of very moderate growth. In the euro area, the estimates from different experts vary between real growth of 0.5% to 1.1% for 2023 and 0.6% to 1.6% for 2024. The US economy is expected to grow by between 1.4% and 2.4% in 2023, while a modest increase of between 0.6% and 1.0% is anticipated for 2024. After a year of steep price rises in 2023, inflation in the euro area and the USA is expected to fall back to lower levels in 2024. The forecasts for both economic blocs are between 2.4% and 2.8% [73].

General conditions increasingly favour rising residential rents

The continuing upward momentum in residential rents remains unchanged. In the last quarter, rents rose by a further +0.5% across Switzerland as a whole. An increase of +0.9% was observed for new-build housing, while older housing fell by –0.1%. The year-on-year increase across Switzerland was +2.6%. The highest quarter-on-quarter and year-on-year rises were recorded in the Lake Geneva region at +0.8% and the Jura region at +4.8% respectively. The southern Switzerland region recorded the lowest growth rates, with a reduction in market rents of –0.7% and –2.3% compared with the previous quarter and previous year respectively [25]. The regional growth rates in net income from multi-family units presented a uniform picture. These were in a range between +1.0% and +1.5% compared with the previous quarter and between +1.0% and +3.1% compared with the previous year. Only southern Switzerland showed a slower rate of change in quarterly terms than in annual terms and thus declining momentum.⁸

On the demand side, growing net immigration in particular is generating an increasing need for housing. In the last two years higher figures have been recorded every month than in the same period of the previous year [13]. That was also true of September 2023, when net immigration was 25.5% higher than the previous year’s September figures, with 10,700 net new arrivals. Net immigration in 2023 is expected significantly to exceed the record set in 2022, when the highest number of net new arrivals since 2008 was recorded, at 81,300.⁹ In Switzerland’s economic centres in particular, where a housing shortage is already to be observed, this trend is to be reflected in rents continuing to go up. In addition, there is expected to be a further increase in the reference interest rate in December 2023 or March 2024. A rise of 25 basis points results in a 3.0% increase in rents. Along with inflation and adjustments to reflect rising costs, tenants will face a further round of rent increases in the coming six months.¹⁰ For landlords, therefore, net income is expected to rise.

On the supply side, there is also no clear reversal in the trend for stagnating construction activity. Although building activity is picking up slightly in certain regions, it has contracted further in others. According to the Credit Suisse construction index and the Schweizerischer Baumeisterverband, the average volume of planned new construction for the last 12 months in the city of Zurich rose above the average for the last 10 years in the third quarter. Planning applications were submitted for over 4,000 residential units. In view of the extremely low vacancy rate of 0.07%, an expansion in construction activity is urgently needed in Zurich. In other Swiss economic centres such as Geneva, Lausanne, Basel and Berne, the number of new building applications has continued to fall. At least one other major centre, Winterthur, recorded an increase in the number of applications for new builds. Overall in the last six months, the volume of planning applications submitted in 63 of the 110 economic regions analysed was above the 10-year average or at the same level. Across Switzerland, the volume in the last six months totalled around CHF 18.8 billion, which is 3.3% above the ten-year average.¹¹

Conversion applications totalled CHF 7.0 billion across Switzerland, which is 15.5% above the ten-year average. A total of 74 of the 110 economic regions recorded above-average project planning activities. The construction index cites two driving forces in this connection that are likely to increase the number of conversion applications submitted. In tourist regions, the rising number of conversion applications is strikingly high. This is likely to be related in particular to the renovation of second homes, as the Second Homes Initiative means that no new second homes can be built in many villages and old ones are therefore being renovated. The second driver is likely to be the increased importance of energy-efficient refurbishment of existing properties. In particular, high energy prices over the last two years have probably focused homeowners’ attention on the need for action.¹²

On the cost side, the production cost index shows a significant reduction in prices for building contractors’ work in building construction / industrial construction, at –11.4% compared with the previous year and –2.9% compared with the previous quarter [18]. The construction price index, which covers market prices for the execution of construction projects more comprehensively than the production cost index, still shows a rising price trend in the first half of 2023, but price growth halved to +4.3% compared with the previous year [19].

Although certain trends such as the reduction in production costs in 2023 are partly positive and the demand for residential space in particular will continue to rise, the construction index forecasts a slight decline in building activity in the residential and commercial markets over the next two years. Only infrastructure construction is expected to see slight growth [16]. Rising revenues in building construction and civil engineering are expected in the near future, owing in particular to inflation and less to increased construction activity. In building construction, neither the number of projects with planning permission nor the number of projects submitted suggests an increase in construction activity. The outlook for the finishing trade is more positive. The increased urgency of energy-efficient refurbishments referred to above is driving up demand for conversions, refurbishments and renovations. The adoption of the Climate and Innovation Act in the summer of 2023 is likely to reinforce this trend in the future, as the new law provides for subsidies for energy-efficient refurbishments such as heating replacement measures, among other things.¹³

“The importance of a well-functioning rental housing market should be emphasised, particularly in view of any future demands from politicians and the public for greater regulation.”

The foundations have been laid for further sharp rises in rents in the housing market. The drivers of this trend set out above can be rectified only in the medium to long term. Owners of existing properties may benefit from increases in their net income. In the short term, however, the situation appears to be disadvantageous for tenants. The importance of a well-functioning rental housing market should be emphasised, particularly in view of any future demands from politicians and the public for greater regulation. The measures in Geneva and the city of Basel show that meeting demands for rents to be set by the state very much discourages investment and is counterproductive in the long term, as lock-in effects lead to reduced tenant turnover and capital investment becomes more complex. Ultimately, this will also slow down the energy-efficient refurbishment of existing properties that is required.¹⁴

Stable to positive trends in the market for office space

In line with their trajectory in the first half of the year, rents in the office market rose by +3.6% at a national level in the third quarter of 2023. In comparison with the previous year, the index is +1.7% higher than the figure for the second quarter of 2023.¹⁵ There are major differences between the various economic centres. While a sharp rise in rents was recorded in the Zurich and Basel regions, with increases of +4.8% and +3.4% respectively quarter on quarter and +4.1% and +4.4% year on year, office rents in Geneva remained stable at +0.3% quarter on quarter and –1.9% year on year following a period of falling rents. In contrast to the Basel region, market participants do not expect the income trend for Zurich and Geneva to be stable but instead see continued growth in income in the future. In addition, initial returns are now expected to fall throughout Switzerland in the future [45].

On the demand side, the KOF Employment Indicator can be used as a leading indicator for trends in the labour market. After a record-high proportion of employers were considering expanding their workforce at mid-2022, this proportion has fallen steadily since then. However, the proportion of employers willing to recruit is still significantly higher than the proportion of companies considering cutting jobs. Market participants are forecasting stable figures for the next quarter.¹⁶ The unemployment rate in Switzerland remains stable. In October 2023 it stood at 2.0% and increased by 4.4% compared with the previous month.¹⁷ KOF and SECO forecast an increase in the unemployment rate to 2.2% and 2.3% respectively for 2024 [8]. The growth in the number of vacancies has been declining steadily since mid-2022, which may be interpreted as an indication of companies’ cautious assessment of the future. In finance and insurance, job vacancies fell by 18.9% in the second quarter of 2023 (more recent figures are not available), which could be linked to factors including the collapse of Credit Suisse. In the information technology sector, the reduction in vacancies was 28.2% [10]. This could be an indicator that companies are putting capital expenditure on digitalisation on hold for the time being in view of uncertain prospects for the future.

Negative total returns foreseeable for office buildings and multi-family units in 2023

After the downward trend in minimum discount rates for multi-family units, which had been observed for a number of years, was brought to a halt in spring 2022 by the turnaround in interest rates and bottomed out at 1.71%, the minimum required rate of return moved rapidly in the other direction and stood at 2.03% in the middle of this year. In the third quarter, the minimum discount rates has steadily increased by five basis points and now stands at 2.08% (in net, real terms) [34, 35].

In line with the movement in minimum discount rates, the downward trend in the market values of multi-family units has also levelled off [27]. While the overall trend over the last 12 months was a steep –11.1%, the rate of change in the last quarter was –0.8%. Even if a positive change in value were to result in the last quarter of the year, the return from changes in value in 2023 (YTD), at –10.7%, is unlikely to come close to being positive by the end of the year. In 2022, investors could still point to a positive return from changes in value of +2.6%. The cash flow return in 2023 (YTD) was stable at +2.9% in the third quarter, which is line with the figure for the previous year. Given the expected negative return from changes in value, the negative total return that was already foreseeable halfway through the year is likely to become a reality for 2023, which would be a first in the last 20 years. While the total return for multi-family units in 2022 stood at +5.5%, the overall performance in 2023 (YTD) was –7.9%.¹⁸

“While the total return for multi-family units in 2022 stood at +5.5%, the overall performance in 2023 (YTD) was –7.9%.”

There are also only slight regional differences in market value trends. With the exception of the Alpine region, which recorded a slight increase of +0.8% in the last quarter, all regions reported negative rates of change. Zurich and Basel brought up the rear with –1.3% and –1.2% respectively. Over the last 12 months, market values have fallen by between –8.0% and –12.0% across all regions. The range for total returns has been from –5.3% to –8.3%.¹⁹

In the more volatile office segment, there are already signs of a trend reversal in 2023 (YTD). The negative rate of change in market values levelled off somewhat in the quarter before last, before returning to a positive trend of +2.3% in the last quarter. Over the last 12 months, the rate of change in market values still stands at –8.3%. The rates of change in net income were positive in the last quarter at +4.3%, which is probably mainly due to the adjustment of rents for inflation under existing contracts. Over the last 12 months, the change was only +0.8%. While the cash flow return of +3.3% in 2023 (YTD) differs only slightly from the cash flow return in the previous year (2022: +3.6%), the return from changes in value, as expected, moved sharply downward compared with the previous year at –8.3% (2022: +8.5%). The total return for 2023 (YTD) is –5.0%, compared with +12.1% in the previous year.²⁰

Differing trends were observed in the office property segment in Switzerland’s various economic centres. In Zurich, a +3.4% quarter-on-quarter change in market values helped to mitigate the year-on-year deficit. Over the last 12 months, this stands at –5.3%. With a cash flow return of +3.0% and a return from changes in value of –7.3%, this results in a total return for 2023 (YTD) of +4.3% (2022: +12.8%). In Geneva, market values have continued to decline, with a rate of change of –1.0% in the last quarter. Over the last 12 months, the figure is –11.2%. Net income rose by +0.7% and fell by –1.7% respectively. The cash flow return fell slightly from +3.9% to +3.5%, while the return from changes in value dropped from +13.2% to –6.9%. The total return therefore amounted to –3.4% (2022: +17.1%). In Basel, net income likewise increased in the previous quarter. The year-on-year trend was stable (0.0%). In terms of market values, Basel is experiencing the same trend as Zurich. At +2.0%, the rate of change in quarter-on-quarter comparisons, negative until recently, mitigated the 12-month comparison of –6.1% to an extent. The cash flow return in Basel is stable at +3.3% (2022) to +3.2% (2023 YTD). As the return from changes in value in Basel was only +0.7% in 2022 anyway, the shock of a negative return of –7.0% in 2023 (YTD) is less severe. The total return fell from +4.0% to –3.8% in 2023 (YTD).²¹

Steadily rising prices for residential property driven by supply-side factors

The growth in mortgage volumes lost some of its momentum in the first half of 2023 (more recent figures are not available). Compared with May 2023, the annual growth rate fell from +3.8% to +3.4% in August 2023. The total volume amounted to CHF 1,166.1 billion [24]. While the SARON variable interest rate remained stable at 1.71% [21], the recent high level of volatility in interest rates on fixed-rate mortgages continued to prevail in the third quarter. The interest rate on a three-year fixed-rate mortgage fell from 2.92% to 2.36%. Five-year and ten-year fixed-rate mortgages showed a reduction from 2.89% to 2.38% and from 2.89% to 2.58% respectively [23]. KOF and SECO expect the SARON interest rate to rise slightly to 1.7% and 1.9% respectively over the next 12 months [20].

The market for owner-occupied residential property again showed a rise in prices. Overall, owner-occupied housing prices recorded a rate of change of +1.7% quarter on quarter and +3.7% over the last 12 months. Prices for single-family units rose by +2.4% compared with the previous quarter and +4.3% over the last 12 months. In contrast, lower growth rates of +0.7% and +2.9% respectively were observed in the owner-occupied apartment segment [57, 58]. Owner-occupied residential property has thus become more expensive every quarter since mid-2018, regardless of what is happening on the capital market or in the real economy. In the last five years, the average price increase across Switzerland has been a hefty +23.4%.²²

“Owner-occupied residential property has thus become more expensive every quarter since mid-2018, regardless of what has happened on the capital market or in the real economy. In the last five years, the average price increase across Switzerland has been a hefty +23.4%.”

There were regional differences mainly in the extent of growth, but not really in the direction of change. The Basel and Zurich regions came out on top with quarter-on-quarter growth of +2.8% and +2.3% respectively. Southern Switzerland recorded the strongest year-on-year growth at +5.0%. This growth is attributable solely to the change in prices for single-family units, as owner-occupied apartment prices in southern Switzerland declined. Southern Switzerland is the only region in which a segment of the residential property market has not experienced positive growth. It is also the only region in which prices have not exceeded the +10% mark over the last five years, standing at +9.5%. Most regions recorded growth of between +18% and +25%, while the Zurich region is clearly out in front with +32.8% growth over the last five years.²³

¹SNB, Monetary policy assessment of September 21, 2023

² Finanz und Wirtschaft, Reactions to SNB’s policy rate decision, September 2023 (German)

³ SNB, Monetary policy assessment of September 21, 2023

⁴ SNB, Monetary policy assessment of June 22, 2023

⁵ SNB, Monetary policy assessment of September 21, 2023

⁶ UBS, Outlook Switzerland, November 2023

⁷ Swiss Life, Perspectives Economics, November/December 2023

⁸ FPRE, Market indices for investment properties, September 2023.

⁹ Staatssekretariat für Migration, Statistik Zuwanderung, September 2023 (German)

¹⁰Neue Zürcher Zeitung, Cost boost for tenants, August 2023 (German)

¹¹Credit Suisse/Schweizerischer Baumeisterverband, Construction index, 3rd quarter 2023 (German)

¹² Credit Suisse/Schweizerischer Baumeisterverband, Construction, 3rd quarter 2023 (German)

¹³ Credit Suisse/Schweizerischer Baumeisterverband, Construction, 3rd quarter 2023 (German)

¹⁴ Neue Zürcher Zeitung, In the free market, residential rents in Geneva have exploded, April 2023 (German)

¹⁵FPRE, Market rent and building land indeces for investment properties, September 2023

¹⁶KOF, Employment indicator, October 2023

¹⁷SECO, The situation on the labour market, October 2023 (German)

¹⁸FPRE, Market indices for investment properties, September 2023

¹⁹FPRE, Market indices for investment properties, September 2023

²⁰FPRE, Market indices for investment properties, September 2023

²¹FPRE, Market indices for investment properties, September 2023

²²FPRE, Transaction price and building land indexes for private property, September 2023

²³FPRE, Transaction price and building land indexes for private property, September 2023.

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