The real estate boom is faltering

Demolish a single family home and build a block of five rental units on the same site. According to this principle, many homeowners were able to improve their income or their old-age provision up until the turnaround in interest rates. Anyone who took out a one-percent fixed-rate mortgage of three million francs could earn around 100,000 francs more with annual rental income of 130,000 francs before taxes and maintenance.

If the project with the five condominiums were implemented today, the owner would have to pay almost 100,000 francs in interest. Together with the maintenance, the project would become a loss-making business.

Gone are the days when it was worth buying an apartment with your savings and then renting it out, says Donato Scognamiglio, partner at the real estate consultancy Iazi: “There’s no other way to put it: buy-to-let is dead .»

These are just two examples of how high inflation, the reaction of central banks and the capital market are increasing the pressure on the real estate market. The various market segments react differently to the new situation – an overview.

Home ownership: Escape to Saron mortgages is becoming less and less effective

At first glance, the market for owner-occupied homes appears unshakable: According to the latest Real Estate Monitor from Credit Suisse (CS), in the second quarter prices for condominiums rose by 7.3 percent year-on-year and those for single-family homes by as much as 8.8 percent. And this despite the fact that the interest rates for ten-year fixed-rate mortgages had already risen to over three percent at times in the middle of the year.

Despite this high level of resilience, the rise in interest rates will not leave the home market unscathed. The CS writes: “It would be wrong to believe that the significantly increased mortgage interest rates would not have an impact on the demand for home ownership.” The excessive demand for houses and apartments is measurably decreasing. When selling a residential property, brokers can currently select between 3 and 4 prospective buyers per property, while in the past it was 15 to 20.

In recent months, many new homebuyers have taken refuge in Saron money market mortgages, which, with interest rates of less than 1 percent, were still much cheaper than fixed-rate mortgages, which were determined by capital market yields. This flight to the Saron is working less and less: After the Swiss National Bank (SNB) raised the key interest rate to 0.5 percent, the cost advantage of the Saron mortgages compared to the secured fixed-rate mortgages is shrinking. Together with the banks’ margin of around 0.8 percentage points, interest rates on money market mortgages will be well over one percent.

Existing homeowners who will have to renew their fixed-rate mortgages in the near future are also directly affected by higher interest rates. Depending on the interest rate at which they took out their original mortgage, they now have to tighten their belts – according to the expert Scognamiglio, very few people are likely to want to sell their own home. “Most will brace themselves against the wind. To a certain extent, the crash takes place in the wallet.”

Forced house sales become an issue above all when couples get divorced and can no longer afford the higher interest costs. The same applies to losing a job, says Scognamiglio.

He expects stagnating prices on the residential property market, CS with a “significantly lower price dynamic”. The boom is over. However, due to the scarce supply, both consider major corrections to be unlikely, unless inflation continues to get out of control or the economy corrects sharply. According to Scognamiglio, the fact that homeowners have to add equity due to sharply falling prices is currently not an issue. The situation on the market for investment properties is more critical.

Investment properties: The yield differential is shrinking – properties in second locations are coming under pressure

Unlike private homeowners, institutional investors such as pension funds always have to align their real estate portfolio in such a way that it yields an additional return compared to so-called risk-free government bonds. Now that yields on ten-year «Confederates» are back above 1.4 percent, the real value of rental income is falling and buyers of residential and commercial properties are less willing to pay – even if their rents are often linked to inflation to a certain extent . The CS real estate experts write: “Although real estate investors are likely to be reluctant to switch to bonds for the time being (. . .), real estate investments have nevertheless lost their irresistibility.”

According to Scognamiglio, it is primarily the prices of investment properties “in second-rate locations” that are coming under pressure. These are already coming onto the market at a discount. However, large real estate companies would hardly post any discounts when valuing their existing properties.

Real estate funds: Prices that have fallen sharply are already offering entry opportunities again

The economist Klaus Wellershoff recently described the price development in real estate funds as a “bloodbath”. The real estate fund index of the Swiss stock exchange Six has lost a fifth of its value since the beginning of the year. That’s because investors in exchange-traded funds can react much more quickly to changes in the interest rate and inflation environment than in directly held real estate.

Institutional investors, who have to stick to fixed quotas for the various asset classes in their portfolios, were understandably the first to sell these funds when the share of real estate had become too large due to the sharp corrections on the stock market.

The price losses in real estate funds certainly offer entry opportunities for investors willing to take risks. Some of the funds are now even showing discounts in the double-digit percentage range, which means they are trading below the net asset value of the properties held.

According to Scognamiglio, investors could theoretically even use this fact to buy and cancel these funds. In this scenario, based on the applicable regulations, they received back 100 percent of the net asset value less a flat-rate processing fee of four to five percent, provided the fund operators did not adjust the valuation of their portfolio downwards in the following year. “That would then be arbitrage, but the industry does not like to talk about this possibility, as it rather assumes that prices on the stock exchange will rise again during this time and that the arbitrage window will close.”

Foreign real estate markets: Switzerland is in a better position

Although the Swiss real estate boom is faltering, the local market is considered relatively robust compared to other countries. The restrictive requirements for granting mortgages protect the market from a price collapse, which is already happening in many countries.

Because if you want to buy a residential property in Switzerland, you have to meet high requirements. For example, the costs of mortgage interest and ancillary costs may not amount to more than a third of gross income. Each mortgage borrower must provide 20 percent of the purchase price in the form of equity. At the same time, if the real estate market threatens to overheat, the Federal Council can oblige banks to hold more equity, which it has already done.

Real estate professor Roland Füss from the University of St. Gallen says that in the current environment, Switzerland is benefiting from the affordability regulations for mortgage borrowers that were enacted in the past. Together with the rapid reaction of the SNB to the increase in inflation, it is to be hoped that the local real estate market will survive the turnaround in interest rates with a black eye. “In France, for example, I have much greater concerns for the home segment.” The loose financing practice of the banks in Germany in the past will probably boomerang in the medium term.