Why home prices are rising despite rising interest rates

When interest rates rise, real estate should become cheaper. In Switzerland, however, there is still little sign of falling home prices. This has to do not least with the changed strategy of many mortgage borrowers.

Residential real estate is still in demand.

Karin Hofer / NZZ

The real estate market is also under increased scrutiny in Switzerland. At the beginning of the year, long-term interest rates started to leave their lows. Since then, and especially since the Swiss National Bank (SNB) also gave a boost to short-term interest rates with its interest rate decision in June, there has been discussion as to when the more than 20-year real estate boom will come to an end or when the market will even collapse.

Willingness to pay should decrease

Because rising interest rates typically put pressure on property prices. If you want to buy your own home and have to pay more interest on your mortgage, you can no longer borrow the same amount of money with the same budget and therefore no longer pay the same amount for a property.

The willingness to pay for investment properties is also falling, because real estate is only attractive to investors if it yields a few percentage points more than risk-free government bonds. In extreme cases, a yield of 2 percent was sufficient in recent years because the yield on federal bonds was negative.

But now you get around 0.5 percent interest again for ten-year Confederates. Accordingly, a property must return at least 3 percent. For this to be the case, a property that generates net rental income of CHF 100,000 must no longer be paid CHF 5 million (equivalent to a 2 percent return), but a maximum of around CHF 3.3 million.

Adjusted for inflation, home prices are hardly increasing any more

So far, however, only investment properties appear to be cooling off on the residential real estate market. According to Fahrländer Partner, prices for apartment buildings fell by 1.6 percent on average in Switzerland in the second quarter. Home prices, on the other hand, continued to rise, according to UBS by around 1.5 percent compared to the previous quarter, according to other data providers by more than 2 percent.

But in contrast to previous years, this price increase took place in an environment of generally rising prices. Because consumer prices also increased by 1.5 percent between March and June. In real terms, i.e. excluding inflation, home prices were more or less constant. The UBS Bubble Index, which measures the risk of bubbles on the Swiss home market, has recently trended sideways.

The Swiss home ownership market remains overvalued

UBS Bubble Index, last reading 2nd quarter 2022, in points

The Swiss home market remains overvalued - UBS bubble index, last value 2nd quarter 2022, in points

Calm down in long-term interest rates

What is the reason for this stability in homes? On the one hand, it is probably due to the fact that the real estate market generally reacts sluggishly to changes. On the other hand, until recently, the demand for homes was so much higher than the supply that a slight decline on the buyer side does not matter at all. Whether twenty buyers are vying for the same object or five does not necessarily have to affect the price paid.

But these are not the only reasons. The interest rate situation has also changed less dramatically for mortgage borrowers than it first appears. Of course, fixed-rate mortgages have become more expensive. Anyone who took out a 10-year fixed mortgage on January 3, 2022 could still do so for an average of 1.2 percent. A good six months later, on June 21, 2.92 percent were already due – almost two and a half times as much.

But since then the situation has calmed down again. Today, 10-year-olds still cost 2.3 percent, which is less than the long-term average. And this could remain so for a while. According to the experts at the mortgage portal Moneypark, more and more factors are indicating that interest rates for fixed-rate mortgages have peaked and could stabilize at the current level for at least the next 18 months. The economic slowdown in particular should slow down the rise in interest rates.

Mortgage borrowers avoid higher interest rates

In addition, nobody is forced to take out a fixed-rate mortgage. As an alternative, there are money market mortgages that are based on the development of short-term interest rates. These so-called saron or rollover mortgages are still dirt cheap with an average interest rate of 0.8 percent. They have not become more expensive despite the increase in key interest rates because the key interest rate is still negative and the banks are based on a base rate of 0 percent.

Money market mortgages are not widespread in Switzerland. At ZKB, almost 90 percent of all outstanding mortgages have been taken out at a fixed interest rate over several years, and the situation at the other banks is likely to be similar. Above all, the associated planning and budget security is appreciated. After all, buying real estate is often the biggest investment or the biggest mountain of debt in life. One likes to have certainty as to how high the expenses are that are related to these debts.

Fixed-rate mortgages still dominate

Mortgage portfolio by product type at ZKB, share in % (as of June 2022)

Money market mortgages (Saron)*

But it looks like there are limits to what mortgage borrowers are willing to pay. At Zürcher Kantonalbank (ZKB), for example, demand for fixed-rate mortgages has fallen sharply in recent months. In return, the bank issues many more money market mortgages that are based on the short-term Saron interest rate. “More than 50 percent of our customers are currently opting for Saron mortgages,” explains Ursina Kubli, Head of Real Estate Research at ZKB. “The ‘insurance’ that a fixed-rate mortgage offers has apparently become too expensive for many.”

The behavior of mortgage borrowers is understandable. It makes a difference whether you pay the bank 9,000 francs a year for a mortgage of 1 million francs (Saron mortgage) or whether it is 25,000 francs.

Saron mortgages are currently booming

Maturities of newly granted mortgage loans at ZKB, share in %

Rollover Mortgage (Saron)

Fixed mortgage 10 years and longer

History speaks for the Saron

However, the strategy is not without danger, because as soon as the SNB raises the key interest rate into positive territory, the interest rates for the Saron mortgages will also rise. However, until these cost as much as the 10-year fixed-rate mortgages do today, it will take a few increases in the key interest rate. The banks are currently calculating with an average margin of 0.9 percent. The key interest rate would therefore have to rise to around 1.5 percent in order to push up the interest rate on the Saron mortgages to 2.5 percent.

As Martin Neff, the chief economist of the Raiffeisen Group, has calculated, it has been financially worthwhile to rely on short-term mortgages at practically every point in the past thirty years. This is because short-term interest rates are only higher than long-term interest rates in exceptional cases.

However, you have to be aware of one thing: the moment you reach your financial limits with the interest rate for your own Saron mortgage, it will no longer be possible to switch to a fixed mortgage because the interest rate will then be even higher will be. So you have to be able to temporarily pay higher interest rates, for example with the help of family loans.

When it comes to risk, go over the books again

From an economic perspective, too, the risks are increasing as Saron mortgages become more widespread. Until now, one could argue that mortgage holders are immune to interest rate increases in the short and medium term because they have their mortgage interest rates fixed for the long term. If more Saron mortgages are now being taken out, this argument no longer applies.

However, the trend towards Saron mortgages can quickly change again. Because unlike a fixed-rate mortgage, you can get out of a Saron mortgage quickly. Switching to a fixed-rate mortgage with the same bank is sometimes possible overnight, but switching to another mortgage provider usually takes a few months.

Now that long-term interest rates have fallen slightly again after their temporary peak in June, one or the other should consider whether a change to a fixed-rate mortgage – perhaps only with part of the debt – is not a good thing in view of the uncertain global situation idea is. A long-term average of 2.3 percent interest is little planning security for debt servicing for 10 years.

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