Swiss Real Estate Market in Good Shape

Switzerland's individual property markets are for the most part well balanced. Supply and demand within the residential market are evenly matched overall, though a closer look at specific segments and regions does reveal a few imbalances. Recovery continues in the office property market. Overcapacities created in previous years are steadily being reduced. There are some initial signs, however, that this highly cyclical market could once again be heading for an excessive expansion of supply. The boom currently being enjoyed by retailers is diverting attention from structural problems in the retail property market and masking the fact that rents are likely to come under pressure during the next downturn. Only the very best locations will then be able to rise above the fight to stay in the market.

According to Credit Suisse's economists, the Swiss real estate market gives little cause for concern compared with its counterparts in other countries. Except in the market for second homes, which shows signs of overheating in various parts of the country, no price bubbles seem to be forming in the Swiss property market.

Strong inward migration provides insurance against any collapse in demand

Supply and demand are just about keeping pace with each other in the housing market. Supply is still being fuelled by the tail-end of the residential construction boom. Although the volume of planning applications and permissions has now started to decline, the record high number of homes already under construction is keeping the market well supplied. More than 42,000 residential units are likely to come onto the market this year. Gradually, the pace of construction activity is falling. On the demand side, there is no danger of an abrupt collapse, despite worries about the future course of the economy. Two things are protecting the market from such a fate. Firstly Switzerland is in the middle of a wave of immigration, particularly from EU and EFTA countries, which is adding a considerable amount of extra demand for housing. Secondly, Swiss households are likely to see their income go up again in real terms this year. Part of this extra money will be spent on housing since spending on housing always correlates closely with income. Historically, households have consistently spent between 16% and 18% of their income on housing costs.

Despite the fact that the market is absorbing the new homes without much difficulty on the whole, signs of growing disparities should not be ignored. The single-family dwelling segment appears to have reached the saturation point, and the number of vacant houses is rising. Longer advertising periods signal that apartments with four rooms or more are also hitting absorption problems. In the urban centers, by contrast, we may well see a shortage of homes, since this is where demand from immigrants is concentrated. With supply failing to keep pace with demand around Lake Geneva, the housing market throughout this region is also looking tight.

Threat of a new supply overhang on the office property market?

Last year's sharp rise in office-based employment helped to further reduce the current excess supply of office space. Even without new impulses, economic activity in Switzerland still has enough momentum for the Credit Suisse economists to be predicting a further rise of 22,000 office-based jobs this year. Given the stable number of approved construction projects, this should mean that the amount of vacant office space will fall again in 2008. No sooner vacancy rates return to moderate levels following the supply overshoot of 2002 and 2003 than the next cycle already threatens. The first sign of this is the leap in planning applications seen over the last year - and these figures do not yet include the many projects that are being planned but are still to reach the application stage. Switzerland's two biggest office property markets are experiencing contrasting situations. While the city of Zurich still offers about 250,000 m2 of vacant office space (4.6%), only 36,000 m2 is waiting for tenants in Geneva (1.1%).

One swallow in retail trade does not make a summer in the retail property market

With consumer sentiment riding high, retailers are currently doing a roaring trade. However, there is a danger that this boom will divert attention away from structural imbalances in the retail property market. Over the long term, sales growth probably won't keep pace with the expansion in retail floorspace. Switzerland's 1.6 m2 of retail space per head is the highest in Europe, and the Swiss market is saturated. The high volume of new floorspace being produced has also prompted a flood of conversion and renovation activity. As a result, the main feature of the retail property market remains the fierce competition that is pushing some players out of the game. As margins are squeezed, only property in prime locations can survive this struggle. Consequently the gap between prime sites and peripheral locations is widening.

Diversification opportunities provided by indirect investment in real estate are still underused
The wisdom of adequate diversification applies as much to property as to any other form of investment. A property portfolio needs to be well diversified in terms of both geography and usage. However, many pension funds simply do not have a sufficient geographical spread of real estate. Smaller pension funds in particular seem to take on excessive concentrations of risk, with two-thirds of their direct property investments located in a single municipality. Securitizing investments like these, i.e. adding them to a wider selection in exchange for shares in the overall portfolio, may offer better diversification and reduce the risk of fluctuating yields.

Source: The FINANCIAL