Demand for real estate fueled by demand drivers

Economic growth and income are two of those drivers. UBS is expecting growth rates of over 2% in the next two years, significantly higher than historic averages, with positive effects on real estate prices. International studies show that high economic growth rates lead to a corresponding increase in housing spending; according to UBS, a 1 percent increase in income should lead to an increase in housing spending of slightly less than 1 percent. Historically low interest rates are a second key demand driver. Although UBS expects inflation to rise in 2011 and the Swiss National Bank (SNB) to hike interest rates by 0.25% in the first half of the year, real estate financing should remain cheap, as borne out by real estate prices.

Demand is also driven by demography: Switzerland's population has grown vigorously for the 33rd year in a row. The free movement of persons from the EU-17 and EFTA member states instituted in June 2007, has obviously left its mark. At the same time, employment has grown, further stimulating the domestic market. Housing demand, especially for single-family homes, should remain strong; prices will only soften if residential construction steps up significantly.

Regional overheating

According to UBS, the Swiss property market began its rise in 1998.  Condominium prices have climbed 56 percent since then, while single-family home prices have gained 37 percent. Disposable income has also risen sharply over the same period, so the affordability of single-family homes has remained more or less stable, with a few regional exceptions.

Prices for single-family homes have more or less doubled in the Bern area over the last 24 years.  If real estate prices continue to rise at their present rate, Lake Geneva prices would sextuple in 24 years. These price trends are not sustainable.  The same applies to the communities surrounding Lake Zurich and Lake Zug, and several high-end resort areas south of the Alps.

In more peripheral areas, UBS believes that rents will be squeezed since peripheral locations are mainly used for cost-sensitive back-office functions. The potential for rent increases in the retail sector is also limited. Only high-end locations and well-managed properties should rise above the flat rental trend.

Rising interest rates mean negative price trends for indirect real estate investments

According to UBS, Swiss real estate equities performed well last year thanks to contained price increases, rapid economic recovery, falling interest rates and robust demand. Companies also invested in their properties.

UBS Research expects this year to be significantly more difficult. The low interest rate environment is currently still very favourable to real estate funds. However, if interest rates rise in 2011 as UBS expects, they will bring down the price of real estate funds, at least in the short term.