Chief Investment Office WM 2018

Real Estate

Focus

Chief Investment Office WM

2018

UBS Real Estate Focus 2018

Editorial

Dear reader,

To this day, spinach enjoys the reputation of being a miraculous source of iron.

For this reason, generations of children have been and still are repeatedly

forced to eat the green leafy stu. This myth is based on an error, the origin

ofwhich goes back over 100 years. A scientist at that time is said to have made

a mistake with the decimal point, which attributed to the vegetable ten times

its actual iron content. The iron content of spinach is a prime example of an

error that has been disseminated without challenge and thus has become

taken for granted.

The debate surrounding fully autonomous vehicles and their impact on the

realestate market shows some parallels with the spinach legend. In this case,

itis not a matter of the undisputed iron content of such vehicles, but rather

the one-sided manner in which the debate is being conducted. As in the case

of the iron content of spinach, hardly a single analysis allows for any doubt

that we will soon be traveling around in fully autonomous vehicles. It is beyond

question that the assistance systems are becoming ever more sophisticated,

thanks to technological advances. But in reality, it is still far from certain

whether and, if so, how private road transport can be fully automated. The

visionaries also seem be in agreement about the impact of fully autonomous

vehicles on the property markets, advising us to align our real estate invest-

ments accordingly as of now. A recommendation which is in our opinion (still)

being made on shaky grounds.

The special theme of this year’s UBS Real Estate Focus does indeed deal with

tomorrow’s mobility and its consequences for the property markets. But so that

in facing today’s challenges you don’t have to consume a regular ration of

spinach like the cartoon gure Popeye, we have also focused again this year on

the market trends which are currently the most important ones for you.

We hope you nd this an engaging read.

Daniel Kalt

Chief Economist Switzerland

Claudio Saputelli

Head Global Real Estate

4 UBS Real Estate Focus 2018

Content

6 Change in mobility

Not a game changer

8 Accessibility

Access to activities is key

10 Autonomous cars

Revolution in the real estate

market?

12 Condominiums and single-family

homes

Footprints keep shrinking

16 Apartment buildings

No longer at any price

20 Mortgages as an asset class

More money from institutional

investors

23 Investment crowdfunding

Higher returns with higher risk

UBS Real Estate Focus 2018

This report has been prepared by

UBS Switzerland AG. Please see the

important disclaimer at the end of the

document. Past performance is not an

indication of future returns. The market

prices provided are closing prices on the

respective principal stock exchange.

Publisher

UBS Switzerland AG

Chief Investment Ofce WM

P.O. Box, CH-8098 Zurich

Editor in Chief

Elias Hafner

Editor

Andrew DeBoo

Editorial deadline

11 January 2018

Translation

24translate GmbH, St. Gallen

Desktop publishing

Margrit Oppliger

Werner Kuonen

Photos

Manuel Stettler Fotograe, Burgdorf

Cover photo

Community hall, Männedorf

Printer

galledia ag, Flawil, Switzerland

Languages

English, German, French, and Italian

Contact

[email protected]

Order or subscribe

UBS clients can subscribe to the print

version of UBS Real Estate Focus via their

client advisor or the Printed & Branded

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Electronic subscription is also

available via Investment Views on the

UBS e-banking platform.

SAP-Nr. 83518E-1801

Mobility

Residential

UBS Real Estate Focus 2018

26 Retail space

Shopping malls reinvent

themselves

29 Ofce space

Prices (still) correcting

32 Hotel investments

Potential in the cities

35 Parking garages as investment

properties

Niche strategy without extra

yield

38 Real estate equities and funds

Not cheap

42 UBS Global Real Estate

Bubble Index

Superstars or bubbles?

46 Global market for direct

real estate investments

Where opportunities still reside

49 Impact of long-term

investment themes on global

real estate markets

Existing properties could

depreciate faster

54 Overview and forecasts

Comm ercial

Global

L is te d

6 UBS Real Estate Focus 2018

The United Nations predicts that two thirds of

the world’s population will call a city home by

2050. A century ago, only 30% of people were

urban dwellers. Urbanization has made great

strides in Western countries. At the end of

2015, for example, around 84.5% of Swiss resi-

dents lived in urban areas, compared to less

than half the population in emerging and devel-

oping nations.

Urbanization and economic progress go hand in

hand. Productivity increases when people live

and work in cities. Also, cities can supply public

services more cheaply (such as electricity, water,

wastewater services, gas and telecommunica-

tions). Urbanization and the emergence and

development of metropolitan areas are essential

for economic growth and, ultimately, for pros-

perity.

Mobility is key to efciency

For an economy to reap the full benets of its

workforce’s potential, people have to be free to

move quickly and independently in its metropo-

lises. The challenges begin here. In 2013, two

thirds of total mobility was concentrated in

urban areas. If infrastructure development fails

to keep pace with current population trends,

people will spend more time sitting in city traf-

c. Trafc disruptions are already serious today.

With demand for mobility expected to triple by

2050, urban planners could face a nightmare

scenario of widespread trafc gridlock, with all

the negative social and economic consequences

that entails.

Intelligent mobility solutions more urgent

than ever

Current capacity constraints can partly be

blamed on urban development since the post-

war period, in which cars came to dominate cit-

ies. To counter this one-sidedness, it is necessary

to apply a more granular understanding of

urban mobility and planning. Ideally, the car

monoculture, in which cars in downtown areas

are usually stuck in trafc jams or parked in

space-hogging lots, will be replaced by a

broader menu of mobility alternatives where

public transit, non-motorized options – such as

pedestrian zones and bicycle lanes – and poten-

tially driverless cars (see page 10) will change

how people get around.

No change in daily travel time budget

Urban and development planning is highly com-

plex, but the consequences of future mobility

plans can be demonstrated quite simply using a

constant travel time budget. Cesare Marchetti

described this budget in 1994, positing that

people in dierent countries and cultures do

not change their average commute times over

decades (Marchetti’s constant). This observation

is based on an intriguing trend: people’s travel

time budgets do not decrease even as faster

travel options emerge. In France, for example,

the average travel speed has increased 3% a

year on average in the past 200 years. In other

words, when transportation gets faster, com-

muting distances get longer.

Not a game changer

Worldwide urbanization is continuing inexorably, and demand

for mobility is keeping pace. New solutions are needed to keep

limited trafc capacity from curbing economic growth. Property

values will only rise in regions that “move closer” from a time

perspective.

Change in mobility

Claudio Saputelli

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Impact on the real estate market

No convergence of urban and rural prices

Marchetti’s constant is one of the most stable

mobility indicators around. On work days, com-

muters travel an average of 70 to 90 minutes in

the countries examined. So what are the impli-

cations for the real estate market?

First, demand will remain high for real estate

markets in urban centers and metropolitan

areas within the travel time budget, even if the

nature of mobility changes, as long as attractive

jobs are concentrated in cities.

Second, property values will rise in regions that

have “moved closer” to workplaces as a result

of mobility improvements or major trafc infra-

structure projects. This trend will drive urbaniza-

tion.

Third, mobility concepts of the future – particu-

larly driverless cars designed to reduce perceived

travel time – will not reduce the dierence

between property prices in city centers and

peripheral regions, particularly outside the travel

time budget. The unique diversity of mobility

oerings, the availability of innumerable ser-

vices and the dense concentration of knowl-

edge will always make major centers more

appealing than rural areas. In addition, major

centers within Marchetti’s constant oer access

to jobs in other (global) major centers thanks to

airports and direct rail connections.

Hans Wilsdorf Bridge, Geneva

“Despite the upcoming mobility

changes, demand for urban real estate

will remain high.”

8 UBS Real Estate Focus 2018

Global Listed Commercial Residential Mobility

Transportation accessibility is important for the

attractiveness of regions as places for people to

live and for companies to be based. Highly

accessible regions, aer all, have lower trans-

portation and time costs, and so are generally

more productive and thus more competitive

than their less accessible counterparts. No won-

der trafc and development planners are so

focused on maintaining or improving accessibil-

ity over the long term. There are two ways to

achieve this goal: the rst is to locate activity

destinations at or near residential areas, and the

second is to optimize transportation services

and infrastructure. In prosperous countries like

Switzerland, these two approaches oen go

hand in hand.

Improvement in almost every region

Accessibility is good in Switzerland in general,

and in most of its towns and municipalities. This

holds true not only within Switzerland, but also

compared to other countries, as various studies

report. Building more transportation routes has

improved accessibility, as have higher speed lim-

its, improvements to existing infrastructure (e.g.

increasing the number of connections) and

road-widening projects that have added extra

lanes.

The Gotthard Base Tunnel is the most recent

example of the large transportation infrastruc-

ture projects that have continuously boosted

accessibility in Switzerland. In fact, according to

BAKBASEL, accessibility has improved in virtually

every region of the country since 2005, with

respect to both public transit and private motor-

ized transportation. The centers of large cities

are the only exceptions; these are now less

accessible by private motor vehicle than they

were several years ago, as factors such as high

population growth nationwide have led to

chronically congested thoroughfares.

Good accessibility bolsters the real estate

market

Good regional accessibility is reected in local

property prices. However, it is impossible to

quantify this eect exactly. There is no univer-

sally accepted denition or methodical

approach for measuring accessibility, so it is

oen estimated based on simplied assump-

tions. Nonetheless, a survey of national and

international studies can be distilled into four

empirical ndings on how accessibility aects

property prices.

Access to activities

is key

Most Swiss locations are highly accessible, by both national

andinternational comparison. Real estate prices are generally

higher in centrally located regions with equally easy access via

public and private transportation. New trafc infrastructure

cannot always aect prices, however.

Claudio Saputelli

Accessibility

More accessible, not just

more mobile

“Mobility” is oen confused with “accessibility.”

Mobility describes whether, how oen and how

easily people, goods and services can move or be

transported. Accessibility, by contrast, is need

and destination-based. It focuses on the travel

times, costs, options, comfort and risks associ-

ated with access to key activity destinations

(work, education, shopping and recreation).

When transportation systems are designed to

meet a community’s needs, their main function

is to provide access to activity destinations at a

low cost and with the least eort possible. Trans-

portation and infrastructure policies should

therefore focus on improving accessibility instead

of merely increasing mobility.

UBS Real Estate Focus 2018

9,000

11,000

7,000

12,000

13,000

14,000

4,000

5,000

10,000

8,000

6,000

2004

060

Zurich

Geneva

Prices rise as accessibility improves

Source: FSO, TranSol, Wüest Partner, UBS

Condominium prices (in CHF/m²) and accessibility (in minutes)*

Municipalities

in Canton Zurich

Travel time to Zurich

Municipalities

in Canton Geneva

Travel time to Geneva

Tax rates relative to canton municipalities

Low Medium High

* Average travel time with personal motor vehicle and public transportation to the r

espective centers;

population size class represented by circle size.

Travel time to central business district

One big driver of property prices is “centrality,”

i.e. the travel time to the nearest central busi-

ness district and the related opportunity cost

(loss of potential benets) of this time. Gener-

ally speaking, the farther away the central busi-

ness district, the lower the property prices.

However, other factors such as a town’s topo-

graphical location, supply and – particularly in

Switzerland – tax considerations can override

this eect and produce an entirely dierent out-

come.

Quality dierences between public and private

transportation

Regions that can be accessed just as well with

public transit systems as with private transporta-

tion tend to have higher real estate prices than

regions with qualitative dierences between

these two modes of transportation. Also, buyers

are willing to pay more for properties that are

easy to access with private vehicles than for

comparable properties that are more accessible

via public transportation. For that reason, prop-

erty prices tend to rise more in response to proj-

ects targeting private motorized transportation

than to projects to improve public transporta-

tion.

Travel time saved by transportation projects

Locations that are already highly accessible –

like big Swiss cities – do not have much room

for improvement. Even large transportation

projects can only lower travel times a little.

Smaller locations are a dierent proposition

entirely; they oen harbor greater potential. As

a result, property prices in more remote com-

muter locations tend to respond more to trans-

portation projects.

Regional development potential

Improved accessibility can stimulate the local

economy, encouraging home construction and

reviving the housing market. This does not hap-

pen automatically, though. Transportation infra-

structure projects can only contribute to eco-

nomic prosperity if the targeted region has

untapped potential of its own, or if the project

connects it to a larger, more dynamic economic

center.

10 UBS Real Estate Focus 2018

Imagine a world where robotic cars whisk you

from one place to the next. It is a much safer

world thanks to intelligent control soware,

lightning-fast reactions, tireless attentiveness,

better all-round visibility and strict adherence to

trafc laws. It is also a world without the stress

and wasted time that comes from battling city

trafc. Driverless cars pick you up at home and

transport you to your destination while you

work or, depending on the car’s features, catch

up on sleep. It may sound utopic now, but it

could become everyday reality. With near

weekly newsbites about autonomous cars, the

automotive industry implies that these vehicles

will start appearing in showrooms in only a few

years’ time.

Forecasts tell us that perceived travel times will

shrink to virtually zero. As a result, motorists

will be willing to drive more frequently and

cover longer distances. Car movements will

increase signicantly too, as unoccupied vehi-

cles roam around picking up passengers or per-

forming other activities. Also, large numbers of

non-vehicle owners – the elderly, disabled, chil-

dren, etc. – will likely adopt driverless cars.

Many questions remain unanswered

Driverless cars are still a long way from becom-

ing widespread though; too many hurdles still

lie ahead. The ethics of programming algo-

rithms to resolve life-or-death questions, for

example, is particularly difcult. People are wary

of accepting actions taken by autonomous

technology that may result in injury or death,

even if autonomous technology has a better

track record statistically than human drivers.

Also, lawmakers have to establish the legal

basis for the use of driverless cars. Germany, for

example, passed a bill in April 2016 that puts

the ultimate responsibility for accidents on the

human sitting in the driver’s seat, if there is any

doubt. As a result, drivers have no choice but to

constantly monitor the system, largely eliminat-

ing the touted advantages of fully autonomous

vehicles.

Technical reliability has been elusive too. None

of the current assistance systems work aw-

lessly. Road sign recognition – for example, the

technology that shows drivers the maximum

legal speed – regularly ceases to work when

signs are dirty. Reading cameras are also partic-

ularly prone to fail due to rain, ice or dirt, or

when the sun is low.

Impact on property markets

Urban parking lots would be relocated

It is currently unclear whether, when and how

autonomous vehicles will change how we get

around. That has not dammed the rise of

reports on how driverless vehicles are poised to

completely disrupt property markets and force

real estate investors to rethink their investment

strategies. They forecast the following big

changes if fully autonomous cars become a

reality one day:

Many people could decide to purchase trips in

an autonomous vehicle instead of owning one

or more cars. This would lower the demand for

garages, parking spaces and driveways; existing

space would be repurposed. Even large down-

town parking garages would become obsolete,

because autonomous cars would either be con-

stantly running or parked in large, fully auto-

matic parking systems on the city periphery.

Revolution in the

real estate market?

Fully autonomous vehicles – or rather, the technology for

them– are almost here. Unclear, however, is how autonomous

driving will actually work in a normal street environment.

Realestate investors betting on big changes in mobility behav-

ior are taking a huge risk.

Claudio Saputelli

Autonomous cars

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Access roads to big apartment complexes,

ofces and retail outlets would have to be rede-

signed to allow large numbers of people to get

in and out of cars. Gas stations would also

come in for change (Switzerland currently has

around 3,400), since autonomous cars would

be maintained and lled up in eets at central

locations. Travel patterns would alter as well.

The ability to relax and even sleep in autono-

mous cars would eliminate the need for travel-

ers to interrupt their trip and spend the night in

hotels close to main trafc arteries.

Betting on a vision of the future

The rise of fully autonomous vehicles is

expected to revolutionize the property market,

which is why governments and real estate

developers are already being encouraged to

devise exible long-term development strate-

gies. However, they are also being told that cit-

ies need even more parking capacity – at least

in the short term. The recipe for success is

therefore to build parking garages that can be

easily converted to retail or other uses over the

long term. Of course, real estate developers

would be well advised to pursue exible long-

term development strategies even without

autonomous vehicles.

Optimistically, it will probably take a decade or

more before driverless cars become a reality and

can be used anywhere, at any time and at least

as safely as human-operated vehicles. Once that

day arrives, another question will arise: How

many people will still drive themselves, either

because they enjoy sitting behind the wheel or

do not trust the machine? Clearly, betting now

on a brick-and-mortar strategy fully aligned

with autonomous vehicles is risky.

Sour

ce: mobilegeeks.de, UBS

Driver’s

tasks

Vehicle’s

tasks

01 2345

Driver drives

and steers

the vehicle

Driver does not

have to operate

pedals

Vehicle can

accelerate and

decelerate

Vehicle can

accelerate,

decelerate

and turn

Vehicle can

accelerate,

decelerate

and turn,

warns driver

early on

Vehicle can

accelerate,

decelerate,

turn and

minimize

driving risk

Vehicle

performs

all

functions

Driver does not

have to operate

pedals or

steering wheel,

has a super-

visory function

Driver only

has to take

the controls

if needed

Driver

can take

the controls

Unassisted Assisted

Partially

automated

Highly

automated

Autonomous Driverless

A long road to full automation

The 5 stages of motor vehicle automation

Vehicle does

not have any

control functions

No driver

12 UBS Real Estate Focus 2018

Last year did not bring many new drivers for

theowner-occupied housing market. Mortgage

interest rates remained stable, population

growth dropped below 1%, and rental apart-

ments became cheaper. Home prices, however,

rose slightly yet again in 2017. Condominium

prices remained stable year-to-year, but prices

of single-family homes increased roughly 2%.

Home prices expected to increase slightly

The owner-occupied home market is mainly

buoyed by low mortgage rates. The cost of

owning your own home in Switzerland (interest

costs, maintenance and provisions) is currently

around 15% lower than the cost of renting a

comparable property. With loan-to-values at

80%, the resulting return on equity is over 4%.

This situation is unprecedented, at least in the

current real estate cycle. Ten years ago, housing

was avery popular investment: the cost of own-

ing ahome exceeded the cost of renting by

40%. This implies that investors expected prices

to increase at the time. In fact, purchase prices

had to increase at least 2% each year to oset

the additional cost of ownership compared to

rental (which was exceeded). The current sav-

ings, by contrast, provide a buer against a

market correction: home buyers would still be

ahead nancially if prices corrected by 0.5%

a year.

This buer is not expected to be exhausted in

2018. Home ownership costs will remain low;

the robust economy has bolstered demand for

homes. Home construction should also remain

at last year’s level, which was 15–20% lower

than in 2014. We expect single-family home

prices to increase slightly. Condominium prices,

however, will likely stagnate since they face

stier competition from declining rents. Abso-

lute purchase price amounts continue to limit

nancing availability, driving demand for small

apartments and maintaining buyers’ willingness

to pay for lesser-quality properties.

Condominiums were in the lead

Prices for condominiums have risen faster than

those for single-family homes in the current real

estate cycle. When adjusted for ination, con-

dominium prices in the available price indexes

increased an average of 2.4% a year over the

last 20 years, while those of single-family

homes climbed a mere 1.9%. Much of this dif-

ference can be put down to three factors.

Footprints keep

shrinking

Single-family homes have gained ground over condominiums.

Stier competition with rental apartments is causing condo-

minium prices to stagnate. Urban concentration will slow new

construction of single-family homes, but will have little impact

on prices.

Maciej Skoczek and Matthias Holzhey

Condominiums and single-family homes

Global Listed Commercial Residential Mobility

120

160

180

140

100

2015 201720072005 2011200920032001 2013

Parallel long-term price behavior

in the two market segments

Source: Wüest Partner, UBS

Inﬂation-adjusted asking prices (index 2000=100) and cumulative

diﬀerence in price change rates between condominiums and single-family

homes (in percentage points)

Condominiums

Single-family homes

Diﬀerence in price increases (cumulative)

+15 percentage points

–5 percentage points

UBS Real Estate Focus 2018

Swiss House XXII, Preonzo (Bellinzona), Architecture rm: Davide Macullo Architects

Single-family homes are too big

The average single-family home has around 170

square meters of living space. With purchase

prices averaging over CHF 1 million, the pool of

possible buyers is limited to 20% of all house-

holds. This shis demand toward condomini-

ums, which cost less than CHF 800,000 on

average. This theory is supported by the fact

that prices for relatively small condominiums

have risen faster than for condominiums over

150 square meters in size.

Single-family homes have worse macro

locations

Condominiums, whether new or pre-existing,

are usually found at better macro locations than

single-family homes. A quarter of all condomini-

ums are found at prime locations, compared to

a h of single-family homes. The annual price

increase at these locations was 1% higher than

the national average over the last 10 years.

Also, the construction boom in condominiums

has improved condominium construction quality

relative to single-family homes. Only a quarter of

all the owner-occupied homes built in recent

years are single-family homes. And modern con-

dominiums are comparable to single-family

homes in terms of comfort, privacy and sound

insulation.

Better rentability favors condominiums

Condominiums remain very popular invest-

ments. The percentage of loan applications

intended for buy-to-rent investments has nearly

doubled since 2007 and has hovered at 18–20%

of all housing loan applications for several years.

Small and medium-sized apartments in urban

centers and metropolitan areas in particular are

ideal investment vehicles for small investors. The

freedom to switch between living in the prop-

erty or renting it out justies the premium on

condominiums over single-family homes.

“Only a quarter of owner-occupied

homes built are single-family homes.”

14 UBS Real Estate Focus 2018

Urban centers

and metropolitan

areas

High-income

communities

Peri-urban

communities

Rural

communities

100–5–10 5

1995–2005

2005–2015

Uncontrolled proliferation

of settlements Densiﬁcation

* According to the FSO’s area statistics as of December 15, 2017

Minimal densiﬁcation in rural areas

Source: FSO, UBS

Diﬀerence between changes in population and changes in building area*,

by community type, in percentage points

Size, location and rentability dierences will

impact relative price trends in the future, too. In

the long term, however, the single-family home

market will be determined by two trends: densi-

cation and aging.

Densication aiming to reverse the trend

Higher oor area ratios mean higher property

values. Single-family homes seem perfectly

poised to prot from urban concentration, also

known as densication, because they occupy a

relatively large piece of land. So far, however,

home values have not risen much outside the

city centers.

No incentives for densication in rural areas

Most single-family homes are located in rural

areas. According to the data, developed areas

have not grown denser at all in the last 10years;

building space increased around 11%, on par

with population growth. Developers simply had

no incentives to densify; land was available and

relatively cheap. Only in city centers and high-in-

come communities did densities increase as high

land prices made it worthwhile to pack more

housing units into the same parcel of land.

Building space thus grew only half as fast as the

population. However, more single-family homes

were built than demolished between 2011 and

2015, even in high-income communities and city

centers. This is because, in most communities, it

only pays o to demolish and replace condo-

miniums if the oor area ratio can accommodate

a doubling of residential oor space.

Spatial Planning Act discourages new construc-

tion of single-family homes

Densication entails using undeveloped oases

within built-up areas as well as “unused devel-

opment rights,” which arise when the actual

built oor space is less than the legally permit-

ted oor space. According to a study by ETH

Zurich and the Federal Ofce for Spatial Devel-

opment, these “internal reserves” could easily

accommodate over a million residents. But den-

sication is not mandatory. Except for the

greater Zurich area, virtually every Swiss region,

including Geneva and Basel, has enough unde-

veloped, properly zoned land to absorb the next

decade of population growth without densify-

ing.

However, Switzerland’s new Spatial Planning

Act aims to use these “internal reserves.” It

gives precedence to the use of inll housing in

developed rural and metropolitan areas over an

increase in oor area ratios. Densication will

take place by packing as much oor space as

possible on such land, which will make new sin-

gle-family home construction difcult.

New condominiums continue to replace single-

family homes with extensive unused develop-

ment rights in upmarket locations. However,

these properties are already selling at a premium

as investment properties or status symbols. In

addition, the new Spatial Planning Act reduces

the net nancial gains from zoning changes by

levying a value-added tax of at least 20% on

property value increases attributable to new

zoning. Most cantons already levy value-added

tax on gains attributable to an upgrade in zon-

ing classications. Taken together, these trends

mean the supply of single-family homes will

grow more slowly in the future than it has thus

far.

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Demographic change causes glut of single-

family homes

Over the medium to long term, however, the

lower supply of single-family homes will not be

enough to turn the price tide permanently. Until

2030, the main buyer group of large residential

units will grow at half the rate as the overall

population due to aging. In fact, demand for

single-family homes is expected to shrink in the

mountainous cantons of Central Switzerland,

Appenzell Innerrhoden and Grisons.

In other words, single-family home prices,

which have outperformed condominium prices

since 2014, are probably about to reach the end

of their rally. Prices in both market segments

should generally track each other closely over

the long term. Fierce competition and relatively

high transparency in the home market will pre-

vent prices in both segments from decoupling

in the long run.

Comparison of asking and

transaction price indexes

Price indexes based on asking prices and those

based on transaction prices should remain

essentially identical in the long term. In the past

10 years, however, transaction price indexes

have gained about 15 percentage points more

than asking price indexes. There are three rea-

sons for this dierence:

(1) In periods of fast-rising demand, transaction

prices are bid up higher than advertised

prices. This is likely what happened at times

in Swiss hot spots. Sellers, however, are

quick to adapt their expectations to changed

market realities.

(2) Transaction records make a more exact qual-

ity adjustment possible. In other words,

prices are adjusted for variations in quality,

such as micro location or building condition.

Since micro locations have deteriorated

among sold properties in the last ve years,

the adjustments have increased transaction

price indexes.

(3) Transaction price indexes weight expensive

regions more heavily. Steeper price increases

at good locations since 2000 have contrib-

uted to the decoupling of transaction prices.

16 UBS Real Estate Focus 2018

Asking rents have only dropped moderately, despite rapidly

increasing vacancy rates. This is partly for psychological rea-

sons. However, the downward trend should accelerate in the

next three years. Prices for apartment buildings have peaked,

and property values could decline if central banks do not

mount a sustained intervention.

Competition in the rental market is getting even

ercer. As of mid-2017, 2.4% of all rental apart-

ments were vacant. This level was last exceeded

in 1998, when 2.8% of rental apartments stood

empty. So far, however, the vacancy rate has

not scared o investors; the number of newly

approved units has declined very little in recent

quarters. This year, the total housing stock is

expected to increase 1.1%.

Vacancy rate poised to hit all-time high

Residential construction is virtually unchanged,

while additional demand is dropping. Net immi-

gration is expected to reach nearly 60,000 this

year, meaning that some 10,000 fewer addi-

tional apartments will be needed than in 2013.

The decline is entirely due to lower net immigra-

tion from EU countries, which has shrunk from

75% to 60% of total immigration in the last

four years.

Several factors are driving this trend. The eco-

nomic recovery in the Eurozone, especially on

the Iberian Peninsula, has slashed net immigra-

tion from Spain and Portugal to negligible levels

in the last ve years. But Switzerland’s weak

labor market has lost its allure, too. If construc-

tion and population trends remain the same,

the vacancy rate will reach a new record high by

2019 at the latest.

Rent decreases still moderate

In extremely tight housing markets, asking rents

(rents for new and renewed leases) tend to

respond very quickly to changes in the vacancy

rate. Rents tend to skyrocket if vacancy rates in

a region drop to around 0.5%.

This happened from 1985 to 1991, when the

nationwide vacancy rate dropped below this

threshold, and asking rents shot up 50% aer

adjusting for ination. In the current real estate

cycle, only the Lake Geneva region has such a

tight housing market. Here, rents increased 5%

annually between 2002 and 2015 – double the

rate in the rest of Switzerland.

If vacancies go up in such tight markets, rents

tend to collapse quickly. For example, rents in

the Lake Geneva region have already shed 9%

since 2015, even though the current vacancy

rate for rental apartments, 0.8%, is only one-

third of the Swiss average. Average advertised

rents have only dropped moderately nationwide.

No longer

at any price

Matthias Holzhey and Elias Hafner

Apartment buildings

140

180

100

160

120

Period with rapid increase in vacancy rate

Asking rents/income

Period with rapid decrease in vacancy rate

200519851975 20151995

Corr

ection

potential

Existing rents/income

Correction potential for asking rents

Source: FSO, Wüest Partner, UBS

Ratio of asking and existing rents to income (index 2000 =100)

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

The index for asking rents is almost 3% below

its mid-2015 peak. Rents declined sporadically

in most cities and metropolitan areas, and even

in large parts of the periphery. In fact, Western

Switzerland (without the Lake Geneva region)

even showed a 1% increase last year.

Loss aversion puts o market shakeout

Psychological factors are probably responsible

for the lack of movement in asking rents, even

in municipalities with rapidly rising vacancy

rates. Loss aversion – the tendency to avoid

losses – has been thoroughly researched in

empirical studies. For many investors, a nancial

loss has up to twice the psychological impact as

an equivalent gain.

In the real estate market, loss aversion explains

why market liquidity declines rapidly when

home prices fall. Potential sellers tend to hold

on to their properties when the current market

price is lower than what they originally paid.

Loss aversion is also the reason why landlords

are hesitant to lower asking rents even aer a

prolonged vacancy. A lower rent is a certain loss

or, at the very least, less than they originally

expected to earn, which they perceive as a loss.

It may pay to wait with new apartments

When advertised apartments remain vacant for

weeks, landlords have to weigh the risk of pro-

longed vacancies against the lower income asso-

ciated with a rent reduction. If rents or rent

expectations no longer reect market conditions

by the time the apartment comes onto the mar-

ket, the asking rent will oen have to be

reduced more than 10% before tenants are will-

ing to sign a lease.

With new buildings, reductions this large can

signicantly lower yields, since the lower rents

usually have to be passed on to all the tenants in

the building. In that case, landlords may prefer

to wait for a deeper-pocketed tenant. It is no

wonder, then, that the vacancy rate has shot up

particularly quickly in new buildings, where

roughly one-ninth of the apartments are empty.

Instead of lowering rents, more landlords are

now trying to lure in tenants with incentives,

which may pose more disadvantages than

advantages.

Action recommended with existing

properties

With existing properties, however, landlords can

usually contain the income loss to one apart-

ment. Here, it pays to quickly adapt rents to the

new reality, especially in regions where the leas-

ing risk is still rising. Also, it is cheaper in the

long run to renovate apartments that no longer

meet market quality standards than to drastically

reduce the rent.

Incentives can attract

the wrong tenants

More rental apartments have been advertised

with sign-up incentives in the past two years –

from rent-free periods to graduated rental leases

to gi cards and free moves. Landlords have

turned to incentives for obvious reasons: they

get prospective tenants’ attention and avoid the

need to lower eective rents, which would

reduce property values. The sweeteners have

become almost de rigeur for commercial proper-

ties, which are rented out under long-term

leases. But it’s not clear that incentives are eec-

tive for rental apartments. Gi cards or even free

moves will likely have very little impact on a pro-

spective tenant’s housing budget and willingness

to pay more in rent.

In fact, sign-up incentives could have unintended

and undesirable consequences. They could give

the impression that something is wrong with the

apartment or landlord and thereby damage a

development’s image. They might also attract

the wrong kinds of tenants. The shorter the

tenant’s intended stay, the more valuable a tem-

porary discount or cash incentive will be. People

who are eager to live in an apartment for rent-

free months will probably move out again aer a

short period of time.

18 UBS Real Estate Focus 2018

Zürich

Glattal-

Furttal

Limmattal

Zimmerberg

Zürcher Oberland

Winterthur

Zürcher Unterland

Bern

Biel/Bienne

Oberaargau

Thun

Luzern

Sursee-Seetal

La Sarine

Olten

Solothurn

Basel-Stadt

Oberes Baselbiet

St.Gallen

Wil

Aarau

Brugg-Zurzach

Baden

Thurtal

Lugano

Lausanne

Morges

Sion

Vacancy rate for rental apartments

HighLow

Leasing risk

Absorption risk

Pfannenstiel

Population size

Vacancy rate for rental apartments based on UBS estimates of rental housing stock

The absorption risk compares growth in the housing stock (supply) with population growth (potential demand) and indicates whether too much

or too little is being built on a regional basis. The increase in supply is determined from the number of building permits req

uested and issued in the last

ﬁve to six quarters. Potential growth is estimated based on the past three years of population growth.

Sour

ce: FSO, Docu Media, UBS

Vacancy rate for rental apartments¹ (2017) and absorption risk² (4Q 2017) by canton (abbreviation) or population

mobility r

egion, in %

Vevey

Unteres Baselbiet

LowMedium High

Rents declining at an accelerating pace

Persistently high vacancy rates put pressure on

rents. We expect asking rents to correct around

2.5% this year. But that does not necessarily

mean the correction phase is over. Unless con-

struction activity changes direction or immigra-

tion surges again, asking rates will probably be

at least 10% lower in 2020 than in 2015.

Existing rents have developed steadily over the

long term. In Switzerland, they have kept step

with wages since 1982, increasing 0.5% a year

in real terms. Therefore, current rents are not

excessive, so we don’t anticipate a broad correc-

tion in the years to come. However, asking rents

are still 20% higher on average than current

rents. This dierence will shrink when asking

rents correct as anticipated. Once this happens,

landlords will be less likely to increase rents for

incoming tenants in existing properties. They will

also have less latitude to change the terms of

existing leases if the reference interest rate rises,

since asking rents act as a ceiling for existing

contracts.

Excess supply risks in Ticino and Western Switzerland

Vacancy rates in the business centers are low

and will probably not rise much in the next

several quarters. Structural vacancy has driven

up leasing risks in the Central Plateau region

and many peripheral regions. The cantons of

Solothurn and Valais, for example, have the

highest percentage of vacant rental apartments

at around 6%, while nearly 4.5% of all rental

apartments are empty in Aargau. The trend is

extremely negative in Ticino, too. An increase

inthe number of building permits and a sudden

drop-o of immigration from Italy will likely

prompt a steep rise in the number of vacant

rental apartments by mid-year. Excess supply

risks have also risen signicantly in the Western

Swiss cantons of Fribourg, Jura and Neuchâtel,

as well as in the hinterlands of Vaud.

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Investment outlook

Valuations peaking

Falling capitalization rates have fueled the rally

in residential investment property prices over the

past 10 years. Prices for apartment buildings

throughout Switzerland have risen nearly 60%

since 2007. Rents, however, have only risen

around 15% over the same period. As a result,

net initial yields have declined from just under

5% to 3.5%. Yields vary regionally as well, from

less than 2% (Zurich District 1) to over 5%

(Goms).

Many investors still nd these yields attractive

given the negative yields on Swiss government

bonds with maturities of up to 10 years or more.

However, interest rates should rise slightly over

the next 12 months as central banks worldwide

tighten the monetary reins. With vacancies on

the rise and rents on the decline, capitalization

rates will likely not fall any more in 2018. In

short, prices for residential investment property

appear to have peaked. Investors have largely

given up on further capital gains. This can be

seen in the stock market: the prices of residen-

tial real estate funds underwent a signicant

correction in the second half of 2017. Expecta-

tions of further increases in residential invest-

ment property prices have zzled out.

Value adjustment looms

Future investment performance depends heavily

on the long-term interest rate trends. Interest

rates will start trending upward once central

banks stop depressing them articially. A small

increase in the yield curve of 0.5 percentage

points or less shouldn’t squeeze prices for

apartment buildings across the board, however.

Investors would still be hard-pressed to nd bet-

ter places to put their money. An increase in the

yield on 10-year Swiss government bonds to,

say, 2%, however, would require substantial

write-downs. Property values would correct

around 20%. Properties in prime locations,

which have responded more strongly to falling

interest rates in recent years, could shed up to

30% of their value. Peripheral locations, by con-

trast, are less sensitive to interest rate uctua-

tions. Instead, they face a higher risk of lost

income in today’s market due to higher vacancy

rates or lower rents. We believe the most attrac-

tive locations are metropolitan area locations

situated at commuting distance from central

business districts; they oer net initial yields of

just over 3% with only moderate vacancy risks.

Source: UBS estimates

* Net yield aer all costs ar

e deducted (including maintenance) in % of purchase price

One franc of rent is worth twice as much

in Zurich as in the mountains

Initial net returns* by population mobility region, in %

under 2.5

2.5 to 3.0

3.0 to 3.5

3.5 to 4.0

4.0 to 4.5

over 4.5

20 UBS Real Estate Focus 2018

Insurers and pension funds now have greater incentives to

oer mortgages. Banks are likely to lose market share due to

stricter banking regulation. Institutional investors can choose

from several mortgage investment options.

Last year, the Swiss mortgage market broke

through the CHF 1 trillion barrier. Banks hold

roughly 95% of the total mortgage volume,

with insurers and pension funds making up only

a small portion of the market. However, the

trend appears to be changing. Insurers’ mort-

gage positions grew by around 6% a year in

2015 and 2016, while pension funds’ mortgage

books expanded 5% in 2016 aer years of

decline. Banks, in contrast, have experienced

slower growth. In fact, large banks’ mortgage

books have recently shrunk. Initial 2017 data

indicates that insurers’ mortgage portfolios are

continuing to grow faster than those of banks.

Institutional investors with a long-term

horizon

Banks nance most mortgage loans with debt

that is callable at short notice. For banks, xed-

rate mortgages are traditional interest opera-

tions: they collect the mortgage interest with

one hand, and pay depositors interest on their

deposits with the other.

Insurers and pension funds, by contrast, invest

capital that insured individuals or plan members

pay in to cover future losses or pension commit-

ments. Pension fund obligations usually have

terms of 10–15 years. For this reason, insurers

and pension funds prefer to extend long-run-

ning loans, oering 15 years by default but

going up to 25 years in some cases. They also

tend to be more conservative about loan-to-

value ratios and market segment risk. So not

only are market shares unequal, but the market

itself is segmented too.

Incentives shi due to regulation and

low interest rates

There are three main reasons behind institu-

tional investors’ current push into the mortgage

market:

Regulation

Stricter capital and liquidity requirements since

the nancial crisis under Basel III have made

nancing more expensive for banks. At the

same time, the Swiss National Bank’s countercy-

clical capital buer and stricter self-regulation

have made mortgage lending more expensive

or difcult for banks. The regulation of mort-

gage lending for institutional investors, by con-

trast, is not quite as stringent.

More money from

institutional investors

Elias Hafner

Mortgages as an asset class

Institutional investors have a small portion

Source: FSO, FINMA, SNB, UBS

Swiss mortgage market, broken down by lender as of the end of 2008 and

2016, in %

34%

2016

2008

Cantonal banks

Large banks

Raiﬀeisen banks

Other banks

Insurance companies

Pension funds

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Negative interest rates

The January 2015, introduction of negative

interest rates shied the incentives for granting

mortgages in favor of institutional investors in

two ways. First, banks do not charge most of

their private clients negative interest, so their

earnings situation is at risk of worsening consid-

erably. To prevent margin erosion in the mort-

gage business, banks have raised lending mar-

gins: mortgage rates at banks have barely

budged downward despite a signicant

decrease in the general interest rate level. Many

pension funds, on the other hand, are aected

by negative interest rates. According to Swiss-

canto’s Pension Funds Study 2017, 58% of

pension funds pay negative interest or deposit

charges, encouraging them to shi some

xed-income or money market positions to

mortgages.

Property values

The low interest environment has prompted

institutional investors to move large amounts of

capital to investment properties. Pension funds,

for example, reduced their bond positions to

32% of their portfolios in 2016 from 38% in

Independently, with a partner or indirectly

Pension funds and insurers wanting to invest in

the mortgage market have several options.

Independent mortgage lending

One option is for pension funds and insurers to

lend mortgages themselves, enabling them to

capture all the returns along the value chain.

Asof mid-December 2017, relatively large insti-

tutional investors oered 10-year mortgages

based on reference rates of around 1.3%

(banks: 1.5%). Whether or not independent

lending makes sense depends heavily on the

maintenance costs for the necessary infrastruc-

ture. As a rule, the bigger the mortgage book

and the longer its intended operating life, the

easier it will be to absorb high initial and xed

costs.

Collaboration with a mortgage partner

Institutional investors can also transfer part of

the value chain to a partner. Working with bro-

ker platforms, for example, gives them quick

access to new clients. Pension funds or insurers

can also act solely as investors. In this case, the

mortgage partner – for example, a bank – han-

dles all the administration. The return for the

institutional investor depends on the maturity;

at the moment, it should range from nearly

0.5–1.0% in most cases. Mortgage partners, by

contrast, can earn an additional return without

having to carry the mortgages on their books.

Separating the underwriting and lending opera-

tions requires properly adjusted incentives,

though. For example, the mortgage partner can

always carry part of each mortgage on its bal-

ance sheet, or the underwriter can analyze a

mortgage without knowing whether the institu-

tional investor or the mortgage partner will be

bearing the default risk and carrying the invest-

ment on their balance sheet.

Indirect investments

Finally, investments can also be made indirectly

through investment foundations or mortgage

funds. Several large banks have created invest-

ment vehicles for this purpose since late 2016

and, in some cases, have moved mortgages

from their own balance sheet into them. This

solution oers the prospect of broad diversica-

tion and the rapid build-up of a mortgage posi-

tion. Also, investors can redeem shares if they

wish. Return expectations vary depending on

the mortgage fund, mainly because of average

maturities (less than one year to six years), but

currently range around 0.2–0.5%. Rigorous

mortgage selection criteria are designed to pre-

vent these investment vehicles from only receiv-

ing “bad” loans. Unlike direct mortgage invest-

ments, these positions have to be marked to

market, which can lead to unwanted coverage

ratio uctuations when interest rates change.

22 UBS Real Estate Focus 2018

2007, and increased the real estate share to

nearly 23% from 17% during the same period.

Demand for investment properties among insti-

tutional investors remains robust, but investors

seem more cautious now. This has brought

mortgages – which, at conservative loan-to-

value ratios, act more like bonds than real

estate investments – onto the radar.

Banks still dominant, but segmentation

stronger

The spread between mortgages and xed-in-

come investments seems highly attractive at

rst sight, and not just because of the negative

interest rate environment. Mortgages have cer-

tain appealing characteristics as well. They are

an illiquid asset class, so investors demand to be

compensated accordingly. Institutional investors,

with their long-term investment horizon, can

bear the liquidity risk and collect the illiquidity

premium. Also, over the long term, mortgages

can provide diversication and carry a default

risk as low as that of bonds. Default rates can

spike, however, as the subprime crisis illus-

trated. Knowing this, institutional investors

should not relax their traditionally conservative

mortgage lending policies just to collect a few

extra basis points. These investors are also wary

of mortgage holdings that shorten capital com-

mitment periods, since they want to avoid

asset-liability mismatching.

While the market distortions caused by negative

interest rates are unlikely to persist over the

medium term, the “regulation gap” between

banks and institutional investors – due to

BaselIV, among other things – could certainly

widen even more. As a result, banks are being

forced to give up some mortgage business and

focus more on the service-oriented, less inter-

est-rate-sensitive links in the lending value

chain. At the end of 2016, insurers were poten-

tially able to invest an additional CHF 37 billion

in mortgages (estimated, not including over-col-

lateralization). Pension funds are generally per-

mitted to invest 50% of their total assets in

Swiss mortgage securities. Even if they did

choose to allocate such an unrealistically high

share of the CHF 800 billion of capital held in

second pillar plans to this asset class, they

would still make up less than half of the total

market. Clearly, banks will continue to domi-

nate the Swiss mortgage market. The market

should continue to split up into segments, how-

ever, which will ultimately lead to more robust

mortgage lending as mortgage asset maturities

become more aligned with investors’ liability

maturities.

Global Listed Commercial Residential Mobility

“The segmentation

should continue

toincrease, which

will lead to more

robust mortgage

lending as mort-

gage asset maturi-

ties adapt to

investors’ liability

maturities.”

UBS Real Estate Focus 2018

Crowdfunded investments in the Swiss residential real estate

market have been delivering blockbuster returns through high

gearing and compromises in macro locations. Investors have been

reaping the rewards during this fair-weather period. Concentra-

tion risks loom, however, particularly for small investors.

Too good to be true? Earn 7% a year in an

ostensibly secure asset class while interest rates

are low. Real estate crowdfunding platforms are

making exactly that promise. These platforms,

which rst appeared in Switzerland in 2015,

have brokered over CHF 200 million in invest-

ments in apartment buildings. Most of the time,

the platforms have kept their promise. Buy-to-let

and residential real estate funds are traditional

alternatives to crowdfunding, but currently oer

much lower returns: 4–5% and 2–3%, respec-

tively.

Up-close look at the dierences in returns

The large dierences in returns on equity, espe-

cially between crowdfunded investments and

residential real estate funds, are largely attribut-

able to leverage, dierences in gross rental

returns and the costs of managing the real

estate portfolio.

Gross rental return – funds oer better location,

liquidity and diversication

On average, crowdfunding providers promise

net rental incomes of nearly 4.5% of the real

estate purchase price. The portfolios of residen-

tial real estate funds, by contrast, pay an aver-

age of 3.5–4% of the fund assets’ fair value. So

why do listed funds return less?

First, they come with certain advantages, like

better diversication and greater liquidity than

individual investments in apartment buildings.

Investors are willing to pay a premium for these

advantages, lowering returns. In investment

crowdfunding, by contrast, the risk is concen-

trated in a few apartments; the secondary mar-

ket is still untested.

Second, fund properties tend to have better

macro locations. Only some 25% of the Swiss

population lives in communities with a higher

macro ranking than a fund portfolio’s median

property. Median properties in crowdfunded

ventures, by contrast, tend to rank much lower;

a bit more than 60% of the population lives in

communities with a better rating.

Third, funds always factor in a rent default rate

of around 4%.

That is much higher than the

average vacancy rate of rental apartments in

invested communities, which is less than 2% on

a portfolio-weighted basis. Crowdfunding g-

ures only include a vacancy buer of around

1.5% – despite signicantly worse macro loca-

tions and community vacancy rates in excess of

5%.

Higher returns

with higher risk

Elias Hafner and Maciej Skoczek

Investment crowdfunding

The rent default rate corresponds to the reduction in income

attributable to vacancies and uncollected rent relative to net

target rent.

What is investment

crowdfunding?

Investment crowdfunding – also known as equity

crowdfunding or crowd investing – in real estate

enables many investors, each using relatively little

capital, to purchase apartment buildings through an

online platform. That way, even small investors can

co-own a residential investment property and prot

from rental income and rising property values.

24 UBS Real Estate Focus 2018

ExcellentAverage Very poor

Investment crowdfunding

Crowdfunded properties oen found

at average locations

Sour

ce: FSO, various investment crowdfunding platforms, annual reports of various real estate funds,

Wü

est Partner, UBS

Percentage of properties, broken down by investment vehicle and

distribution of multifamily housing inventory and by macrolocation category

(in % of the total inventory)

Macrolocation of municipality

Real estate funds

Inventory of multifamily dwellings

in Switzerland

Finally, rental incomes from crowdfunded invest-

ments are assumed values. The rents for apart-

ments with published square-meter prices tend

to correspond to Wüest Partner’s asking rents in

upmarket properties in the same community.

This is an optimistic assumption at best, given

the micro locations of crowdfunded properties.

These factors provide a broader context for inter-

preting the dierence in gross rental returns.

Real estate platforms do not appear to be buy-

ing at an especially favorable price-to-risk ratio.

Managing real estate portfolios – funds are

not cheap

Managing a real estate portfolio incurs expenses:

for taxes, maintenance, repairs and administra-

tion.

Crowdfunded portfolios set aside around 5%

ofrental income for maintenance and repairs.

That may be realistic in the short run for most

new or newly renovated properties, but is prob-

ably too low in the long run. Residential real

estate funds, by contrast, put the eective costs

at 10–15%.

Crowdfunding platforms charge around 10% on

average for portfolio administration. With real

estate funds, the fund management company

and custodian bank (including external advisors

and administrators) collect 15–20% of total rent

income.

Taxation is also dierent. End investors have to

pay tax on income and capital gains from

crowdfunded investments. Real estate funds are

taxed separately, as well. The actual rate varies

considerably, depending on the regional focus

and investment type (direct or indirect), but

tends to average close to 15%.

To recap: crowdfunded investments incur aver-

age costs of 15–20% of rental income before

personal tax, compared to over 40% for residen-

tial real estate funds. The resulting return on

invested capital is around 3.5% for crowd-

funded real estate and around 2% for residen-

tial real estate funds. However, crowdfunded

investments make ambitious assumptions about

maintenance and repair costs, which will proba-

bly rise over the long term. Also, end investors

have to pay taxes on a larger slice of their

returns from platforms than from funds, since

about half the funds hold the real estate directly,

making distributions to end investors tax-ex-

empt. Crowdfunding investors also have to pay

extra fees, including property gains taxes, if the

property changes hands. On balance, it remains

to be seen whether crowd investing is in fact

more cost-efcient.

Leverage – the most important performance

driver

Leverage is very attractive given the historically

low mortgage rates available today. Crowdfund-

ing platforms and residential real estate funds

are taking out long-term mortgages with rates

at generally less than 1%. Mortgages on crowd-

funded properties usually average 60% of the

property value, while funds have a debt ratio of

around 20%. As a result, the return on equity

for crowdfunded real estate is 6–7%, compared

to only 2.5% for residential real estate funds.

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Residential property – investment forms at a glance

Buy-to-let Investment crowdfunding Residential real estate funds

Minimum investment Several CHF 100,000s Generally CHF 100,000 Less than CHF 100

Gross rental return* Nearly 3.5% 4 to 5% 3.5 to 4%

Return on equity 4 to 5% (before deducting

administration costs

assuming a 60% LTV)

6 to 7% (aer deducting

administration costs)

2 to 3% (aer deducting

administration costs)

Gearing Up to 80% 55 to 65% Around 20%

Financing costs Variable Generally less than 1% Generally less than 1%

Taxes Rental income counts as taxable

income aer deducting nancing

and maintenance costs. Selling the

property triggers additional taxes

such as property gains taxes.

Distributions count as taxable

income. Selling the property

triggers additional taxes such as

property gains taxes.

Fund charges and taxes oen account

for 10 to 20% of net rental income.

Income tax must be paid on distribu-

tions from funds that hold indirect

real estate investments. No income or

capital taxes for funds that hold direct

real estate investments.

Administration costs

(as a % of net rental

income)

Property management incurs

additional costs if the work is

outsourced.

Approx. 10% (including

performance fee upon reaching

a minimum occupancy rate)

15 to 20%

Investor’s property rights

and say in decision-making

Entry in land registry,

sole ownership

Entry in land registry, co-ownership

(25 owners on average)

No entry in land registry, no say in

decision-making

Typical property size CHF 0.5 to 1.2 million Median property CHF 4.5 million Median property CHF 7.8 million

Diversication None Low Medium to high

Liquidity Illiquid Poor Relatively high

Net rental income divided by purchase price/market value (aer deducting vacancy [buer])

Source: UBS, as of 15 November 2017

Only for risk-tolerant, broadly diversied

investors

Risk, in other words, is a big reason for the dif-

ferences in return on equity. We believe the mar-

ket cycle for apartment buildings has reached an

advanced stage. Given the high gearing of

crowdfunded investments, relatively small inter-

est rate hikes or declines in rents could trigger

signicant corrections. If market realities do not

live up to optimistic expectations for high rental

incomes, low vacancy rates at average locations

or minimal renovation requirements over the

investment period, the annual aer-tax return

will drop – and with it, the buer for corrections.

If vacancy rates and maintenance and repair

costs turn out to be typical for the market, the

investment will likely turn a loss if the property

value experiences a 10–15% correction over an

average investment horizon of six years, and so

will underperform an investment in residential

real estate funds. If property values decline 10%

with a loan-to-value ratio of 60%, investors will

lose a quarter of their invested capital (excluding

rental income). Many small investors, in other

words, will bear a high concentration risk if they

allocate a large portion of their total assets to

crowdfunded investments, regardless of shared

ownership of the property.

Investors able to absorb signicant losses in a

single position – say, because they have a large,

broadly diversied portfolio – may nd crowd-

funding a welcome opportunity to boost returns

by making highly leveraged investments in apart-

ment buildings at peripheral macro locations.

Club deals are another alternative, where several

wealthy investors put funds into real estate with-

out going through platforms.

26 UBS Real Estate Focus 2018

Global Listed Commercial Residential Mobility

Sales per square meter are highest in the largest train stations

due to robust demand. Shopping centers in quieter locations

are, however, feeling greater pressure. Malls are looking for

new ways to boost visitor numbers. Leisure and entertainment

oases are gaining stature.

Shopping malls in train stations have the highest

sales per square meter on an annual basis. In

2016 (latest available data), retailers at Bern sta-

tion generated around CHF 31,000 per square

meter, followed closely by Lucerne station,

Geneva Cornavin and Zurich Central Station

with around CHF 25,000 per square meter. By

comparison, the Glatt shopping center, which

topped the list of Swiss malls without a direct

station connection, generated only CHF 14,000

per square meter. The main reasons for the high

sales are the long store hours and easy access to

quick shopping for commuters.

No wonder demand for space at major public

transit nodes remains strong. Vacancies are rare,

and rents are high. Retail trafc should increase

over the long term too, since SBB expects com-

muter numbers at Switzerland’s biggest train

stations to increase around 50% by 2030. Inves-

tors have responded by building new retail space

near train stations – including the large malls

“Europaallee” and “Welle 7,” which recently

opened next to Switzerland’s busiest train sta-

tions in Zurich and Bern. Retail space has been

added at other train stations too, including

Bellinzona and Zurich Oerlikon.

Conversion edges out new construction

Shopping centers in quieter locations are strug-

gling with plummeting sales in absolute and

per-meter terms. In 2016, they sold over 10% or

CHF 1,000 less per square meter than in 2010.

Investor sentiment has slumped as well: while

over 60 new malls opened between 2000 and

2009, only 18 are expected to open between

2010 and 2019. Last year saw only one new

opening, but it was a signicant one. The “Mall

of Switzerland” in Ebikon boasts close to 50,000

square meters of retail space, and ranked num-

ber four by size nationwide at its opening in

November – or number two if leisure and enter-

tainment space are included. Other new malls,

“Mattenhof Süd” in Lucerne and “The Circle”

at Zurich Airport, are planned for opening in

2019.

Market saturation, the growth of e-commerce

and widespread shopping tourism have

prompted investors to try a dierent approach

to improve their chances of success: renovation.

The number of conversion and rehabilitation

projects increased rapidly between 2008 and

2015. During this period, almost half of Switzer-

land’s malls underwent a complete or partial

makeover. Owners clearly hope that moderniz-

ing and sprucing up their retail space will attract

Shopping malls

reinvent themselves

Maciej Skoczek and Sandra Wiedmer

Retail space

2000/01

2002/03

2004/05

2006/07

2008/09

2010/11

2012/13

2014/15

2016/17

2018/19

Investment activity on the decline

Source: GfK, UBS

Number of new and remodeled shopping centers

New

Remodeled

UBS Real Estate Focus 2018

Waldhotel at Bürgenstock Resort Lake Lucerne, Obbürgen (Stansstad)

more visitors and boost retail sales, thereby

increasing demand for space and raising rents.

Renovation activity has, however, weakened

since 2016 – not surprising since around 90% of

Swiss malls were rebuilt or renovated between

2000 and 2015.

E-commerce hampers brick-and-mortar

competitors

The classic mall concept has seen its day. Today,

investments in shopping centers will only deliver

the expected returns if the centers themselves

adapt to the new market realities. The brick-

and-mortar sector is losing revenue to shopping

tourism and online retailers. In September 2017,

retail sales had fallen more than 5% compared

to the end of 2014. A tenth of all retail sales in

Switzerland are now generated through the

internet.

E-commerce poaches most of its sales from the

brick-and-mortar non-food sector, but more

food purchases are likely to shi online as well.

The two largest online food retailers, for exam-

ple, have increased sales over 40% since 2010,

while traditional channels have seen a slight

decline in food sales. New online providers in

the food market will likely steal additional mar-

ket share from brick-and-mortar stores in the

future.

Paradigm shi to leisure and entertainment

centers

Online retailing will probably lower the demand

for space among retailers even further. To com-

bat vacancies, which could squeeze them out of

the market or shut them down altogether, many

shopping malls will have to overhaul their mix.

Existing malls are attempting to stand out from

the online retail world by oering shoppers

experiences that they cannot get in cyberspace.

The advertising slogan for the “Mall of Switzer-

land” is a prime example, “Where shopping

becomes an experience.” Restaurants, movie

theaters and leisure areas with tness and well-

“Since 2008, half of Switzerland’s

malls underwent a complete or partial

makeover.”

28 UBS Real Estate Focus 2018

ness equipment complement the conventional

retailers. “Welle 7” in Bern takes this concept

astep further. Located right by the train station,

itoers conference rooms, coworking spaces,

aschool, and a food court as well as shopping.

Managers of “Avry Center” near Fribourg pre-

sented their own plans in early 2017: to com-

pletely overhaul the current retail range and to

add a multiplex movie theater, a swimming pool

and a park. They have attempted to make the

center even more attractive for commuters with

a new SBB and bus station, as well as apart-

ments on the mall grounds. “The Circle” at

Zurich Airport has taken a novel approach: at

one of Switzerland’s busiest trafc nodes, it

consists mainly of showrooms where visitors can

experience the brands and look at the products.

The actual purchasing happens online.

110

120

100

500

300

600

100

400

200

2015201420132012 2016

Switzerland

100

120

Oﬀered space (right scale)

Rents fall as the supply of space

increases

Sour

ce: Wüest Partner, UBS

Asking r

ents for Switzerland and market regions (index 4Q 2012=100)

and oﬀer

ed retailed space (in 1000 m²)

Zurich Basel Bern Geneva

Declining returns for retail space

According to Wüest Partner, 630,000 square

meters of retail space was vacant in mid-2017 –

double the level four years ago and a new

record that is larger than the total area of Swit-

zerland’s 15 largest shopping malls. Vacancies

have grown the most in small and medium-

sized cities. However, vacancies in the metro-

politan areas of large cities have increased

signicantly as well.

Falling demand for space has squeezed rents

for retail space. Owners, faced with the pros-

pect of vacancies, have been forced to lower

their rent expectations. All told, asking rents

for retail space are down nearly 10% from

their 2012 peak. Declines in all large centers

have been steeper than the Swiss average,

with Geneva experiencing the strongest cor-

rection – over 20%.

Sinking rents and stagnant property values

have eroded total returns. In 2017, retail

space investments only returned around

3.5% – the lowest level since IPD started

collecting data in 2002, and the lowest

value of all property usage types last year. For

2018, we expect another slight decline in the

total return on retail spaces.

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

The pro-tenant market is putting downward pressure on total

returns from ofce space portfolios. The supply surplus has

stabilized, however, and is expected to shrink slightly this year.

Competitive pressure remains due to ongoing large-scale

development projects in German-speaking Switzerland.

Ofce space owners have been forced to make

concessions to tenants for roughly three years

now due to rising vacancies and the large num-

ber of new developments. In and around Zurich

and Geneva, companies willing to relocate and

potential anchor tenants are being courted with

incentives such as rent relief. The challenging

market situation is having a lagging impact on

real estate portfolios.

Total returns on ofce space investments

declining

The gap is widening between total returns from

commercial and residential portfolios. According

to IPD indicators, total returns on a residential

portfolio were consistently 10 percentage points

higher than those on an ofce space portfolio

from 2012 to 2016. In the ve years prior, total

returns were still equal. While losses in rents for

ofce space were still less than 5% from 2010

to 2012, they have since risen to 8% of target

rents.

Also, investor willingness to pay for prime loca-

tions has declined. Ofce space purchase prices

have dropped an estimated 10% since the start

of 2016, while the prices for residential proper-

ties have increased 10%. Vacant ofce proper-

ties currently sell at substantial discounts in

order to speed up the marketing process, which

can be rather drawn out.

New construction activity remains high

Investments in ofce concrete exceeded 2 billion

Swiss francs each year between 2011 and 2015.

This is roughly 50% more than in the preceding

10 years. Over the last two years, by contrast,

new construction activity has gradually weak-

ened. The number of building permits issued

indicates that investments have dropped by a

third. Even so, new construction still stands at

1–1.5% of the building stock on an annualized

basis.

Demand for space could not match that rate.

From 2011 to 2015, the traditional ofce sectors

– nancial services, information and communi-

cations technology, service providers and admin-

istration – created around 25,000 jobs a year,

Prices (still) correcting

Matthias Holzhey

Ofce space

2.5

1.5

3.5

0.5

3.0

2.0

1.0

20172015201420132012 2016

Traditional ofﬁce sectors Ofﬁce jobs/professions

Demand for ofﬁce space undergoes

structural change

Source: FSO, BESTA, UBS

Annual employment growth rates (in %)

30 UBS Real Estate Focus 2018

basically on par with the long-term average.

Since 2016, however, the average increase has

been a mere 12,000 jobs, rendering a growth

rate of 0.8%. Indeed, demand growth in the key

tenant groups has come to a standstill as well.

Demand for ofce space undergoes struc-

tural transformation

Ofce space is not only demanded by banks and

service providers, but also by rms in logistics,

manufacturing and healthcare. In the manufac-

turing sector, for example, around 50% of all

employees already work in service jobs, with

more on the way. The number of ofce jobs in

all branches of economic activity has increased

signicantly in recent years. Ofce jobs have

been growing at an annual rate of 2% since

2015.

Admittedly, an increasing number of ofce

employees does not mean an equal increase in

demand for ofce space. Commercial ofce

jobs, for example, have not boosted large ofce

space leases much at all. Recently, however, the

rise in employee numbers did manage to pre-

vent Switzerland’s market imbalances from dete-

riorating even more.

Investors focusing on growth triangle

How can we tell? Mainly from vacancies and

ongoing construction activity. Most availability

rates of real estate brokers have been stagnant

since 2015. Even ofcial statistics show that, in

the German-speaking cities of Basel, Bern and

Zurich, vacancies were stable or down, with cur-

rent vacancy rates of less than 2.5%. The story

was similar in Western Switzerland. In 2016,

ofce space vacancies were stable in the Canton

of Vaud and down signicantly in the Canton of

Geneva.

Building permits, however, have sidestepped in

recent years. Between 2012 and 2014, around

40 permits were issued throughout Switzerland

for major projects that each represented over

CHF 20 million in construction investment.

The period from 2015 to 2017 came close to

this level yet again, despite a clear decline in

demand. Apparently, ofce market investors still

believe the average prospects in the Swiss ofce

market are good enough to launch major

projects.

Focus on growth triangle in

German-speaking Switzerland

Source: Docu Media, UBS

Number of building permits for large ofﬁce projects with > CHF 20 million

in investment

Growth triangle

Zurich-Basel-Central Switzerland

2012–14 2015–17

Rest of Switzerland

Lemanic Arc

2012–14 2015–17

Global Listed Commercial Residential Mobility

“The renewal

of expiring leases

still involves lower

rents.”

UBS Real Estate Focus 2018

However, planned projects are clearly shiing

away from the Lake Geneva region to the

German-speaking growth triangle of Zurich-

Basel-Central Switzerland. The number of

approved major projects dropped to six from

16 in the Lake Geneva region, while it went up

to 25 from 14 in the growth triangle.

More corrections expected

Stronger economic growth this year should

accelerate employment growth in the tradi-

tional ofce sectors to 1–1.5%. As a result, we

should see slightly lower vacancy rates through-

out Switzerland. But conditions in the ofce

markets around Zurich and Geneva remain dif-

cult. The large increase in ofce space due to

the pipeline of major projects in planning or

under construction leaves little hope for quick

improvement. Expiring leases are still being

renewed with lower rents. As a result, (further)

corrections will likely be inevitable in many real

estate portfolios.

Regional market summary

Most cities are “on safe ground”

Investors face the greatest risks in the economic

regions of Geneva and Glattal-Furttal. Building

permits have been stuck at a high level since

2015, preventing a reduction of existing imbal-

ances. Here, the highest availability rates in Swit-

zerland – in excess of 10% – and the large year-

on-year increases in listed ofce space present

high leasing risks.

Demand for ofce space remains strong in

urban locations. All the urban regions examined

– with the notable exception of Geneva – had

moderate availability rates and appear set to

decrease even further.

Investment activity is apparently accelerating in

Central Switzerland. Building permits in Zug

indicate that the region is experiencing the

strongest increase in supply of all the regions.

The share of advertised space in total stock was

already above average here and continued to

increase last year. Systematic risk is thus higher

here than in Lucerne, where the ofce space

expansion and availability rates are lower.

In Basel, construction activity is dominated by

space intended for large companies’ own use.

Advertised space is still under 3% despite the

vigorous increase in supply, signaling that ofce

space is scarce. Once pharmaceutical and insur-

ance corporations are done consolidating their

ofces, however, there is a risk that vacancies

will rise.

The economic regions of Winterthur, St. Gallen,

Lucerne, Lugano and Lausanne have the lowest

leasing risks of the largest ofce space markets.

Here, availability rates are low or declining.

Building permits and the disappearance of the

supply surplus from recent years indicate a

well-balanced market.

106

Availability rate

1412

Relatively low Relatively high

Stable IncreasingDecreasing

Expected change

in availability rate

Basel-Stadt

Zimmerberg

Aarau

Bern

Baden

St. Gallen

Luzern

Lugano

Zurich

Limmattal

Zug

Geneva

La Sarine

Lausanne

Neuchâtel

Winterthur

Unteres Baselbiet

* Diﬀerence between supply increase (permitted ofﬁce space as a percentage of the ofﬁce space

inventory since 2016) and potential demand (annualized employment growth 2011 to 2015, in %)

Glattal-Furttal

Highest oversupply risks in Geneva

and Glattal-Furttal

Source: FSO, CSL, Docu Media, Wüest Partner, UBS

Availability rate as of mid-2017 (in %), expected increase in supply

in comparison to potential demand*, market size represented by circle size

32 UBS Real Estate Focus 2018

Investments in Swiss hotels produce meager returns. Their

biggest challenges are high xed costs, low occupancy rates

and cutthroat competition. Large cities, however, remain

robust markets.

Make no mistake: hotels are on the decline.

Many have crumbled under the growing com-

petitive pressure. The number of beds may be

up overall, but the number of hotels has

dropped over 10% since 2008. Declines in the

tourist cantons Grisons, Valais and Bern were in

line with the national average. Ticino was hit

particularly hard, with one out of every four

hotels having closed its doors. Only Zurich,

Geneva and Basel managed to buck the trend.

Suboptimal operating structure erodes

returns

For hotel operators, the biggest challenge is the

combination of unpredictable occupancy rates

and a high proportion of relatively invariable

costs. Unlike apartments, which generate stable

income streams, hotel rooms are booked by a

changing roster of guests at uctuating market

rates. However, the rooms, sta and services

must be ready all the time. Also, roughly six out

of every seven francs invested in hotels are tied

up in property, plant and equipment – one of

the highest ratios in the entire Swiss economy.

Most of the property, plant and equipment con-

sists of real estate with high maintenance costs.

The high operating expenses squeeze prot

margins. According to the accounting statistics

published by the Federal Statistical Ofce, the

average prot margin (net prot relative to sales)

fell from 2–3% between 2006 and 2010 to less

than 1% between 2011 and 2015. That cuts

into returns from hotel investments. We esti-

mate that the return on equity for Swiss hotels

has only been about 1% since 2011, despite

leverage of nearly 80%. By comparison, equity

in Switzerland’s largest listed real estate compa-

nies returned 6–7% a year during the same

period, with lower leverage.

Low demand also a structural problem

Growing competition and the cyclical slump in

demand are making hotel properties even less

protable. First, occupancy rates are low at

Swiss hotels. In 2016, half of all hotel beds

stayed empty on average, as the strong Swiss

franc made it more attractive to vacation

abroad. As it turned out, 2016 became the rst

year in which Switzerland’s tourism balance of

payments was negative since recordkeeping

began in 1975: foreign tourists spent less money

in Switzerland than Swiss tourists spent abroad.

Foreign exchange rate uctuations and interna-

tional competition aect Swiss mountain hotels

the most, because their guest structure is less

diversied than average. Roughly 80% of all

guests in the mountain regions come from Swit-

zerland or the Eurozone. The growing inux of

guests from Asia cannot make up for declining

visitor numbers from Europe, even if the number

of overnight stays went up year-on-year in the

summer of 2017.

Second, the low occupancy rate also points to a

structural problem. Since 1995, the number of

overnight stays in Switzerland has risen only

10%, while Austria and Italy have reported

increases of over 20%, and France and Germany

growth of even 50%. Third, rentable vacation

apartments are becoming more important with

the growth of online platforms (such as Airbnb).

Increasing competition for hotel guests is likely

to hit mountain regions hardest, since their cus-

tomers are much more price-sensitive than visi-

tors to the cities.

Potential

in the cities

Thomas Veraguth and Maciej Skoczek

Hotel investments

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Hotel chains invest in Switzerland

For all these difculties, international hotel

chains have invested in the Swiss market in

recent years. They dominate the one-star seg-

ment, holding roughly 80% of all rooms. In the

luxury segment, half the rooms are owned by

hotel chains. Their market share in the mid-tier

segment (three stars), however, is a mere 10%.

Hotel chains have focused on Zurich and

Geneva, where they own around 50% of rooms,

and hold about 30% and 15% of the market,

respectively. The number of overnight stays in

large cities increased over 10% from 2008–

2016, driving above-average occupancy rates.

Demand is robust in major cities because a large

proportion of visitors are business travelers. Busi-

ness travel evens out seasonal uctuations and

reduces sensitivity to cyclical swings due to

greater diversication in terms of countries of

origin. Outside of cities, however, the number of

overnight stays dropped 5% nationwide during

the same period.

Hotel chains oer various advantages over tra-

ditional family hotels. Running several hotels

under one name with more beds generates

economies of scale, lowering management

costs per room and boosting returns. Also,

guests can benet from loyalty programs or cor-

porate agreements, which strengthen customer

loyalty to the chains. Finally, hotel chains enter

markets via franchising schemes or other long-

term contracts that allow a relatively quick mar-

ket exit if business is bad. If a family hotel is

unprotable, owners oen cannot imagine clos-

ing its doors. These businesses are handed

down over generations, with owners deeply

emotionally invested; they may make a less than

optimal decision to keep their hotel open.

Regional analysis

Cities: a bulwark for investors

Currently, the Zurich, Bern and Lausanne metro-

politan areas oer the best prospects for Swiss

hotel investments. If 2013–2016 trends con-

tinue, hotels in these growth markets will likely

benet from a rise in overnight stays and occu-

pancy rates. Lucerne and Interlaken oer the

best prospects as vacation destinations. The eco-

nomic regions of Lucerne and Glattal- Furttal cur-

rently report the highest occupancy rates among

all the growth markets.

In the saturated markets, occupancy rates are

onthe decline even as the number of overnight

stays increases. The number of available beds is

growing faster than demand; Basel and Geneva

are prime examples. However, Geneva still has

above-average occupancy rates even while the

trend is pointing down.

Areas where successful newcomers crowd out

current hotel operators (the “demise of the

hotel”) may see increasing occupancy rates

despite a decline in overnight stays. These con-

solidating markets include tourist regions in

Appenzell Innerrhoden, Glarus and Locarno.

four-starthree-startwo-starone-star ﬁve-star

Hotel chains Other operators

Hotel chains well represented in

economy and luxury segment

Source: Horwath HTL, UBS

Number of hotel rooms in Switzerland by star category (in thousands,

le scale) and number of rooms in hotel chains as a percentage of the

total rooms in each star category

34 UBS Real Estate Focus 2018

Investments in consolidating markets, though

not risk-free, can be protable with a promising

strategy for attracting and retaining guests.

A simultaneous decline in overnight stays and

occupancy rates can cast doubt on positive

returns over the medium term. Most markets in

Grisons, Upper Valais and the Bern regions of

Kandersteg and Saanen qualify as contracting

markets. Only the Zermatt market has an

above-average occupancy rate.

An analysis of building permit applications sub-

mitted and permits issued since 2013 for hotel

projects with a total capital expenditure of at

least 20 million Swiss francs shows that investors

are not afraid of contracting markets, even in a

weak market environment. Competition will

heat up even more and is likely to contribute to

the demise ofthe hotel. Also, several building

projects are concentrated around Zurich and

Lausanne, where current market trends have

made investors feel upbeat.

Many hotel projects in contracting markets

Map of Swiss hotel industry’s potential¹, by market quadrant

Pontresina

St. Moritz

Davos

Arosa

Opﬁkon

Zürich

Bern

Luzern

Engelberg

Ascona

Lugano

Interlaken

Grindelwald

Lauterbrunnen

Montreux

Lausanne

Meyrin

Genève

Basel

Zermatt

Building permits for hotel projects²

¹ The map shows changes in occupancy rates and overnight stays between 2013 and 2016 in the main municipalities in each region

; color-coded based

on the matrix in the top le. Dark colored regions had an occupancy rate of at least 50% in 2016. No data are available for gr

ay colored regions.

² Building permits for hotel projects with a total investment volume of at least CHF20million since 2013 (not an exhaustive

list).

Sour

ce: FSO, Docu Media, UBS

Decrease Increase

Occupancy rate

Overnight stays

Decrease

Increase

Consoli-

dating

Growth

Contrac-

ting

Saturated

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

The parking garage market is illiquid and heavily regulated,

but the yield is oen not adequate given the level of risk.

Modernization has become an international trend, with new

technology and multifunctionality on the rise. Switzerland’s

inventory of parking garages is aging, so revitalization has

considerable potential.

Private transportation is deeply entrenched in

Swiss society. According to the Federal Statistical

Ofce, privately owned cars are responsible for

65% of the 37 daily kilometers traveled per

capita. The number of passenger cars has risen

17% to 4.5 million vehicles since 2005. Motor-

ization rates (number of vehicles per 1000 peo-

ple) have risen particularly fast outside of large

cities. Records on the supply of parking spaces

are far less exhaustive, however. Switzerland is

estimated to have eight to 10 million parking

spaces, or roughly two spaces per vehicle. Taken

together, all these parking spaces are worth over

100 billion Swiss francs, with parking garages

accounting for around 20% of the total, accord-

ing to Wüest Partner. Most parking spaces, in

other words, are located outdoors or in under-

ground parking facilities.

Fewer public on-street parking spaces

Planning and construction laws for private park-

ing spaces are particularly responsible for the

large number of parking spaces. Some regula-

tions, for example, dene both the largest possi-

ble number of private parking spaces as well as

the minimum number required, depending on

building use, oor space and access to public

transportation. While parking space require-

ments vary depending on the canton and

municipality, they are nonetheless responsible

for the good parking availability, particularly in

rural areas. Wüest Partner estimates that the

vacancy rate for private parking spaces in Swit-

zerland as a whole is around 10%.

In cities, by contrast, public parking spaces are

much scarcer. To make downtowns more walk-

able and attractive, cities such as Zurich,

Geneva and Bern have worked out compro-

mises that move most public parking spaces to

parking garages. The city council of Zurich, for

example, passed a “historical compromise” in

1996 capping the total number of public park-

ing spaces at the high-water mark set in 1990,

and moving above-ground parking spaces to

underground facilities. These urban planning

decisions have increased demand for parking

garages. The number of public on-street park-

ing spaces in downtown Zurich has dropped

20% since 1990, while parking garage capacity

has increased a similar amount.

Niche strategy

without extra yield

Sandra Wiedmer and Thomas Veraguth

Parking garages as investment properties

300

200

350

100

250

150

20151985198019751970 1990 200520001995 2010

Lucerne

Motorization rate has barely budged

in city cantons

Source: FSO, UBS

Number of passenger cars per 1,000 inhabitants, by canton

(index 1970 =100)

Bern Vaud

Basel-City Geneva

Zurich

36 UBS Real Estate Focus 2018

ZurichBaselLausanneBernGeneva

City peripheryInner city

Lucerne

* Multi-family dwelling with six 100m² apartments with 3.5 rooms and four 120m² apartments

with 4.5 rooms

No maximum

Zurich and Lucerne most heavily

regulated

Source: Parking space or building regulations for the cities and cantons, UBS

Minimum required and maximum permitted number of private parking

spaces per multi-family dwelling* in the inner city and on the city periphery

Maximum

Minimum

Maximum

Minimum

Large capital outlay and regulatory hurdles

Some parking garages are government-run or

operated by a stock corporation for the local

government, and so aim to just break even.

However, there are also parking garages run by

for-prot companies in the private sector. These

investments involve a large capital outlay and

considerable regulatory hurdles, including envi-

ronmental impact assessments for parking

garages with 500 or more parking spaces, traf-

c management schemes oreven referendums.

This may explain why parking garages have

remained a niche investment market with less

appeal than other real estate sectors. Parking

garages in top locations oen have a monopoly,

and can charge clients high parking fees. Never-

theless, the yields oen do not reward investors

enough for taking on more risk than in other

property segments. According to Wüest Partner,

parking garage investments earned a net rental

yield of around 4% in 2016 – on par with ofce

space. The nancials of listed Swiss real estate

funds tell a similar story: according to our analy-

sis, parking spaces in these portfolios yielded an

average of 3.8% per year.

Invest directly or indirectly

Parking garages have lower maintenance costs

than other real estate sectors. Investors who

acquire parking garages directly can manage

the facility themselves or outsource operations

to an outside company. Outsourcing oers the

advantage of long leases and steady income.

Operating investors can choose among various

rental strategies. We estimate that full-day rent-

als can generate up to four times, and hourly

rentals as much as eight times as much income

as long-term leases of parking spaces with

monthly rent payments. Hourly rentals carry

more operator risk, however, since the spaces

may end up vacant and generate no income at

all. Long-term rentals can also be restricted to

certain times (daytime or weekdays, for

example).

Global Listed Commercial Residential Mobility

“Full-day rentals

can generate up

to four times as

much income as

long-term leases

of parking spaces.”

UBS Real Estate Focus 2018

Alternatively, one can invest in parking garages

indirectly through funds. Switzerland does not

have any parking-specic funds. European vehi-

cles that mainly invest in the Netherlands, Ger-

many, France and the UK earn an annual distri-

bution yield of around 6% through leverage,

which is better than the average 4% dividend

yield paid by European real estate equities.

Long-term leasing of individual parking spaces

can generate an average gross yield of 5%,

according to data on Switzerland’s largest urban

centers. Now that parking apps have made it

much easier to temporarily rent parking spaces,

short-term rentals may be protable as well.

Parking garages face new demands

Digitization and new mobility forms

Digitization and connectivity have come to

parking garages. More cities and parking struc-

tures are equipped with parking guidance sys-

tems that control trafc ows and make avail-

able parking spaces easier to nd. Occupancy

rates are higher thanks to more efcient sig-

nage. Some parking garages even have an

online reservation system for parking spaces

with lower rates for advance booking.

Autonomous vehicles are placing new demands

on parking garage infrastructure, too. The

world’s rst automated valet parking service is

slated to launch this year as a pilot project at

the Mercedes-Benz Museum in Stuttgart. It

works by connecting vehicles to smart infra-

structure. The driver can drop o the vehicle at

the entrance to the parking garage. A simple

smartphone command then guides the vehicle

to an assigned parking space. Such automated

parking requires a drop-o and pick-up area,

where drivers and passengers can get into and

out of the vehicles, as well as an intelligent sys-

tem to control the vehicles. The pay-o is huge,

though: it improves space utilization by up to

20%, allowing parking garage operators to

squeeze even more vehicles into the same area.

Autonomous valet parking is not (yet) legally

permitted in Switzerland at all or Germany in

general, however.

Multifunctionality

Denser cities and tighter quarters have chal-

lenged architects and urban planners to make

better use of space. For parking garages, this

means a shi toward multifunctionality. Innova-

tive new concepts have proven that parking

garages can have their own personality and

charm, instead of just being grim concrete bun-

kers. Garage roofs now hold observation plat-

forms, large playgrounds, recreation areas and

even parks with greenery. Building interiors

house art exhibitions or open spaces for the

public, for example.

Parking garage properties can also be converted

to entirely new primary uses. For example, a

parking garage in Cologne was recently rede-

signed into a combination condominium/park-

ing building. The project transformed an

unprotable parking garage into an attractive

property; all the condominiums have been sold.

Another revitalization project in Cologne, to be

completed this year, will convert a centrally

located parking garage into a hotel complex

with shops and parking.

Many of Switzerland’s 1,500 parking garages

(Wüest Partner estimate) were built during the

parking garage construction boom of the 1960s

and 1970s. Clearly, they hold tremendous

potential for revitalization and modernization.

38 UBS Real Estate Focus 2018

Global Listed Commercial Residential Mobility

Listed real estate securities combine attractive distributions with

the ability to hedge against price volatility in the overall stock

market. However, their prospects are dimmed by high market

premiums and gradually rising interest rates. Companies now

focus on replacement buildings, renovations and exible usage

concepts.

Last year, real estate funds and equities under-

performed the overall stock market for the rst

time since 2013. They started the year strongly,

but lost steam in the summer. Prot-taking,

greater concerns about vacancies and declining

rents, a growing preference for cyclical stocks,

and large numbers of new issues and capital

increases by real estate funds ate into the total

returns of the rst half of the year. Aer rallying

in December, real estate funds were still up

nearly 7% and real estate equities 10% at the

end of 2017. The Swiss Performance Index (SPI),

however, returned 20% last year.

Real estate equities become independent

Real estate equities are impressive long-term

performers. Since being established as a seg-

ment of the Swiss equity market shortly aer

the turn of the millennium (see page 40), real

estate equities have outperformed the overall

stock market in 10 of the last 18 years, and are

the unrivaled performance champions for the

entire period. Since 2000, real estate equities

have returned over 100 percentage points more

than the SPI in terms of total return. Their price

trends over time are also relevant for investors.

Until about 2013, real estate equities tended to

exhibit price patterns very similar to the overall

stock market.

This correlation with the total stock market has

been weakening since 2013, though. When

interest rates rose in 2013, for example, real

estate equities corrected because US monetary

policy was expected to tighten. General equities,

however, paid good returns. Prices of real estate

equities and real estate funds, by contrast, have

been very strongly correlated since 2013, a

change from the previously weak correlation.

In eect, real estate equities have emancipated

themselves from the overall stock market and

now constitute an independent sector. This

more real estate-specic behavior has also

increased their sensitivity to interest rates.

Minimal price gains expected for indirect

real estate investments

We expect the stock market to be robust in

2018, given the upbeat economic forecasts.

However, the rising tide of the overall market

will not li all boats equally. Real estate equities

Not cheap

Stefan Meyer and Elias Hafner

Real estate equities and funds

–20

–50

–40

–10

–30

201320092007200520032001 2011 20172015

Real estate equities

Real estate equities developed a life

of their own in 2013

Source: Bloomberg, Thomson Reuters, UBS, as of December 29, 2017

Rolling performance* over 12 months (in %)

SPIReal estate funds

* Real estate equities: all equities equally weighted, excluding dividends; SPI: excluding dividends;

real estate funds: excluding distributions

UBS Real Estate Focus 2018

Grisons Museum of Fine Arts, Chur

now have a distinct life of their own, aer all.

With premiums averaging 29%, real estate

equity valuations started out this year rather

high by historical standards. Interest rates are

also expected to climb slightly by the end of the

year, which tends to lower the prices of real

estate securities. In 2018, we expect real estate

equities to deliver a total return that is not much

higher than their dividend yield of around 4%.

The average premium for real estate funds was

27% by the end of 2017, well above the long-

term average. This is partly due to direct inves-

tors’ continued willingness to pay high prices.

Prices should not climb any more this year,

though. However, real estate funds currently

oer an attractive distribution yield (2.6%) as

well as diversication if equity market prices

come under pressure across the board.

Fundamental analysis

Interest costs dropping more slowly

Debt interest for the real estate companies

under review fell from 2% in 2015 to 1.85% in

2016. The average maturity of all the compa-

nies’ debt was close to ve years. Of these com-

panies, Zug Estates, had the longest average

maturity (8.2 years), and Allreal the shortest

(three years). Even though general interest rates

did not fall any more in 2017, companies proba-

bly still managed to lower their interest rates

modestly once again. However, these cost sav-

ings are dwindling as the impact of the time lag

fades. Companies are therefore looking to lock

in interest rates for longer terms, reecting

expectations of a moderate increase in interest

rates over the medium term.

Average mortgage rates for six of the best-capi-

talized real estate funds dropped 0.2 percentage

points to around 1.25% in 2017. The biggest

fund even managed to take out short-term

mortgages at negative interest rates. As loans

“Companies are striving to lock in interest

rates for longer terms.”

40 UBS Real Estate Focus 2018

with interest rates as high as over 2% come

due, average interest rates will continue to drop

here and there. Real estate funds have lower

interest rates than real estate equities due to

somewhat shorter average maturities (4.3 years),

larger residential allocations and less leverage.

That does not mean that balance sheets at Swiss

real estate companies are weak, though: equity

ratios are 40% or more.

Vacancies in residential portfolios

on the rise

Quality is measured not just by balance sheets,

but also by proactive property management.

Property and tenant care clearly impacts rental

income and vacancy rates. In 2016, the average

vacancy rate dropped from more than 7% to

6.6%. We expect that this rate fell even further

to 6% last year. Allreal and PSP are likely to have

made the greatest progress. Zug Estates and

Flughafen Zürich have the lowest vacancy rates.

To ll vacant space and maintain rent levels,

though, new leases now have to include entice-

ments like rent-free periods and nancing for

tenant improvements.

The overall rent default rate for real estate funds

has changed very little since 2016, coming in

near 5%. However, trends vary depending on

the usage type. While rates in portfolios that

focus on commercial space went down, vacan-

cies in residential real estate portfolios went up

– echoing the trends in the Swiss rental market.

Real estate equity sector – independent with upside

potential

Pure-play real estate equities have been trading

on the Swiss Exchange for roughly 45 years. The

oldest listed rm, Intershop Holding, was estab-

lished in 1962 and has been listed since 1972.

Other companies did not follow until shortly

aer the turn of the millennium. Spring 2000

saw a veritable “IPO big bang”: four new pure-

play real estate companies joined the SIX Swiss

Exchange ticker in a few months: Allreal Hold-

ing, PSP Swiss Property (PSP), REG Real Estate

Group (which was acquired by PSP in May 2004)

and Swiss Prime Site (SPS). Flughafen Zürich AG,

established in 1948 as “Flughafen Immobilien-

gesellscha,” was listed in 2000, too. Today, the

company is more than just an airport operator;

it is also a successful landlord.

In December 2005, the Swiss Exchange

launched the SXI Real Estate Shares Index,

which now has 12 real estate stocks and a capi-

talization of 16 billion Swiss francs. Until 2016,

however, real estate equities were still included

in the nancial service sector, in the shadow of

large banks and insurance heavyweights.

In September 2016, real estate equities were

emancipated. A new, 11th sector was born, and

now features in the world’s leading share

indexes like the S&P Dow Jones and MSCI, rais-

ing the presence and prestige of real estate

equities. Switzerland, however, has not yet

taken this step, so the Swiss real estate equity

sector harbors considerable upside potential.

Real estate companies publicly traded in the

Swiss equity market make up only 1% of the

estimated total value of Switzerland’s real

estate.

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Key nancials for the largest listed Swiss real estate equities

Unless otherwise stated, all gures are in %

Flughafen

Zürich

SPS PSP Allreal Mobimo Inter-

shop

HIAG Zug

Estates

Investis

Market capitalization¹ 6758 6076 4013 2650 1559 986 923 914 728

Vacancy rate

2015 1.5 6.7 8.5 7.5 4.7 11.5 16.0 5.4 3.3

2016 2.0 6.1 9.3 5.1 4.8 11.3 15.3 1.8 3.7

2017

1.8³ <5.5 <8.5 2.9³ 4.9³ ~11.3 15.1³ 1.4³ 3.3³

Dividend growth

2011–2016 27.5 0.5 2.2 0.9 2.1 0.0 – – –

2016–2019

3.3 0.4 1.0 4.2 1.6 0.0 4.0 8.0 0.0

Pay-out ratio

Dividend policy² Variable

div. + initial

additional

div.

≥ CHF 3.70 >70 ~100 of

non-P&D

prots

≥ CHF 10 CHF 20

since 2007

≤ 40 Attrac-

tive +

stable

2016 82 92 89 82 63 70 109 47 216

2017

77 95 89 84 97 67 102 39 121

Average 2011–16 52 92 89 78 91 76 105⁶ 44⁷ –

Dividend yield

2017

2.9 4.4 3.8 3.6 4.0 4.1 3.3 1.3 4.1

2018

3.1 4.4 3.9 3.8 4.2 4.1 3.4 1.4 4.1

Equity ratio

55 43 54 52 43 42 54 57 47

In million CHF

According to company sources

As of the 1st half of 2017

Consensus forecasts

As a percentage of net asset value

2014–2016

2012–2016

This table is a reference list and does not constitute a recommended list.

Source: companies, UBS; as of November 14, 2017

More digital, exible, comprehensive

Real estate companies and funds are making

defensive plays. However, it is still hard to gen-

erate growth in this market environment. Real

estate companies stand a better chance, since

they generally manage their portfolios more

actively and operate in other business seg-

ments, which should protect dividends. For the

time being, the companies are developing very

little new land for their own portfolio and are

only carrying out large projects if they are heav-

ily pre-leased. They are focusing instead on

replacement buildings, renovations, higher den-

sity, and new concepts and services. Landlords

are responding more to their customers’ needs,

analyzing their customer data more precisely,

building more sustainably and relying more on

digital assistance.

Investis, for example, acquired equity in Polytech

Ventures, a start-up for technology-based real

estate services. HIAG has invested in cloud ser-

vices with dedicated ber optic lines for compa-

nies. And Zug Estates plans to transition its port-

folio to renewable energy and a zero-carbon

footprint over the medium term. Sustainability is

becoming increasingly important, even for real

estate funds. Aer all, modern-day designs

make it easier to repurpose real estate and pro-

vide much greater exibility in how properties

can be used.

42 UBS Real Estate Focus 2018

Global Listed Commercial Residential Mobility

House prices in big cities are especially likely to skyrocket

during market booms due to expectations of constantly rising

prices. A correction seems inevitable once sentiment shis or

interest rates rise. Toronto faces the greatest risk of a real estate

bubble.

Last year alone, prices in Munich, Toronto,

Amsterdam, Sydney and Hong Kong soared

more than 10%. A 10% annual rate means that

house prices double every seven years – a clearly

unsustainable pace. Nevertheless, most residen-

tial property buyers are still afraid of missing out

on further price gains. This price behavior seems

logical for three reasons.

First, nancing is cheaper than ever before in

many cities. Second, the global increase in

wealthy households is driving demand for

upmarket neighborhoods. Third, construction

activity cannot keep pace with demand.

Low mortgage interest rates gloss over

market imbalances

The decade-long decline in mortgage interest

rates has made home purchases more attractive

and driven up the average willingness to pay for

residential property. In European cities, for exam-

ple, annual usage costs for condominiums (inter-

est and principal payments for mortgages) are

still below the 10-year average, even though

real home prices have increased 30% since

2007. In Canada and Australia, the negative

eects of higher prices on aordability are

largely oset by lower mortgage interest rates.

Will prices rise forever?

Expectations of continued long-term price

growth have fueled demand for real estate

investments in large cities. Many market partici-

pants assume that prime locations will see the

biggest increases in value over the long term –

much like superstars. “The Economics of Super-

stars” explains why small numbers of people

earn enormous amounts of money in certain

industries such as show business.

Superstars

earn much more than the average worker – well

out of proportion to the dierence in quality or

performance. Accordingly, home prices in the

most attractive cities should signicantly exceed

prices in average cities or rural areas over the

long term, even though the property is unaf-

fordable for the average household. For empiri-

cal evidence of this theory, look no further than

Hong Kong, London or San Francisco.

There is an intuitive explanation for this phe-

nomenon: national or global increases in

wealthy households generate continuous surplus

demand for prime locations. In other words, if

the supply does not grow fast enough, prices in

“superstar cities” will become decoupled from

rents, incomes and nationwide price levels. The

data seems to bear out this hypothesis: In cities

surveyed by the UBS Global Real Estate Bubble

Index (see page 44), home price ination was

170% between 1980 and 2017. The general

ination rate in these countries was 100%,

while real income in the cities rose 50% and

rents rose a mere 30%.

Superstars

or bubbles?

Matthias Holzhey and Maciej Skoczek

UBS Global Real Estate Bubble Index

Rosen, Sherwin. 1981. “The Economics of Superstars.” American

Economic Review 71 (5): 845-58

UBS Real Estate Focus 2018

Growing international demand, especially from

China, has crowded out local buyers and lent

further credence to the “superstar city” theory

in recent years. An average price increase of

nearly 20% over the last three years has con-

rmed even the most optimistic expectations.

Susceptible to excesses

These expectations have made large cities espe-

cially susceptible to excesses in market booms.

The belief in endlessly rising housing prices is

extremely self-reinforcing and pro-cyclical. It also

explains why global cities have seen bigger price

corrections than the countries as a whole. Fol-

lowing the widespread corrections of the late

1980s, it took most cities until the early 2000s

to recover. Anyone who bought a home in Lon-

don in 1988, for example, had to wait until

2013 – 25 years, in other words – until their

investment had gained more value, in percent-

age terms, than the average British home.

Fundamentals matter

One look at the boom and bust cycles of hous-

ing markets over the last 35 years highlights the

importance of fundamentals. Nine of 10 prop-

erty crashes of –15% or more were preceded

bya clear overvaluation signal, according to the

methodology of the UBS Global Real Estate

Bubble Index. Real-time calculations for 1980 to

2010 indicate a 50–60% probability of a crash

within 12 quarters aer such an overvaluation

signal. By comparison, there is a 12% advance

probability of a real estate crash in any quarter

of that period.

Notable, however, is that the model has sent

outwarning signals too oen and, in some

markets, too early. Investors who followed these

signals lost out on high capital gains, especially

in recent years, when central banks distorted

market incentives with unprecedented quantita-

tive easing programs. On average since 1980,

though, avoiding overheated markets has been

a wise move.

“Nine of 10 property crashes were

preceded by a clear overvaluation signal.”

Upper West and Hotel Waldorf Astoria, Berlin

44 UBS Real Estate Focus 2018

Toronto

Stockholm

Munich

Vancouver

Sydney

London

Hong Kong

Amsterdam

Paris

San Francisco

Los Angeles

Zurich

Frankfurt

Tokyo

Geneva

Boston

Singapore

New York

Milan

Chicago

bubble risk (> 1.5)

overvalued (0.5 to 1.5)

Fair-valued (–0.5 to 0.5)

undervalued (–1.5 to –0.5)

+ 2.12

+2.01

+1.92

+1.80

+1.77

+1.74

+1.59

+1.31

+1.26

+1.13

+1.08

+0.92

+0.90

+0.83

+0.45

+0.32

+0.20

+0.09

–0.66

–0.5 0.5 1.5

Sour

ce: UBS

Latest index scores for the housing markets of select cities

According to the UBS Global Real Estate Bubble

Index, Toronto faces the greatest risk of a bubble

following last year’s signicant increase in imbal-

ances. Stockholm, Munich, Vancouver, Sydney,

London and Hong Kong are still showing telltale

signs of a bubble; Amsterdam has joined the

group, too, following last year’s run of price

increases. Homes in San Francisco, Los Angeles,

Zurich, Frankfurt and Geneva are overvalued. By

contrast, property markets in Singapore, New

York and Milan are fairly valued, while Chicago

is undervalued, as it was last year.

Price bubbles are a regular occurrence in prop-

erty markets. The term “bubble” describes sig-

nicant and persistent asset mispricing that can-

not be proven to exist until it bursts. However,

property market excesses show repeating pat-

terns in historical data. Typical signs include a

decoupling of prices from local incomes and

rents, as well as distortions of the real economy,

such as excessive lending and construction activ-

ity. The UBS Global Real Estate Bubble Index

uses the presence of such patterns to measure

the risk of a real estate bubble.

UBS Global Real Estate Bubble Index

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Price-to-income ratio

In most global cities, not even a highly skilled

employee in the service sector can aord to buy

a 60-square-meter apartment. Even someone

earning twice the average wage of a highly

skilled employee in the service sector would be

hard-pressed to buy an apartment of this size in

Hong Kong. Unaordable apartments are oen

a sign of strong foreign investor demand as well

as strict construction and rental market regula-

tions. Should investor demand decline, the risk

of a price correction will rise, and the long-term

prospects for further price increases will deterio-

rate.

From a home buyer’s perspective, aordability

also depends on mortgage interest rates and

repayment obligations. Relatively high rates for

interest and principal payments in the US, for

example, weigh heavily on monthly incomes

despite relatively low price-to-income ratios.

Conversely, it is easy to maintain high purchase

prices if full repayment of principal is not

required and interest rates are low, as is the

case in Switzerland and the Netherlands, for

example.

Price-to-rent ratio

An extremely high price-to-rent ratio indicates

that house prices are heavily dependent on low

interest rates. In all cities with indicators above

30, house prices are susceptible to a sharp cor-

rection should interest rates go up. Indicators

below 20 are only found in US cities, which is

due, among other things, to higher interest

rates and comparatively weak regulation of the

rental market. Landlord-tenant laws in France,

Germany, Switzerland and Sweden, by contrast,

are very pro-tenant and prevent rents from

reecting the actual market level.

If indicators for the price-to-rent ratio skyrocket,

then this is not only a reection of interest rates

and rental market regulation, but also of the

expectation of increasing prices, as in Hong

Kong and Vancouver. Investors assume that

capital gains will compensate them for inade-

quate rental income. However, should these

hopes fail to materialize and expectations

weaken, housing owners in markets with high

price-to-rent ratios will probably have to absorb

signicant capital losses.

Hong Kong

London

Paris

Singapor

New

York

kyo

ncouver

Amster

dam

Sydney

Munich

Stockholm

Geneva

ronto

San Francisco

Zurich

Frankfurt

Milan

Los Angeles

Boston

Chicag

Current value Range*

* Range due to diﬀerences in data quality

Value in 2007

1 5 10 15 20

Home ownership

barely aﬀordable

Source: UBS

Number of years that a skilled employee has to work

to buy a 60m² apartment

11 15 20 25 30 35 40

High sensitivity

to interest rates

Ratio of purchase prices to rents

for a comparable apartment

Zurich

Munich

Stockholm

Vancouver

Paris

London

Hong Kong

Singapore

Milan

Geneva

Sydney

Frankfurt

New York

Toronto

Tokyo

Amsterdam

San Francisco

Los Angeles

Boston

Chicago

46 UBS Real Estate Focus 2018

The global real estate cycle is drawing to a close, shiing the

focus toward rental yields. Residential and logistics properties in

Continental Europe still oer opportunities in this environment.

However, political risks have dimmed the long-term outlook in

some EU countries.

The hunt for yield in response to historically low

interest rates worldwide has spurred real estate

investment and pushed up property prices glob-

ally. Last year, for example, prime yields fell to

all-time lows in virtually every sector and region.

The only saving grace: the large yield gap

between government bonds and real estate still

makes investment in properties attractive. The

global real estate cycle has already begun its

gradual decline, though. Global transaction vol-

umes have fallen roughly 7% since peaking in

mid-2015, according to Jones Lang LaSalle.

Property values will rise far less this year than in

previous years due to soer fundamentals and

the well-advanced market cycle. They may even

fall in the course of 2019. This soening of

growth rates will make rental yields more

important. Unfortunately, the expected large

supply of new properties limits the potential for

signicant rent increases. Investors will be

well-advised to avoid excessive locational risks

and pay close attention to occupancy rates and

tenants’ long-term credit standings. Some mar-

kets still have promising investment opportuni-

ties. Generally speaking, though, market condi-

tions are less attractive than they were a year

ago. We recommend being selective about

property purchases and keeping leverage mod-

erate.

Majority of markets unattractive

The balance between risk and opportunity has

deteriorated even more worldwide in the past

two years. We would currently only describe

one-third of the markets we analyzed as bal-

anced or attractive.

APAC

We view Japan, China, Australia and Hong Kong

as unattractive due to the absence of macroeco-

nomic drivers, generally high levels of debt and

the fact that supply is growing faster than

demand. In Singapore, by contrast, more stable

economics will likely prop up the real estate

market and gradually restore the balance

between supply and demand.

Where opportunities

still reside

Thomas Veraguth, Nena Winkler and Sandra Wiedmer

Global market for direct real estate investments

European real estate relatively attractive

Source: UBS

Relative risk/return relationship

Ofﬁce Retail Residential

Logistics/

Industrial

Favorable Unfavorable

Overall

Canada

Cont. Eur

ope

Germany

Switzerland

Japan

China

Australia

Hong Kong

Singapor

Brazil

Balanced

This assessment considers the attractiveness of a market compared to its own historical data.

Ex Germany and Switzerland

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Americas

Risks and returns are more or less balanced in

the US market. Investors can still nd opportuni-

ties among residential, ofce and logistics prop-

erties. The Canadian real estate market, in con-

trast, exhibits elevated systemic risks due to high

household debt levels, while Brazil faces political

and economic risks, which is why we classify

both markets as unattractive.

Europe

We view the UK and Switzerland as unattractive

due to looming imbalances while Germany,

France, Spain and Italy harbor upside potential,

particularly for housing, which is driven by

urbanization, and for logistics properties, which

have beneted from demand for centrally

located warehouses and distribution centers.

Focus on Europe

UK – Real estate cycle far advanced

Prospects are dim due to political uncertainty

leading up to Brexit and the Bank of England’s

tighter monetary policy. The UK is also farther

along in the cycle than other markets. We

expect net present values to decline as much as

5% in the next 12 months. Rent growth should

decline in the ofce, retail and logistics seg-

ments as ofce vacancies rise due to an inux of

new properties and relatively fragile demand.

We recommend holding prime properties with

long-term rental contracts and stable cash ows.

New investments should focus on logistics and

mixed-use urban building complexes.

Germany – On the rise, but uncharted

territory ahead in the medium term

Low nancing costs, capital inows and a

booming economy have extended the upswing

phase of the real estate cycle. Political risks in

other countries have heightened interest in Ger-

many, widely viewed as Europe’s safe haven.

Investors have unfortunately not given enough

consideration to the long-term risks surrounding

Germany’s contingent liabilities in the Eurozone.

Nonetheless, the market still contains attractive

value-add opportunities, such as buildings in

prime locations that are (partially) vacant or in

need of renovation. Prime ofce yields, unfortu-

nately, average only 3.2% for the top ve cities

(Berlin, Düsseldorf, Frankfurt, Hamburg,

Munich). These historic lows are driven by strong

investor interest, a limited supply of properties

and a relative dearth of sellers. Ofce space

vacancy rates (currently 5.2%) will likely fall even

further, which should push rents up slightly if

the economy continues to grow. The retail sec-

tor encompasses everything from booming

online providers and prime retail-tainment-type

malls to secondary properties whose appeal is

fading. Housing demand is strong in large urban

areas; vacancy rates are less than 2% in Munich

and Berlin. The logistics sector is experiencing

strong demand, with prime yields currently at

4.5%.

France – Growing optimism centered

around Paris

Paris ranks second among European cities, sur-

passed only by London. Its investment market

isbroad, liquid – and expensive: prime yields

are3% or less. Demand for ofce space was

recently more robust, while relatively tight supply

has created openings for rent increases for mod-

ern properties in good locations. The impending

Brexit has made Paris relatively attractive for

companies keen to maintain access to the Euro-

pean market. Paris is the world’s third-largest

investment location, so theadditional demand

will unlikely shi the market enough to drive up

prices. Lyon, France’s second-most important

investment location, has a relatively dynamic

economy, but plays little to no role on the global

stage. Moreover, Lyon’s yield premium over Paris

is below its historical average.

“Political risks

inother countries

boost interest

inGermany.”

48 UBS Real Estate Focus 2018

–2

–1

654

APAC

Low yield,

positive gap

High yield,

positive gap

High yield,

negative gap

Low yield,

negative gap

Yield gap

Europe Americas

* The authors estimated the rental yields for CN, HK, SG and BR

Positive yield gap for most markets

Sour

ce: Ares, Bloomberg, Centaline, IAZI, Moody‘s/RCA, MSCI/IPD, NBS,

Rating and V

aluation Department Hong Kong, URA, UBS

Yield gap between income return and yield on 10-year government bonds

(in percentage points) as well as income return* (in %),

2018 values are estimated

Rental yield

Spain – Recovery concentrated in Madrid

and Barcelona

Commercial properties have beneted from an

accelerating business cycle and falling renanc-

ing costs. Due to the repeated euro crises, the

cycle is less advanced in Spain than in other

European markets, but prime locations – espe-

cially in Madrid and Barcelona – have caught up

quickly in the last two years, thanks to foreign

capital. As a result, prime yields are now 3.8%

– near the levels found in other large European

cities. Yields remain stubbornly high, relatively

speaking, in the peripheries of both cities,

though. Rents are expected to rise in Madrid as

well as Barcelona since demand is stable and

supply is fairly tight. Prime rents for ofce space

in Madrid are still 30% below their 2007 highs.

Investors in search of good investment opportu-

nities can look at mixed-use real estate or can

consider renovating properties in locations near

downtown Madrid or downtown Barcelona.

Italy – Political discord stymies broad-based

upswing

Italy may not have completely recovered from

the latest nancial crisis, but that did not stop

real estate transaction volumes from rising in

2016. The only liquid location, Milan, where for-

eigners account for two-thirds of the transac-

tions, generated a bit more than 40% of the

transaction volume, followed by Rome at 14%.

Retail space is in demand in Milan and Rome

due to rising tourist numbers. This generally

high demand, taken together with the relative

paucity of prime properties, is continuing to

exert pressure on initial yields, which currently

hover around 4.0% for ofce real estate in

prime locations in Rome, and around 3.5% for

equivalent properties in Milan. Renovations in

Milan represent an attractive form of invest-

ment. Unfortunately, the medium-term outlook

is clouded by political discord and the highly

fragile banking sector.

Global Listed Commercial Residential Mobility

UBS Real Estate Focus 2018

Long-term trends open opportunities for innovations that

ultimately impact property values. These innovations don’t

generally prop up building and land values directly, but rather

apply more pressure to adapt. Real estate investors keen to

minimize value losses should watch seven investment themes

particularly closely.

Property value is mainly determined by supply

and demand, and can be represented as the

weighted average of fair value, capitalized value

and new construction value. The total value of a

property consists of the value of the land and

the value of the buildings constructed on the

land. Generally speaking, land accounts for one-

third and buildings two-thirds of a property’s

value.

Land is forever; buildings are temporary

The land value is the equivalent of a capitalized

stream of payments that the owner can gener-

ate by using the land in the most protable way

possible. Location plays a big role in property

values. An attractive location can determine a

property’s leasability and market liquidity.

The building value is determined by age, xtures

and ttings, construction quality and current

lease status. Unlike land, buildings have a lim-

ited useful life over which they are depreciated.

Depreciation rates vary depending on the prop-

erty’s construction quality relative to the market

standard. The average annual depreciation rate

is up to 2% of the building investment value for

residential buildings, up to 4% for commercial

structures, and up to 8% for factories and ware-

houses.

Direct and indirect eects on property value

New building technologies and building meth-

ods directly aect building value. Better con-

structed buildings tend to be worth more. Con-

versely, older buildings will depreciate more

quickly if buildings are constructed at nearby

competing locations using more advanced tech-

nologies. Building depreciation is generally oset

by the rise in property value attributable to rent

increases. However, buildings can depreciate so

fast that the overall building value will still fall. If

location attractiveness improves due to, say,

urban planning programs or increases in build-

ing density, the resulting indirect eects will pri-

marily boost the land value in absolute terms

and as a share of total property value.

Signicance of long-term

investment themes for real estate

investments

Seven investment themes aect property

values

We have analyzed the impact of innovations and

innovation-related investment themes (see p.51)

on the fundamental drivers of real estate value.

These drivers break down into three basic cate-

gories: short-term, long-term and institutional.

Short-term factors are macroeconomic compo-

nents such as per-capita earned income, the

business cycle, ination, exchange rates or the

discount rate. Long-term drivers of real estate

value include demographics, location attractive-

ness, construction technology and construction

efciency. Institutional factors refer to aspects of

the legal and regulatory environment such as

taxes, levies, regulations or laws. The following

investment themes have a signicant impact on

real estate value:

Existing properties could

depreciate faster

Nena Winkler and Thomas Veraguth

Impact of long-term investment themes on global real estate markets

50 UBS Real Estate Focus 2018

Global Listed Commercial Residential Mobility

Energy efciency, clean air and carbon reduc-

tion, automation and robotics

More expensive construction standards relating

to internet technologies, smart building applica-

tions, energy efciency, emissions reductions or

alternative energy sources increase the cost of

new buildings and thus drive construction cost

ination; development tends to be more expen-

sive. At the same time, construction technology

is constantly improving even as the construction

industry itself seeks out new efciency gains

through innovations such as digitization or auto-

mation and robotics.

Thanks to all these trends, older buildings should

be steadily replaced by new, better and more

efcient structures, and thus gradually lose

value. However, tenants, with their rising expec-

tations, are unwilling to absorb all of the

increase in new construction costs, even if it

means lower utility costs. Steering taxes intro-

duced to accelerate these trends can make older

buildings at a particular location even more

expensive. Thus, market-standard properties can

certainly command higher rents, but they can-

not generate excess returns over an extended

period of time.

Smart mobility and mass transit rail

Building densities in urban centers are rising due

to spatial planning, mass transit rail and smart

mobility. Mass transit rail increases land scarcity

in the inner city because it concentrates

demand. This causes land values to rise, since

each unit of space can now generate more

value. Whether this means prospective tenants

will willingly pay more for a particular property

depends largely on the location’s attractiveness

and the tenants’ own earning capacity, not on

the innovations themselves.

Retirement homes

Longer life expectancy has fueled demand for

retirement homes with dierent levels of care

and assistance, driving up the property values of

retirement and nursing homes. Demand is also

rising for independent living properties featuring

amenities such as wheelchair accessibility and

senior-friendly bathrooms. In addition, more

senior citizens now want to live in cities in order

to have better access to medical care.

E-commerce

E-commerce has fundamentally changed how

people shop. This still-growing trend aects

retail properties by increasing demand for high-

end properties in urban locations that can serve

as showrooms and retail-tainment centers, while

curtailing interest in retail space in sub-prime

locations. In the logistics sector, e-commerce has

fueled demand for properties located near city

centers, since they are perfectly positioned to

enable quick, efcient last-mile delivery.

Excess returns only temporarily possible

Real estate investors can leverage innovations

and new technologies to temporarily earn an

excess return.

However, it’s oen impossible to pass on all the

additional costs to tenants. Innovations can

quickly establish themselves as the new stan-

dard, depending on the level of new construc-

tion activity and the speed of adaptation. It

doesn’t take long for “obsolete” or non-up-

graded inventory to start selling at a discount.

UBS Real Estate Focus 2018

Long-term trends and related investment opportunities

The UN estimates the world population will

grow to around 10 billion by 2050 from 7.5 bil-

lion presently. Up to 9% of the world population

will live in 41 megacities by 2030, most notably

Tokyo, Delhi and Shanghai, and 70% will inhabit

an urban setting by 2050. In 2030, the number

of people aged 60 and up will outnumber the

under-25-year-olds in developed nations. These

three global trends – urbanization, population

growth and aging – present challenges and

opportunities alike for investors.

Seven long-term investment themes

signicantly aect real estate investments

UBS CIO WM identied 26 long-term invest-

ment themes based on these three dened

trends. We then analyzed these themes in terms

of their impact on property values. Based on this

analysis, we believe property values will be par-

ticularly impacted by seven themes and the

innovations underlying them: energy efciency,

clean air and carbon reduction, automation and

robotics, retirement homes, smart mobility,

e-commerce, and mass transit rail.

The 26 long-term investment themes (Longer Term Investments LTI)

of CIO WM

Source: UBS

Arranged according to their inﬂuence on real estate values, decreasing, in a clockwise direction

LTI

Aging

Population

growth

Urbanization

Energy efﬁciency

Clean air and carbon reduction

Automation and robotics

Retirement homes

Smart Mobility

E-commerce

Mass Transit Rail

Retirement planning

Security and Safety

Agricultural Yield

Digital data

Educational services

Emerging market

healthcare

Emerging market

tourism

Emerging market infrastructure

Frontier markets

Medical devices

Silver Spending

Water scarcity

Waste management

and recycling

Renewables

Generics

The Middle East –

Prosperity beyond oil

Obesity

Oncology

Protein consumption

Investment themes with the highest impact on real estate assets

52 UBS Real Estate Focus 2018

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UBS Real Estate Focus 2018

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Version 07/2017.

Allreal 1, 2, 3. Flughafen Zuerich 3. Intershop Holding AG 3, 4. Mobimo Holding 1, 2, 3. PSP Swiss

Property 1, 2, 3, 5, 6. Swiss Prime Site 1, 2, 3. Zug Estates 3.

1. Within the past 12 months, UBS AG, its afliates or subsidiaries has received compensation for invest-

ment banking services from this company/entity or one of its afliates.

2. UBS AG, its afliates or subsidiaries has acted as manager/co-manager in the underwriting or place-

ment of securities of this company/entity or one of its afliates within the past 12 months.

3. UBS AG, its afliates or subsidiaries expect to receive or intend to seek compensation for investment

banking services from this company/entity within the next three months.

4. Within the past 12 months, UBS Securities LLC and/or its afliates have received compensation for

products and services other than investment banking services from this company/entity.

5. An employee of UBS AG is an ofcer, director, or advisory board member of this company.

6. UBS Fund Management (Switzerland) AG benecially owns more than 5% of the total issued share

capital of this company.

As of 9 January 2018

54 UBS Real Estate Focus 2018

Overview and forecasts

2019P2018P2017P2016201520142013

Economy

Gross domestic product growth (in %)

2.5

1.5

0.0

0.5

2.0

1.0

Interest

Yield on 10-year federal government bonds (end of year, in %)

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0

–0.2

2013 2014 2015 2016 2017 2018P

YieldProperty prices are dependent on interest rates (only symbolically)

–1.8

–1.2

–0.6

0.0

0.6

1.2

2010 2011 2012 2013 2014 2015 2016 2017 2018P 2019P

Inﬂation

ear-on-year change in consumer prices (in %)

2018P201620142012201020082006200420022000

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Population

P = Prediction

Source: FSO, Bloomberg, SECO, SNB, UBS

Population gr

owth (in %)

55UBS Real Estate Focus 2017

Helpful for investment decisions

UBS Real Estate Local Fact Sheets contain

key statistical information on the local

real estate market in every Swiss munici-

pality. They can be used for various pur-

poses such as investment decisions, mar-

ket analyses or comparisons with other

municipalities.

UBS Real Estate Local Fact Sheets are

published in German, French, Italian and

English and can be obtained from your

client advisor.

UBS Real

Estate

Local Fact

Sheets

1.8%

This year and next year, we expect

economic growth of 1.8% – the

average growth rate since 2000.

This trend should benet commer-

cial properties in particular.

0.9%

Population growth should reach

0.9% this year, which means that

in 2018 around 10,000 fewer

additional homes will be needed

than in 2013.

0.1%

Long-term interest rates will likely

rise slightly to 0.1% by the end of

the year. Low interest rates will keep

real estate demand high.

0.6%

Consumer prices will probably rise

0.6% on an annual average – the

fastest increase since 2010. Slightly

higher ination will have very little

impact on rents, however.

2011 2012 2013 2014 2015 2016 2017

2018

10 years

Business cycle and income

1.8 1.0 1.9 2.4 1.2 1.4 1.0 1.8 1.4 Real gross domestic product

0.8 –0.1 0.6 1.2 0.1 0.3 0.1 0.9 0.2 Real gross domestic product per capita

0.7 1.5 0.9 0.9 1.5 1.1 0.2 0.1 0.9 Real wages

Ination and interest rates

0.3 –0.7 –0.2 –0.1 –1.1 –0.4 0.5 0.6 0.1 Average annual ination

0.1 0.0 0.0 –0.1 –0.8 –0.7 –0.7 –0.5 –0.1 3-month Libor CHF

0.7 0.6 1.3 0.4 0.0 –0.1 –0.1 0.1 0.8 Yield on 10-yr Swiss federal bonds

Population and employment

1.1 1.1 1.3 1.2 1.1 1.1 0.9 0.9 1.1 Population

2.9 2.9 3.2 3.0 3.2 3.3 3.2 3.0 3.1 Unemployment rate

1.4 2.0 1.6 0.8 0.8 –0.3 0.5 0.8 1.0 Employment. in FTE

Owner-occupied homes

4.8 5.1 3.4 2.2 1.5 1.0 0.0 0.0 3.4 Asking prices for condominiums

4.1 3.7 4.7 1.3 2.3 1.3 2.0 0.5 3.2 Asking prices for single-family homes

4.0 5.1 5.1 3.5 3.4 2.8 2.5 2.0 3.9 Growth in mortgage lending to individuals

Rental apartments

2.8 3.1 2.9 2.2 1.0 –1.3 –1.0 –2.5 1.9 Asking prices

–0.9 1.2 1.3 5.8 –1.5 –3.4 –3.0 –3.0 –0.5 Asking prices for new builds

1.4 0.6 0.4 1.2 0.9 0.2 1.0 0.5 1.2 Price index for passing rents

2.5 2.3 2.0 2.0 1.8 1.8 1.5 1.5 2.3 Mortgage reference interest rate

4.4 4.4 4.1 4.2 4.1 3.9 3.8 3.7 4.3 Net cash ow yield

3.3 2.8 2.7 1.9 4.1 4.2 2.0 0.0 2.5 Appreciation return

7.9 7.3 7.0 6.1 8.4 8.2 5.8 3.7 6.9 Total performance

Vacancies and construction

0.9 0.9 1.0 1.1 1.2 1.3 1.5 1.7 1.1 Residential vacancy rate

1.2 1.3 1.4 1.4 1.3 1.2 1.2 1.1 1.2 Building permits. on housing stock

Ofce space

–1.4 4.9 5.4 0.2 3.0 1.2 –1.0 –2.0 1.7 Asking rents

6.6 6.5 6.3 6.6 6.9 6.6 6.5 6.5 6.6 Properties available for sale

4.9 4.4 4.3 4.4 4.2 3.9 4.0 4.0 4.5 Net cash ow yield

3.1 1.8 0.8 –0.2 0.8 1.1 0.5 –0.5 1.1 Appreciation return

8.1 6.2 5.1 4.2 5.0 5.0 4.5 3.5 5.7 Total performance

Retail space

0.9 6.3 1.5 –3.3 –1.1 –3.2 –0.5 –3.0 0.7 Asking rents

4.5 4.3 4.2 4.2 4.1 3.6 3.5 3.5 4.3 Net cash ow yield

4.1 2.7 2.3 1.0 1.1 1.1 0.0 –1.0 2.0 Appreciation return

8.8 7.1 6.5 5.3 5.3 4.7 3.5 2.5 6.4 Total performance

Real estate equities

6.1 12.3 –6.9 13.6 9.6 11.7 10.1 – 8.7 Performance

22.4 24.4 21.9 20.5 30.1 27.2 29.0 – 22.7 Average daily trading volumes (CHF m)

16.7 17.2 8.2 5.6 12.5 17.7 23.2 – 10.8 Estimated premiums

10.2 8.9 10.1 8.0 12.9 11.8 8.7 – 11.2 Volatility

Real estate funds

6.8 6.3 –2.8 15.0 4.2 6.8 6.6 – 6.9 Performance

17.3 19.9 20.8 19.3 25.4 22.6 27.9 – 19.9 Average daily trading volumes (CHF m)

27.0 28.8 17.5 19.2 29.1

27.2 27.5 – 22.1 Estimated agios

7.2 6.6 8.4 7.6 12.1 9.2 8.8 – 7.9 Volatility

Benchmark

6.9 6.5 5.7 5.1 5.8 5.8 4.6 – 5.5 Perform. of real estate investm. foundations

–7.7 17.7 24.6 13.0 2.7 –1.4 19.9 – 6.1 Performance of Swiss Performance Index

18.4 11.5 12.8 10.6 18.4 15.5 8.8 – 15.9 Volatility of Swiss Performance Index

7.6 2.2 –3.3 8.5 2.4 1.6 –0.1 – 3.5 Performance of Swiss Bond Index (“AAA”)

DriversResidentialCommercialListed

Unless otherwise indicated, all gures refer to percentage growth over

the previous year.

UBS projections or forecasts (as of January 10, 2018)

UBS forecast

Average: 2008 to 2017

End of year

Direct investment in existing properties

Premiums on net asset values of real estate equities (premiums) and real estate funds (agios)

Source: SECO, FSO, SNB, Wüest Partner, BWO, IPD, Docu Media, Bloomberg, UBS

650846