In several developed countries, including Switzerland, prices for residential real estate have been steeply rising for 20 years or so. The aftermath of the Global Financial Crisis (GFC, 2008-09) caused a severe setback in the USA and Ireland, but less-damaging downturns elsewhere, and almost none at all in Switzerland. Thereafter, prices recovered to reach new peaks in 2021. This trend has prompted many commentators and analysts to warn of a “bubble” in housing prices.

Real house prices in Switzerland, the US, Germany, and the UK (2015=100)
Source: OECD

Swiss single-family house prices from Fahrländer Partner, IAZI, and Wüest Partner since 2000
Source: Swiss National Bank

Lately, there have been signs that the market is cooling in response to the sharp increase in interest rates as central banks responded to inflation caused by supply shocks during the pandemic and the Russian invasion of Ukraine in February 2022. This cooling has been seen by some as a portent of a disaster to come.

Euro area interest rates – loans for house purchase (annual percentages)
Source: ECB

Should Swiss real estate investors take heed and sell? First, investors must ask themselves if there really is a bubble. To answer that, it helps to study the findings of William Quinn and John D. Turner, authors of Boom and Bust: A Global History of Financial Bubbles, published in 2020.

They devised the “bubble triangle” to illustrate the cause of market bubbles, arguing that they arise when a combination of easy money, speculation, and marketability (or liquidity) is catalyzed by an external event such as technological innovation or a change in government policy.

The bubble triangle
Source: Cambridge University Press

There can be no question that from 2008 until 2021, money was in plentiful supply, as well as easy and cheap to access, as interest rates declined to historic lows and even negative levels in many countries, including Switzerland.

Money supply growth in Europe (in EUR trillion)*
Source: European Inflation Tracker

* According to European Inflation Tracker: M0 is known as base money and includes banknotes in circulation as well as (required and excessive) reserve deposits of commercial banks at the ECB. M1 includes currency in circulation and sight deposits of customers at commercial banks. M2 includes all of M1 as well as deposits with an agreed maturity of up to two years and deposits redeemable at notice of up to three months. M3 includes all of M2 as well as repurchase agreements, money market fund shares/units, and debt securities with a maturity of up to two years.

Long-term interest rate in Switzerland since 2008
Source: Federal Reserve Bank of St. Louis

Quinn and Turner call these easy-money conditions the “fuel” for a bubble, which they liken to a fire. The “oxygen” is the marketability, or liquidity, of the affected assets – whether they are easy and quick to buy and sell. While listed equities and bonds are highly liquid, the same cannot be said for residential real estate. Houses and apartments can take weeks, even months, to be traded.

The two authors indicate that the third side of the bubble triangle is “heat”, a result of speculative behavior. In other words, people buy for the short term because they think prices will rise and they can sell for a quick profit. They do not buy because they think the asset is undervalued or because it satisfies some personal goal such as investing for their retirement.

A substantial number of people buy homes with the aim of “flipping” them. These are speculators, so defined because, first, they do not intend to live in the properties and, second, they do not intend to hold them for more than a few months or, at most, a year.

Some level of speculation is helpful to the real estate market because it provides liquidity. However, above a certain level, it adds to transaction costs and can create a bubble. That level can be determined by measuring the price-rent or price-earnings ratios. These widely used affordability indicators compare average house prices to, respectively, average annual rents and individual incomes. An elevated ratio and, more importantly, one which deviates widely from its historic average, can indicate speculative excess.

Switzerland price-to-rent ratio
Source: Trading Economics

In Switzerland, the ratio was 126.7% at the end of 2022, as shown in the chart above. That’s 71% above its 2002 low, but still 11.4% below its all-time peak in 1989, decades ago. This suggests that the Swiss real estate market may not be in a bubble.

In terms of defining a bubble, the ratios have not deviated greatly from their long-term averages. The price-rent chart confirms this, while the next chart of the price-earnings metric ranks Swiss as just the OECD’s tenth highest.

House price to income ratios for OECD countries (2015=100) as of Q1 2023 or the latest available
Source: OECD

Finally, a bubble requires a catalyst, a spark that will ignite the combustible confluence of easy money, abundant market liquidity, and rampant speculation. The writers of Boom and Bust state that, historically, the spark has been either a new technology, such as the internet during the “dot-com” bubble (1995-2000) or a new government policy – or both. This differs from Hyman Minsky’s theory of market instability in which even just a small price reversal can spook speculators and cause a crisis.

The technology sector, exemplified in the chart below by the tech-dominated NASDAQ market, has been a stock market leader for more than a decade on the back of growth in online sales, social media, blockchain, artificial intelligence, and many other factors. However, none of these represent new technology.

Performance of NASDAQ, S&P 500, and Russell 2000 since the 1980s
Source: Yahoo Finance

If we are to look for a current catalyst for the possible real estate bubble, it would be the central bank policy of Quantitative Easing. Quantitative Easing, the developed world’s response to the GFC, was a fundamental change in monetary policy that had no modern precedent apart from post-1991 Japan.

It was first implemented in the USA in November 2008, and, having leveled off by 2020, it was renewed during the COVID-19 pandemic. The total of this monetary largesse from the Federal Reserve, BOE, BOJ, and ECB is estimated at over USD 28 trillion. Aimed at boosting investment in economic development, the prevailing lack of business confidence meant that little of the money was applied to increasing economic growth. Most of it was poured into tradable assets of almost every kind: equities, bonds, precious metals, collectibles, cryptocurrencies, and real estate, of course.

However, unlike equities, real estate is less prone to sudden reversals. The relative stability in residential real estate is evident by comparing the next two charts. The first shows the long-term movements in the MSCI World Index of equity markets.

Performance of the MSCI World Index since 1980
Source: CNBC

The second provides a more-or-less comparable picture of house prices across a selection of OECD economies. The difference in peak-to-trough volatility is clear.

Annual real house price indexes for OECD countries (1980=100)
Source: OECD

Only in response to the notoriously frothy market that Ireland experienced before the GFC was there anything in real estate resembling the steep reversals of equities.

Experience shows, therefore, that “crash” and “house prices” are not, in general, words that belong together. A contributing factor in the difference between equity and real estate markets is that central banks can influence the real estate market through monetary policy, while it is difficult for central banks or governments to influence the stock market.

With Ireland as the benchmark, the most extreme fall that might be seen in a real estate market is about 50%. Switzerland, as noted already, is not undergoing anything even close to the speculative excess that drove that downturn.

In any case, Swiss demand for housing remains solid, despite homeownership having become more expensive than renting.

Comparison of the financial cost of residential property vs. rental housing
Source: Credit Suisse

According to Credit Suisse, the main factor supporting that demand has been a growing shortage of new homes under construction. The bank suggests that revisions to planning legislation, enacted in 2014, are the main cause of this shortfall.

Whatever the true reason, Credit Suisse forecasts that the residential vacancy rate will drop to just one percent as building activity declines from 54’000 new apartments per year between 2015 and 2018, to an expected 42’000 in 2023 and 2024.

Not only does there not appear to be a Swiss real estate bubble at present, but the likelihood of a market crash seems remote as well. Here’s how UBS rates the outlook: prices are overvalued but the “bubble risk”, while elevated, is not ominous.

Swiss Real Estate Bubble Index as of 1st quarter of 2023
Source: UBS

On the other hand, there is no escaping the effects of higher interest rates and persistent inflation on the ownership premium and, therefore, on affordability and demand. Even if expectations for lower economic growth reduce that premium, the increased attraction will likely be offset by greater caution on the part of buyers as growth slows.

There is a fairly benign range of expert forecasts for Swiss residential real estate prices over the coming 18 months. Credit Suisse is an example. It expects “a soft landing”, with prices stagnating or, at worst, suffering a small drop (a little of which has already happened as can be seen from the tiny change in housing prices for Q1 2023).

Swiss house prices as of the Q1 2023
Source: Real Advisor

Even those who post fearful headlines only proceed to set out a series of pros and cons before, at best, reaching an inconclusive forecast.

Whatever the outcome, it’s good to remember that prime Swiss real estate, such as that enjoyed by Le Bijou’s clients and investors, tends to ride out contrary market winds – storms, even – with relative aplomb.

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