Switzerland is a highly developed country with a stable economy. Switzerland borders with France (in the west and north-west), Germany (in the north and northeast), Austria and the Principality of Liechtenstein (in the east), Italy (in the south and south-west). There are four official languages in Switzerland: German (65% of the population), French (20%), Italian (9%) and Romansh (less than 1%). Switzerland is chosen by large world banks, largest corporations and investment companies who set up their headquarters here. Switzerland maintains a good reputation for the security of business and investment, and this attracts businessmen and entrepreneurs from all over the world.
The reason for commercial real estate demand
Commercial real estate is interesting as:
a guaranteed long-term permanent revenue, such as from rent (leases in Switzerland are usually signed for five years, and renewed for the same length; in large projects, such as shopping malls, fixed leases for 10, 15 and 20 years are common);
it yields higher returns, with minimal risk, compared to a bank deposit and the average yield, which our investors expect, is 6–7 %, while return on equity using external debt reaches 10–12 %;
a long-term investment — a hedge against inflation and a stable capital investment;
the flexibility of acquiring both by an individual or a company. When a company is purchasing commercial real estate, confidentiality is assured (the owner’s name in this case does not appear anywhere, including in the Land Registry) and this enables tax savings;
there is no restriction for foreign investors in the quantity of the acquired property.
low interest rates on bank deposits in Switzerland (less than 1 %);
record low mortgage rates in Switzerland (2–3 % per annum).
Commercial real estate acquisition permit in Switzerland
There is no need to obtain a special permit for the purchase of commercial property — any foreign citizen can buy an unlimited number of commercial properties of any size in any region of Switzerland, and just as freely sell them. Moreover, the purchase can be registered by an individual or a local or foreign company.
It is slightly more complicated to acquire a commercial facility that is partly residential. For example, an office building could have an apartment for the building manager.
If the residential area does not exceed 10 % of the total floor space, such a building may be acquired by a foreign investor who can use the residential area for his or her own needs.
Unfortunately, very often residential spaces exceed 10 %. Although the law does not specify the exact size of residential areas, local authorities are generally very zealous in such situations. In order to make a decision to sell a facility to foreigners, one may need the consent of a special commission that examines the ratio of residential to commercial floorspace in the facility.
What determines the profitability of commercial real estate?
The degree of regional economic development and its prominence
The level of development of a region and its popularity may have an impact on the profitability of property there. For example, the region of Zurich, the world-renowned financial center, attracts a large number of investors, which leads to the fact that the gross yields in this region tend to be 1.5–2 % lower than in other regions of Switzerland.
On the contrary, the region between Geneva and Lausanne in the canton Vaud in French-speaking Switzerland, which is little known to investors, has been actively developing its infrastructure over the last 5–10 years, but is still undervalued by foreign investors. Nevertheless, a yield of 6.8–9 % is rather common in this region (see the Comparative table of average gross yields in the Swiss cantons).
Also interesting in terms of investment are:
Fribourg (on the border of German and French-speaking Switzerland). This region has attracted world famous companies such as Cartier, Wella and Michelin, providing enterprises with a more favorable tax regime than in Zurich or Geneva. Moreover, the canton Fribourg has one of the highest occupancy rates of office spaces;
Vale, which has been actively developed in recent years due to foreign investors and investments in tourism infrastructure;
the cantons of Zug and Lucerne, the industrial areas of Bern, Aargau, Basel.
High demand for well-built commercial property located in central urban areas, with reasonable rent, causes the cost of these objects to increase and thus reduces gross yields. For example, the gross yield of 4 % for commercial property on the main street of Zurich (Bahnhofstrasse) is not uncommon. However, an office building in good condition in an industrial area can yield up to 10 %. Thus, the location of the facility has an enormous impact on the level of profitability.
A Swiss real estate think tank (IAZI) annually examines the costs that a property owner should be ready for. Thus, out of CHF 100 gross income from a lease (for instance, on an office space) owners keep on average CHF 70, and CHF 30 are spent on maintenance and other costs associated with the property management, concierge services, gas, water, electricity, taxes and insurance. Management costs account for 4–5 % of annual gross revenue, costs of utilities, as well as minor repairs and concierge services are on average 4–5 %, insurance and other costs — about 5 %. However, utility costs for a facility in good condition are up to 40 % of the total annual expenditures (excluding financing costs).
A great effect on the upkeep costs of a property has its functional designation: investors, who invested solely in residential property (apartment buildings), spend on average CHF 34 out of 100 of their rent income. For real estate of mixed use this figure reaches CHF 33, but for office space — just CHF 15–18.
Functional designation of a property
In addition to location and differences in maintenance costs, the functional designation of a property plays an important role, as the property might be intended only for office space, production, retail, etc.
A building originally constructed for production will have higher gross returns than an office building.
It is believed that special-purpose buildings designed to house manufacturing firms have a higher risk of vacancy in comparison to office buildings (largely because office space, if necessary, is easier to convert for other purposes, such as apartments or a hotel).
Construction year and condition of building
Newly constructed buildings tend to produce lower gross yield (average of 6 %) than older ones (average of 8.2 %). The old buildings in the French-speaking Switzerland offer the highest rate of return, though they also pose a greater risk, as they require major repairs. Therefore, when buying a property, it is very important to evaluate the building and to assess its future maintenance costs for 5–10–15–20 years, and to project these costs on the revenue. It is very common to think at first glance that a property has a yield of 8–10 %, but when taking into account repair costs, the figure can decline to 6–7 %.
The Swiss real estate market exhibits the following trends that should be considered when choosing properties for investment.
Economic growth: the most established regions continue to develop actively. But in addition to favorable conditions in the region, one must take into account the size and quality of available space. It also increases the attractiveness of the properties that offer the possibility of rebuilding or remodeling.
Centralization: large multinational companies tend to prefer large, interconnected buildings. If such facilities cannot be found in one region, they are willing to consider other places that offer high quality facilities.
“Periphery problem”: this is when the property is located far from central regions. In the medium term, this is likely to result in a decline of profitability due to the more complicated process of finding tenants, vacancy and overestimated property profitability expectations.
“The vision”: this factor has already become pressing in the real estate market. Today, when choosing properties, forward looking investors take into account all possible factors influencing the long-term profitability of the sites, including a central location, design features, the facility’s multi-use possibility, energy efficiency and more.
Well-positioned properties in the “top” regions with long-term leases are rarely available and are sold at high prices. Net profitability of such projects is on average 4 %.
Features of investment in commercial real estate
In our opinion, the most important aspect of investing in commercial real estate is the decision to make the investment. Decisions about investing in residential property are often taken emotionally, with the decisive factors being the location, view, quality of construction and finishing, even if they increase the purchase price. However, investments in commercial real estate should be based on sober calculation.
The approach “like / do not like” is not always appropriate, since the profitability of commercial buildings, such as office, retail or warehouse space, is usually affected by two factors — the term of the lease and maintenance costs of the building.
These figures are not always possible to extract from promotional materials and their verification require further study, analysis, documentation, and also involvement of independent experts. The real situation may differ significantly from what is initially claimed by the seller.
In recent years, there are increasingly more investments in commercial real estate by investors from emerging markets such as Russia, Ukraine, Kazakhstan, Israel, the Middle East, India and China, as well as neighboring countries with Switzerland — Germany, the Netherlands, France, UK. On the one hand, this is due to the exceptional political and economic stability of Switzerland and its appeal for long-term investment and capital safeguarding. On the other hand, it is connected with political or economic instability in the investors’ home countries, leading them to prefer to invest in something that gives stable and projected earnings, higher than bank deposit rates or conservative banking products.
It is common for investors to come from a highly profitable business associated with natural resource extraction and, after listing a company on an exchange, they often expect high returns comparable with the income in one’s own business. Unfortunately, this rarely happens. Therefore, a good investor is notable, above all, for his wisdom and foresight. Making the first steps in a different country, it is difficult to expect an investment that will generate returns of two to three times higher than the market average. These “hot” opportunities would long ago have attracted the attention of local investors.
In such projects, foreigners cannot own a controlling stake; their share of financial participation is limited to 30–40 %. In this market, real estate funds that belong to leading Swiss banks and pension companies that invest specifically in apartment houses are very active. In recent years, there had also been a lot of projects springing up related to the construction of homes for elderly people. This also involves very large players that do not require an independent foreign investor with a venture share of 30–40 %. Nevertheless, there are many projects in which attracting capital from abroad is welcome.
The hotel business in Switzerland
According to the Association of Swiss Hoteliers, Switzerland is at a crossroads. Unfortunately, more than half the hotels in the country are outdated both morally and physically. Service in most hotels does not correspond to the ever-increasing demands for service, while prices are high in Switzerland, which leads to a complete discrepancy between the price and quality. In fact, most two-star, three-star or even four-star hotels are outdated and require complete reconstruction. But the good news is that today, modern four to five-star hotel complexes are appearing, offering increased comfort, including lifts, spa, hot springs and golf courses.
These hotels offer year round occupancy and enjoy an active demand. But implementing such projects requires significant investment. For example, the construction of a modern four-star hotel requires an investment of about CHF 30 million, while five-star hotels and complexes now run for CHF 80–120 million.
If office or industrial premises are purchased for a commercial structure, do not forget about the possibility of obtaining mortgage loans.
In Switzerland, there are three types of mortgages: fixed rate loans, variable rate loans and money market loans.
The interest rate on mortgages with a variable interest rate depends on the financial market; the fixed rate, as a rule, is unchangeable for three to five years. Borrowing money market loans is based on the LIBOR rate for the money market in euros.
The size of a mortgage loan usually does not exceed 80 % of the market value of a residential real estate, where 65 % is obtained as a first mortgage that requires no amortization, which is customary in other countries. In this case, a second mortgage must be obtained, which is subject to depreciation.
A bank verifies the state of the property and the creditworthiness of the borrower in accordance with its own rules. Initially, the buyer must pay at least 20 % of the purchase price. Annual expenses for the buyer in this transaction (interest, principal and maintenance) should not exceed one-third of his or her gross income.
In case with a commercial real estate, the loan size depends directly on profitability. When crediting industrial projects, the loan size may reach 50 % of the total project cost — its market value or construction cost including equipment. For offices and office space, this value reaches 70 %, but the lender provides a loan with built in terms of possible risks.