Switzerland: Not enough of a good thing
Nina Röhrbein charts demand for Swiss domestic property and a market that cannot satisfy institutional demand
Real estate is one of the most established asset classes for Swiss institutional investors. Pension funds have traditionally had a high allocation, sometimes including a stock of housing available for employees to rent. But holdings remain overwhelmingly domestic, and funds cannot get enough of this inflation proofing asset class thanks to its income generating and inflation proofing qualities.
Swiss investments are almost exclusively direct property, while international real estate is generally approached via collective fund structures. According to Complementa Investment Controlling's Risiko Check-Up survey of Swiss pension funds, average exposure to Swiss real estate stood at 15.2% at the end of 2009. Only 1% was invested in international property.
"Overall, the allocation to property has remained relatively stable over the last few years," says Jeannette Leuch, COO at Complementa. "Swiss real estate strongly dominates property portfolios - and will continue to do so - due its perceived inflation hedging ability, low volatility and lack of legal and currency risks, which are more common in foreign real estate. Swiss property has withstood the financial crisis well and been able to offer diversification.
"Investment opportunities in foreign real estate are rare to find outside global REIT structures and require a lot of effort, particularly from small and mid-sized pension funds. If pension funds invest in foreign real estate directly, it tends to be mainly in infrastructure and most likely in more established assets, such as brownfield sites."
Pension funds that have a 20% allocation to real estate are likely to invest 2-3% of it to international property, whereas pension funds with a 10% allocation tend to have all of it invested in Swiss holdings, according to Felix Kottmann, CEO of Kottmann Advisory.
But despite their already generally high exposure to property, Swiss pension funds would exceed it, if the opportunity arose. "Almost all pension funds would like to increase their real estate investments from their current allocation," says Christoph Oeschger, CEO of several pension funds, president of Avadis Investment Foundation's Swiss real estate committee and member of its private equity committee, which acts as a fiduciary manager to two dozen Swiss pension funds including that of power and automation technology firm ABB. "However, a contingency crisis is putting a stop to this for now. In other words, current vehicles or platforms which provide exposure to real estate are not able to satisfy existing demand. There is simply not enough Swiss property to go around at the moment."
Kottmann agrees: "If more domestic real estate was available or the asset class was more liquid, some pension funds would probably invest more than 20% in Swiss real estate," he says.
Derick Bader, head of marketing and reporting and in charge of the alternative product specialists team at Pictet, points out that demand is spurred by the absence of any bubbles or blow-ups in more than a decade.
Swiss pension funds have gradually begun to increase their international property allocation in recognition of the need to diversify away from their home market, although the international part plays second fiddle to the overwhelmingly dominant domestic portfolio. Oeschger even expects the foreign property exposure to level off at current rates and not to grow much further.
One of the reasons why few pension funds undertake direct investments in foreign property is that those tend to be commercial properties, whereas Swiss real estate opportunities mainly consist of residential properties. The rental market in Switzerland is widely recognised, which makes it easy for investors to buy into. "Swiss pension funds tend to invest in foreign real estate via securitised, highly liquid structures, such as classic REITs on a regional basis," says Oeschger. "They cover North America, Europe and in varying degrees also Asia-Pacific."
Instead of being the sole owners of property, Swiss pension funds often opt to invest with other pension funds via an investment foundation managed by a property administrator, a so-called Anlagestiftung. Between 60-80% of Swiss pension funds invest in Swiss property through Anlagestiftungen, estimates Kottmann. Some of Complementa's pension fund clients are still on waiting lists for Immobilienanlagestiftungen, which also suggests that they have not yet been able to grow their property allocation to their targets. Anlagestiftungen equate to direct property holdings with regard to their risk-return profiles but can achieve a higher grade of diversification, as properties can be widely scattered.
Diverse Swiss markets
Regional diversification is the key - whether Swiss properties are managed directly or through an Anlagestiftung. Geneva, for example, is home to many international organisations; Basel has a chemical and industrial corporate base and Zurich is the centre of the financial services industry and its employees. "By investing across different regions Swiss real estate investors can obtain some degree of diversification in their portfolio," says Leuch
But regional diversification has its limits. "To diversify his domestic real estate portfolio, a Swiss investor today buys almost everything that is available and is of reasonable quality," says Kottmann. "Private living space makes up 60-80% of the allocation of Swiss real estate portfolios and domestic property within Anlagestiftungen comes with attractive returns and low risks. Real estate funds, on the other hand, are often not defensive and transparent enough for Swiss investors - plus usually trade on a pretty high premium to the net asset value - and hold significantly fewer residential premises. Due to this perceived lack of options, conservative Swiss pension funds cannot further diversify their property portfolios within Switzerland, and many investors currently do not know where to invest their money."
The practice of some pension funds offering their residential properties to company employees to live in has been consigned to history although Oeschger does not rule out that some of them still exist.
"The main reasons for the halt to this practice are market-economic and social," he says. "Favouritism of employees, whether it is on a first come, first served basis or through cheaper rent tariffs is going against the market. A similar train of thought applies to favourable mortgages or loans. Is it correct that many others have to subsidise homes or mortgages for the benefit of a few? In the end the belief prevailed that pension funds need to generate yields in line with the market because they have to be able to pay their pension liabilities."
Today, the future currently looks uncertain for Swiss property portfolios.
"I doubt they will grow much further," says Oeschger. "The question is also how much of the demand is driven by cashflows and the desire to escape low interest yielding investments. In this current low interest rate environment, Swiss real estate and its excellent track record are sought after. However, once we return to interest rates of 6-8%, the strife for Swiss real estate is likely to be put into perspective."