The panel discussion recently organized by Zürcher Kantonalbank (ZKB) to present the latest Rating Guide on the real estate market and real estate financing confirmed the familiar picture: residential property prices in Switzerland, for a host of good reasons, only know one direction — up.

Indeed, there are many factors and drivers supporting the market: low interest rates, persistently high immigration, a structurally tight supply — and of course the experience of the last 30 years (since the crisis of the 1990s), in which prices have only risen. The most recent confirmation came last Tuesday, when Raiffeisen announced that momentum in its transaction price index for residential property had even accelerated.

Affordability, Green Bonds, and the Collateral Pool Risk

It’s understandable that the ZKB panel discussion focused on topics that are indeed relevant for investors, banks, and certain segments of the population, but do little to change the overall picture of the market. These include regulation, which on the one hand reduces housing affordability and on the other makes refinancing generally more difficult for banks.

Looking at the Swiss Pfandbrief — the key instrument for refinancing mortgage loans — the discussion touched on why there are no green bond formats of Pfandbrief issues and how, in a crisis, a so-called «collateral pool competition» (Deckungsstockkonkurrenz) could arise. Mortgages play an increasingly important role for banks as collateral when securing emergency liquidity from the Swiss National Bank (SNB). At the same time, the traditionally high safety of Pfandbrief bonds for investors must not be compromised — a safety based largely on the high quality of the collateral pool.

Interest Rate Hikes Barely Slow the Price Surge

What remained essentially unquestioned — as is often the case when discussing the outlook for Swiss housing — is the very robust condition of the market. This is largely because the (ever-dwindling number of) sceptics have been proven wrong time and again over the past 20 years.

Not even the significant interest rate hike — by Swiss standards — following the pandemic (which has in hindsight turned out to be a temporary interest rate «hump») managed to noticeably cool the market. For a long time, the risk of interest rate changes — especially a rapid and sharp rise — was considered the most compelling argument for why the upward trend might break.

To this day, interest rate risk remains an important (albeit somewhat less prominent) theme in the ritual warnings issued by the financial regulator Finma and the SNB.

Warnings from Finma and the SNB

In May, Finma outlined in a supervisory communication its views on what sustainability criteria mortgage affordability should meet. These criteria are, by definition, closely linked to interest rate risk, as they are meant to ensure — according to the authority — «that potential interest rate increases do not negatively impact the borrowers' ability to repay.»

Meanwhile, the SNB maintains in its latest Financial Stability Report that its stress tests continue to indicate that a sharp rise in interest rates, combined with a correction in property prices, represents the biggest risk for banks active in the mortgage business. Furthermore, the SNB again (albeit somewhat subtly) reiterates its long-standing observation (pp. 13 ff. of the report) that price developments in the real estate market cannot be explained by fundamental factors alone. In the residential property segment, prices are currently 15 to 40 percent above what fundamentals would justify, according to both simple indicators and econometric models.

Why Is the Gap Never Closed?

According to the SNB, this gap between observed prices and fundamentally justified levels tends to close in the medium to long term, and could at times lead to abrupt price corrections. What the SNB does not explain, however, is why such a correction has yet to occur in the Swiss real estate market — for decades.

It is undisputed that the market plays a key role for Swiss banks and thus for the financial system. Over three-quarters of all bank loans are mortgages. Despite global crises, economic fluctuations, and temporary rate hikes over recent decades, real estate has become increasingly expensive, and mortgage volumes have steadily grown. As a result, the broad consensus is that everything will continue to run (well) just as it always has.

And What If Immigration Is Curbed?

Given such consensus, it may be worthwhile to stir the pot and consider an alternative scenario: the likelihood of a significant correction in property prices in the coming years should not be underestimated. However, the main driver is unlikely to be interest rate risk. After all, rates would probably only rise sharply (barring an unpalatable stagflation scenario) if the economy were growing strongly — which would in turn support real estate prices.

A more probable trigger for a correction would be a restriction in the currently unbridled immigration from the EU. The Swiss electorate might, for instance, find appeal in the Swiss People’s Party’s (SVP) Sustainability Initiative — particularly as it offers a way to push back against «density stress» without having to fear immediate consequences.

A Stress Test for Many Currently Thriving Business Models

If the market comes to realise that the single most important structural driver of the past decades is losing momentum, this could indeed mark the beginning of a long-overdue correction phase. It wouldn’t have to lead to a crash to put pressure on many business models in Switzerland’s heavily real estate-dependent domestic sector — models that have thrived in an environment of constantly rising prices.

Banks would likely feel the impact as well, although — due to a lack of historical precedents — the channels and severity of the impact remain unclear. Ultimately, this could vindicate the SNB’s longstanding concerns — and shift the priorities of future industry conferences.

The Dialectic of Politics

Two final thoughts on politics: in such a scenario, it is conceivable that the local (construction) industry and its suppliers — the traditional SVP clientele — would be heavily exposed. Whether all supporters of the Sustainability Initiative are aware of this is questionable.

Conversely, the fact that the initiative would enshrine a population cap (maximum 10 million residents by 2050) — a second- or even third-best economic solution — in the constitution does not necessarily argue against it.

After all, Switzerland has had positive experiences with similar approaches — the debt brake (Schuldenbremse) being a prime example.