What Switzerland has to fear most in a real estate crash

Before interest rates rose, all was right with the world. Not today. Dealing with the turnaround in interest rates.

Niklaus Vontobel / ch media

Real estate boomed, boomed, boomed. That was the case in 2020 and 2021 in almost all industrialized countries. Prices have risen to record highs, writes the International Monetary Fund (IMF) in its current “World Economic Outlook”. But in the spring of 2022 it was suddenly over. Prices fell in two-thirds of all countries; everywhere else they were still rising, but much more slowly.

Behind the turnaround in real estate prices was another turnaround: that of interest rates. They fell to record lows in 2020 and 2021. After that, central banks had to fight inflation, and interest rates shot up in the industrialized countries in one of the most powerful rate hikes in decades. Mortgage interest rates averaged 2.8 percent at the beginning of 2022 and 6.8 percent at the end of 2022. Suddenly the interest costs are more than twice as high when buying a home. This puts pressure on demand – and thus also on real estate prices.

What’s next? Reports from the IMF show in which country the risk of a crash is greatest and what the interest rate hike has already done there.

The worldwide overview

The IMF has identified five criteria that make a price decline or even a crash more likely. If households have particularly high mortgage debts in relation to their income, the interest costs weigh all the more heavily. A turnaround in interest rates is therefore more effective. At the same time, this turnaround will take effect more quickly the more variable-rate mortgages are taken out. This is the second criterion that makes real estate markets vulnerable.

The third criterion is how many homeowners have a mortgage at all and are therefore feeling the effects of the interest rate turnaround. Fourth, prices can fall the lower the higher they went up before. Exaggerations are often followed by understatements. And finally, the IMF looks at the extent of the interest rate turnaround so far: the higher the respective central bank has raised its key interest rate, the greater the burden of rising interest costs.

The IMF has ranked 27 countries according to these characteristics: the higher, the greater the risk of a crash. Canada, Australia and Luxembourg are at the top. Norway, Sweden and the Netherlands are only slightly less at risk. The USA, Portugal and Denmark are also high up in this risk ranking. The situation around Switzerland, in Austria, France, Germany and Italy is comparatively relaxed. (table at the end of the article)

Scene Canada

Canada has had a boom. In two decades, real estate prices have nearly quintupled, rising particularly quickly during the pandemic. From April 2020 to February 2022 there was another increase of 50 percent. In the end, what the IMF describes in its country report as “unsustainable heights” was reached.

The turnaround in interest rates followed and with it the descent from those unsustainable heights. So far there has been a price drop of 16 percent. Interest costs are now twice as high, which will feed through to an estimated 30 to 40 percent of all mortgages by the end of the year. And the Bloomberg news agency reports that many households are already unable to pay the interest rates.

The banks are therefore under pressure to act: they don’t want payment defaults, and certainly not forced sales. So they relax their standards. Repayments are suspended; the interest is not collected but added to the mortgage. When mortgages expire, they accommodate.

That’s what the regulators expect. The banks should help to avoid payment defaults. This is also stated in a draft of guidelines for dealing with the rapid rise in interest rates. And everyone is hoping that Canada’s central bank, the Bank of Canada, will lower interest rates again before the end of the year.

How are things in Canada? The IMF believes house prices will fall “by 20 percent or more” from the peak over the next few years. In some cities it could be significantly more. All in all, a “healthy correction” is the most likely, but it could be much worse. For example, if inflation remains high and the central bank has to raise interest rates even more.

The greatest risk for Switzerland

As for Canada, it also sounds for Switzerland. Inflation is what worries him the most, says expert Donato Scognamiglio from the consulting firm Iazi. If it doesn’t fall below the 2 percent mark again soon, the Swiss National Bank will have to do a lot more than previously thought – which would have consequences. Scognamiglio: “Many business models will no longer work.”

Many experts are currently expecting a rather mild turnaround in interest rates: In June, the key interest rate will rise again by 0.25 percentage points – and that would be enough, inflation would be defeated, the interest rate turnaround ended at a rate of 1.75 percent. But what if this is not enough? What if inflation doesn’t fall below 2 percent?

Scognamiglio believes that this could well happen and that National Bank President Thomas Jordan would then have to raise the key interest rate to 2.5 percent. This would raise interest rates on money market mortgages to at least 3 percent. Much more would have to be paid on 10-year fixed-rate mortgages.

One of the many business models that no longer work at all is “buy-to-let”. This is buying your own home not for your own use but for renting out. Anyone who has taken out a mortgage for this now hardly earns anything; if interest rates are even higher, it’s definitely a losing proposition, as Scognamiglio says. You pay the bank more than you have income. «‹Buy-to-let› is dead: no one gets in anymore; whoever has already done it has to go further.”

In a next phase, more homes would come onto the market. Many investors with failed business models would at some point no longer want to pay more and sell, but at a discount. Prices are falling, other business models are coming under pressure – and so it would continue in a typical downward spiral until the federal government and the national bank intervene.

However, Scognamiglio does not believe in such a “giant crash”. The demand for real estate remains high, not least due to immigration and the increasing per capita need for living space. At the same time, supply remains scarce. Because building on greenfield sites is prohibited by spatial planning and is made more difficult in the centers by objections and regulations. And once it’s built, it has to be demolished first. For example, in a new building with 100 apartments, only 40 are lost, and only 60 are added net.

Ultimately, this turnaround in interest rates is like a thunderstorm looming in the distance, says Scognamiglio. “You don’t know if it’s passing you or heading for you.” (aargauerzeitung.ch)