Global Real Estate: A New Cycle Awaits

Despite this, the core (low-risk) market segment remains robust and has attractive expected returns. The prevailing consensus suggests that most sectors have almost bottomed out. This, coupled with expected interest rate cuts, which are anticipated to be considerably sharper than in Switzerland, presents a rare prospect. For investors with significant exposure to the Swiss real estate market, establishing or expanding a global allocation offers diversification, a larger opportunity set, and enhanced returns.

Recent interest rate hikes led to a considerable increase in real estate financing rates, pushing them above equity yields. This resulted in non-accretive leverage (the use of debt reduces return on equity), which, combined with higher discount rates, severely dampened transaction activity. Bids lowered in both magnitude and pricing level across most real estate markets, and valuations have declined by up to 30%. Nonetheless, leasing profiles and demand remain positive (except for the US office sector). Moreover, lower levels of anticipated supply form a basis for strong expected returns. In view of the repricing and forecasted interest rate cuts, we expect financing rates to be lower than equity yields this year. Currently, property yields are around 5%, displaying notable spreads to government bonds and are at a level that was last seen shortly after the global financial crisis.

Constructing a well-diversified global portfolio offers insulation against local market downturns and regional risks. The international real estate markets do not move in perfect sync, and this is also the case in relation to the Swiss market, creating an opportunity for investors to improve their risk/return profile. Additionally, property cycles differ in terms of duration and stage across markets, providing the possibility to capitalise on strategically timed investments/divestments. As a result, investors can selectively allocate to enhance returns and diversify risk.

Adopting a global approach to real estate investment allows investors to benefit from emerging trends, such as the increase in data usage and digitalisation through investments in data centres. This example highlights the limited size of the Swiss property market and the lack of scope for institutional investment. In addition to the positive characteristics of diversification, international markets are more liquid than the Swiss market. Thus, returns and the ability to adapt to shifting market conditions can be amplified.

To contrast the performance of NAV-based Swiss and international real estate funds, we used the KGAST index (for Swiss funds), which was launched in 1998, and an international counterpart, the NFI-ODCE index (for US funds), which has existed since 1978 and therefore serves as a suitable long-term comparator. The data reveals a significant outperformance of US versus Swiss real estate, reporting respective annualized returns of 6.42% (hedged in CHF) and 5.07%. Even greater outperformance was achieved when investing at the beginning of the current cycle. For an investment commencing in Q1 2010, the US index achieved 5.58% p.a. (hedged in CHF) and clearly outperformed the Swiss index, which returned 4.03% p.a. Despite the current drawdown, there is an overall performance difference of 22.6% (hedged in CHF) for these indices over this cycle.