Should you give in to the siren calls of Swiss property yields?

As seen in this month’s Master Investor Magazine.

No overview of property investment opportunities around the world would be complete without including the ultimate safe haven investment destination – Switzerland! Investments in bricks and mortar have always had a strong safety aspect, and Switzerland, in turn, is one of the world’s most renowned places to safely stash away a nest egg. Are Swiss properties worth an investment, and might they even be an alternative to negative interest rate investments into Swiss bonds? Master Investor investigates…

Any analysis of investment opportunities in Switzerland will have to start with the game-changing abandonment of the Euro exchange rate floor and the subsequent economic shock Switzerland experienced. The consequences of this particular move will impact the country for years to come.

In January, the Swiss Central Bank allowed the Swiss Franc to freely fluctuate. The subsequent appreciation relative to the Euro and the US Dollar caused tremendous issues for the export-orientated Swiss economy. Overnight, Swiss products became 30% to 40% more expensive for foreign customers. Swiss products were never exactly cheap, but have now become incredibly expensive.

Anyone travelling to Switzerland who has bought a $5.50 Starbucks coffee will have a rough idea what Swiss industry is dealing with. The same coffee would cost $1.95 in New York and $3.10 in London. Thanks to its exchange rate, Switzerland is currently home to two of the world’s most expensive cities, Zurich and Geneva. The Swiss Franc’s relative illiquidity and status as one of the world’s most highly regarded safe haven currencies has led to its value soaring, in a way that a few years ago no one would have ever thought possible.

It’s not just the prices of day-to-day goods that are hard to get your head around. Equally baffling are the country’s bond yields and how they compare to the yields that are achievable through investing into property in the very same country.

Swiss bonds with a maturity of up to 10 years are yielding a negative interest rate, which basically requires savers to pay a bank to keep their money. There is now such a growing problem with savers simply taking cash out of the bank and stuffing it under the mattress, that Swiss authorities are said to be seriously considering banning cash altogether and switching to a digital currency.

Swiss property, on the other hand, yields 3.2% to 3.8% p.a. In an era of negative bond yields and high stock market valuations, investing into property currently represents one of the few ways for pension funds, insurance companies and other large and safety-conscious investors to generate an attractive and reliable yield.

However, the question is: how reliable and sustainable are such yields?

Switzerland is currently a country of contradictions. Whereas the economy shows clear signs of dipping into a recession, property companies are sticking to their plan to increase supply. They are being encouraged by cash-rich investors who want to deploy yet more money into office properties, simply for lack of having any suitable alternatives. For as long as bond yield remain negative, even a gradually declining rental yield seems like the lesser of two evils. Throw in the opportunity for leverage – money being available easily after all – and it is possible to achieve a return of 5% to 6% on what seems like a relatively safe asset class.

That’s why companies like PSP Swiss Property (ISIN CH0018294154) continue to experience a high level of interest. Set up in 2000, the company is now managing one of the country’s largest property portfolios, valued at CHF 6.5bn (£4.2bn). The company’s portfolio is focused on central locations in Zurich, Geneva, Basel, Berne and Lausanne. Two thirds of the company’s rental income comes from office space, 15% from retail space, and 6% from parking spaces. A team of almost 90 staff members are actively managing the portfolio, and they have managed to find strong anchor tenants, such as the Swiss Postal system, Google, and the national telephone company, Swisscom.

The company at last count showed CHF 99 per share in equity, and currently trades at CHF 78 per share. If PSP Swiss Property liquidated its entire portfolio tomorrow, it would have to pay taxes on accumulated capital gains, but even after taking those into consideration it could achieve a liquidation value of CHF 83 per share. In other words, shares in PSP Swiss Property are currently trading below their liquidation value.

Its most recent dividend was CHF 3.25 per share, giving the share a dividend yield of 4.1% p.a. Despite fears that Switzerland is facing a recession, and despite the looming over-supply of properties in at least some locations, there is steady interest from yield-hungry investors.

Will the dividend payout likely remain at the current level, and what’s the risk of falling property prices dragging down the company’s net asset value and share price?

Even after sifting through all recent research on the Swiss property market, little is clear about the market’s future trend. On the outskirts of major cities, large amounts of office space oversupply have appeared on the horizon. Yet, in central locations, quality space remains in short supply and high demand, although there are signs of over-supply of smaller, lower quality offices in inner-city locations. Swiss banks, on one hand, are facing secular changes to their business models and how banks in general operate. At the same time, high-tech companies continue to move into Switzerland, to take advantage of the highly qualified work force and the ability to utilise a stable legal environment and first class infrastructure.

Throw in the fact that most rental agreements for the properties held by PSP Swiss Property are long-term, and the company has a high degree of safety when it comes to projecting its income.

In theory, at least, PSP Swiss Property should make for a safe investment with an attractive dividend yield. In real life, however, not all is as safe as it seems. The Swiss currency, economy and property market have entered unchartered waters. Market imbalances of the kind currently seen in Switzerland more often than not end in tears. It’s hard to foresee how the current phase of seemingly attractive rental yields for Swiss properties could come to an end. However, it had been equally hard to foresee the Swiss Franc’s sudden appreciation in January 2015, given how the Swiss Central Bank had reassured markets about the exchange rate floor just days before abandoning it.

The combination of sky-high prices by global standards, rising supply in a weakening economic environment and unprecedented imbalances in capital markets should lead investors to heed caution instead of giving in to the temptation of a seemingly attractive yield. If an unexpected shock hits the system, the 4% annual yield is unlikely to make up for the subsequent drop in capital values. Also, the currency risk is, in any case, a considerable one. A currency that appreciated by 30% to 40% overnight could eventually move in the opposite direction at an equally fast pace.

For now, it would seem preferable to follow further developments from the sidelines.