Swiss pension funds are increasingly moving into the development phase for new investments, finds Barbara Ottawa

A country where the national bank has to constrain lending to real estate does not sound like anywhere in Europe. But then things are often very different in Switzerland.

"Swiss institutional investors do not provide debt financing like the Bayerische Versorgungskammer does in Germany," says Stephan Kloess, head of KloessRealEstate consulting.

According to an Ernst & Young survey of Swiss investors, a lack of junior or senior banking loans will not be a problem in the domestic market this year. Instead, respondents believe the spread between asking price and what investors are prepared to pay will be the major obstacle for transactions this year.

"There are few good properties on the market and the demand is higher than the supply," says Reto Schär, head of domestic real estate at the Pensionskasse of Swiss retail giant Migros.

Florian Küng, spokesman at BVK, the CHF24.3bn (€20.2bn) Pensionskasse for the canton of Zürich, also says "certain market segments are very expensive".

Despite this market environment, the CHF3.9bn collective scheme Profond announced earlier this year it had set up a real estate division with the aim to grow the fund's domestic property exposure from CHF280m to around CHF800m over the next five years, increasing its exposure to 20%.

The focus will be on core residential in the German-speaking eastern part of Switzerland, but Profond stated that "opportunities in western Switzerland might be included in the portfolio", since it is "always examining purchase opportunities for residential units and retail or business properties in our strategic markets".

Herbert Meierhofer, head of the real estate committee at Profond, adds: "At the moment we are not buying residential properties in Switzerland because they are overpriced." Instead, Meierhofer is looking into buying land and working with developers. "We have to get into the project development phase much earlier than before," he says.

Schär agrees, saying there are "interesting returns to be had in projects in which we can enter at an early stage".

Kloess attests to the trend, saying it is the "bottleneck on the Swiss property markets" that is pushing institutional investors into providing equity for projects, sometimes at a very early stage where they see more attractive yields, albeit with added risks.

Christoph Ryter, chief executive at the Migros Pensionskasse, says the Pensionskasse is lucky to be able to look at large deals. "At CHF5m and below the competition is so tough that promised yields are quite low," he says.

Generally, Swiss funds pursue conservative strategies for their real estate portfolios, based on stable low-risk returns, which Ryter describes as "a substitute for bond investments".

And based on such expectations "the market is still interesting," says Küng, because the spread between risk-free assets, such as Swiss bonds, and expected returns from real estate is still high - at least for the time being.

"Net returns from properties are around 4.5% but it is clear this will come under pressure," says Meierhofer and points out that "well-known investors are already buying properties in Zürich for a net yield of 3.7%".

Schär also sees the sustainable net return from property portfolios at between 4.5% and 5% over the next 10 years, although this will mainly be derived from income rather than capital growth. For 2012, Ryter would be "satisfied with anything just above 5%".

Migros Pensionskasse has different problems to those of other investors; it entered the market at an earlier stage and is currently slightly above its strategic property exposure of 25%.

"We might even sell some of our properties this year, apart from optimising costs and rental income in the portfolio," says Schär.

New investment opportunities might also arise from some insurance-based investors having to sell some of their property under pressure from Solvency II, Kloess points out.
Profond is looking to pick up some of these existing properties, and it has widened its focus to mixed-use properties with apartments as well as retail space.

Meierhofer says the "main driver for rents is immigration to Switzerland and that is still ongoing" with more and more people seeking to actually buy homes now that loans are cheap.

According to Kloess, the residential sector is rather overpriced in some regions but he says there is demand and potential in the niche sector of affordable housing.

In the office sector Kloess expects "a dangerous situation" with yield expectations rather than increasing rents forcing up prices. It may happen "that investors are now paying a high price for something where there will not be a higher rent in future," he says.

He adds: "Yield compression is continuing as prices increase across all locations, qualities and sectors, which means that some sectors in some locations are certainly not priced to risk."

Pensionskassen are avoiding investing in projects such as hotels, leisure centres or infrastructure where they would have to take on operational risk. "From a risk consideration viewpoint as well as because of investment regulations such investments are not possible," confirms Meierhofer.

"What we could consider and have actually already done is financing infrastructure projects, like designing a village square with additional retail, business opportunities or residential units," he adds.

One obstacle, says Kloess, is Pensionskassen looking to invest abroad but often hesitating. "This is because Swiss investors still believe in their domestic market and the experiences of the financial crisis are still deeply entrenched," he says. But he stresses that there are opportunities in indirect investments, as past experience also proved.

Another obstacle is that many institutional investors cannot report real estate returns with the currency adjusted. Küng notes: "Swiss real estate does not have a currency risk." For Meierhofer foreign property is "nothing we look into based on risk considerations and because we still see opportunities in Switzerland".

Migros, though, has been invested abroad for several years and is looking to diversify its portfolio further mainly via investments in Europe and Asia. The US might also be interesting, Ryter says, were it not for unresolved tax issues.

While Schär is not considering infrastructure for the "classic conservative Swiss real estate portfolio", the MPK might look at infrastructure abroad "for cash flow-oriented investments".

Kloess says infrastructure is an alternative being considered by some Swiss investors given the current market environment.

"Up to now there has been no need for alternatives to Swiss property. But now there is and the advantage of infrastructure is that, other than with foreign investments, Swiss investors do not have any bad experiences with this asset class," he says.