In recent years, inflation in Switzerland has been so low that many investors have neglected to hedge against inflation. This could change if inflation continues to rise. It is a common assumption that real estate can act as protection against inflation. But is this really the case?

For the first time since the global financial crisis in 2008, inflation has exceeded the ceiling of 2% set by the SNB. At 2.9 percent (as of May 2022), the inflation rate is at its highest level since June 2008. Are real estate investments effective in hedging against inflation?

In May 2022, prices were rising by 2.9 percent year-on-year. By international standards, this may seem rather small, but for us this is unusually high: indeed, over the past ten years, the national consumer price index never increased by more than 0.9 percent. This is why, on June 16, the Swiss National Bank raised the key interest rate for the first time in fifteen years. This took place earlier and, above all, was of a magnitude that was not what many experts had been expecting, i.e., by 50 basis points to minus 0.25 percent. By means of this interest rate hike, the SNB intended to curb consumption, in order to allow prices and inflation to fall. Thus, loans and investments are becoming more expensive.

When inflation picks up, investors tend to put money into real and tangible assets such as real estate in order to protect themselves against the threat of a loss in purchasing power. So how effective is direct investment in real estate or indirect investment in real estate equities, investment funds and ETFs in hedging against inflation?

What happens, when interest rates rise?

The private bank Rahn+Bodmer has investigated how real estate equities and funds evolve during a period of rising interest rates. To this end, they analyzed the SXI Real Estate Broad (40 funds and 16 shares) and the SXI Real Estate Funds Broad (40 funds). In five out of eight times, the real estate indices performed worse than the major Swiss stock indices. Since the beginning of 2022, with the shift in the yield curve, real estate funds have lost value and partially lost their yield advantage over the government bonds of the Swiss Confederation and corporate bonds (AA to BBB rating). Compared to 10-year Swiss government bonds, the yield premium has fallen significantly over the past twelve months. This falling yield premium is putting pressure on real estate fund prices. Conclusion: Real estate funds tend to perform worse than stocks during phases of rising interest rates.

Commercial or residential properties?

Real estate is considered crisis-proof. However, the inflation protection it provides is often overestimated and controversial. The consensus is that real estate offers better protection against inflation over the long term than the short or medium term, and new properties are more efficient at doing this than older ones, which require expensive renovations or even total restructuring. There are also differences between property categories.

  • Home ownership: A house or an apartment allows you to benefit from the rising value and the falling level of debt, adjusted for purchasing power. However, real estate prices in Switzerland have risen sharply over the past twenty years and are unlikely to rise that much further in the next few years. The protection against inflation offered by owner-occupied residential property is greater in better locations, such as in the cities or if there is a lake view, compared to anywhere more ‘peripheral’ As soon as real estate prices are rising more slowly than inflation, residential property can no longer offer protect against it.
  • Investment properties: In recent years, increasingly, investors have acquired real estate as an alternative investment, Institutional investors choosing ‘multi-family’ properties, private investors condominiums or multi-family properties. Inflation protection is lower compared to owner-occupied houses, because repairs, renovations and maintenance are expensive and costs usually rise more than rents can be increased. Tenancy law is heavily regulated, with rents linked to the reference interest rate and renovation and maintenance costs cannot simply be proportionally adjusted.
  • Commercial real estate is more sensitive to the economic backdrop than owner-occupied residential property or investment properties. When inflation rises and rising interest rates slow economic growth, demand for commercial real estate tends to decline. Tenants move out or seek to renegotiate their rents. As a result, prices per square meter decrease and vacancy rates are higher. Both put pressure on returns. Thus, commercial real estate can only protect against inflation to a limited extent.

From 1 to 2.5 percent in just one year

Many investors have been able to generate solid returns from real estate. In recent years, monetary expansion was not accompanied by strong economic growth: cheap money was one of the strongest price drivers for the real estate market. With the first rate-hike since 2007, this is likely to change: ten-year fixed-rate mortgages entail costs which are now two and a half times as high as a year ago, after the decision of the SNB. That is why you should consider whether it is appropriate to sell a proportion of your property, real estate stocks, real estate funds or real estate ETFs, as they offer only limited protection against inflation.

“Real estate should be part of every portfolio. The proportion depends on your personal situation and your financial goals. The best thing you can do is to talk to an independent consultant.”