The buy-to-let investment strategy has gained considerable ground over the past few years. Understandably, since buy-to-let returns appear extremely attractive in a low interest environment. The current average gross initial yield (rental income achievable in relation to the purchase price of the apartment) is a healthy 3 percent. By comparison, the returns on government bonds with a maturity of up to 15 years are currently in negative territory.
Golden years followed by times of higher risk
Another reason why this strategy is so popular is that it has proved extremely profitable in the past. The average Swiss condominium cost around 450,000 francs at the end of 2002. Since then, the equivalent value has risen to around 700,000 francs. Assuming that the owner leased the apartment to third parties throughout this period and then sold it, the result would have been an annual yield of over 7 percent. The returns could have been even higher with external financing.
High returns in the past are no guarantee for future success, however. Especially as the positive returns were mainly due to the boom on the real estate market and associated price increases. In future, big price upturns are unlikely for condominiums, so the main driver in recent years no longer applies. What is more, potential for correction has built up over the past few years. This is one of the main reasons for taking a more critical view of these investments.
Numerous risk factors
The chances of success also increasingly depend on rental returns. But it will become much harder to raise rents in future, because strong construction activity and uncertain economic prospects have already significantly increased the vacancy risk. The fact that rents are generally only 40 percent linked to inflation must also be taken into account. Adopting a net view – in other words, taking upkeep and other costs into account – rental returns look to be well under 3 percent on average.
A thorough analysis of the risk-return ratio should also factor in the following stumbling blocks, which are typical for buy-to-let investments:
- Illiquidity: Transferring money from real estate to other investments costs time and money.
- Vacancies: Insolvent tenants or apartments that remain empty for long periods can quickly upset your income statement.
- Conflicts of interest: Conversion and renovation work require a majority vote in the condominium owners' association. Different priorities, lengthy negotiations, etc. often result in delays and additional costs.
- Taxes: Although debt interest and maintenance costs are tax-deductible, rental income is taxed as additional income. Private investors may find themselves in a higher tax bracket.
- Diversification: If you invest the majority of your assets in real estate, your portfolio will be insufficiently diversified. Serious losses cannot be excluded in the event of market corrections.
Prospects vary in different parts of Switzerland
Success also depends on geographic factors, as shown in an analysis of the 50 largest cities in Switzerland. In many mid-sized cities, condominium prices seem excessive in relation to their rental income. This is so in Chur, Riehen, Montreux and Wädenswil, for example. In cities on lakes, it’s particularly hard to achieve attractive returns when letting out condominiums. Locations such as Fribourg, Baden, Bulle or Dietikon, however, are much more interesting: initial returns are relatively high, and vacancy risks comparatively moderate. Returns in major cities such as Zurich, Geneva, Basel, Lausanne and Bern tend to be low, however.