Investment properties: how financing works

Author: Bernhard Bircher-Suits, FundCom AG

When it comes to investing, the following rule of thumb applies: real estate is more stable in value than securities. It is also less susceptible to market fluctuations and offers protection against inflation. One thing is clear: apartment buildings have been among the most attractive asset classes in Switzerland over the last few years. According to a renowned real estate consultancy firm, mixed-use investment properties achieved an average total return of 6 % in the first quarter of 2024.

However, the prices of investment properties are no longer rising unchecked: in the first quarter of 2024 they changed hands at -0.1 %, as shown by the SWX IAZI Investment Real Estate Price Index.

Prices for investment properties stabilising

This stabilisation of investment property prices, as temporary as it may be, corresponds to the first decline in the willingness to pay in several years. However, over the past 12 months, investment properties continued to record robust, albeit declining, price increases of 3.2 %.

Further, the Swiss National Bank’s decision to cut key interest rates at the end of March 2024 could inject more capital into the real estate market and increase price pressure. What is undisputed among experts is that demand for rental housing will remain strong in the near future, especially in urban centres.

Investment properties can also be flats or houses

Investment properties don’t just include apartment buildings, but also single-family homes, condominiums, offices and commercial properties purchased purely for investment purposes. Such properties not only offer monthly rental income, but also a potential long-term increase in value.

Investment properties are particularly attractive for people of retirement age due to their monthly rental income. Investment real estate also offers protection against currency devaluation (inflation), as rents can be adjusted in the event of inflationary developments. In times of falling savings and mortgage interest rates as well as volatile stock markets, investment real estate is an option worth exploring. 

Investment real estate: high prices, limited supply

Admittedly, the supply of attractive investment properties in urban regions of Switzerland is low and prices are high. There are also cluster risks: if you put too much of your savings into a property, your assets are usually tied up for a long time.

Before buying an investment property, take your time to find the right one. Check the property and its value carefully, and have an appraisal of the property carried out. Calculate the optimal mortgage amount by taking into account your full financial situation (assets, taxes, pension).

When putting money into an investment property, the aim is to generate the highest possible return from the rental income. This should exceed the regular expenses for the mortgage and the property. If the previous rental income is rather low compared to similar properties or if there are a lot of vacant properties, you should exercise caution.

Bank financing for investment properties

But how do you finance a new investment property and what do you need to bear in mind? Banks are often willing to finance residential investment properties, as they see this as a relatively safe form of investment and demand for rental apartments in urban centres is high.

For example, major bank UBS assesses both its customers’ ability to pay and the specific investment property according to its own evaluation methods. UBS spokesperson Cécile Rietschi says: ‘One of the prerequisites for financing is that the loan and affordability are present.’ Other factors that a bank takes into account when providing financing include:

Location, condition and size of the property

A good macro and micro location in the municipality and a well-maintained condition increase the chances of obtaining financing. Banks prefer properties in economically stable regions such as Zurich, Basel and Geneva where there is high demand for rental apartments. It’s also clear that the more apartments there are in an apartment building, the more attractive it becomes, as it offers advantages in terms of management compared to apartment buildings with only a few units.

Rental income

The expected rental income plays a decisive role. It must be sufficient to cover the monthly mortgage repayments, interest charges and amortisation payments. In addition, banks ensure that rental prices are in line with the market and that stable returns can be expected in the long term.

Vacancy risk and housing mix

Experts understand vacancy to mean that a habitable property remains unused for at least 3 months. This leads to a loss of rental income and costs for listings, repairs and finding new tenants. Despite housing shortages in urban regions of Switzerland, some cantons have above-average vacancy rates. The canton of Jura has the highest vacancy rate in Switzerland at 3.17 %, followed by Solothurn (2.39 %) and Ticino (2.17 %). Apartments with 5 or more rooms are especially likely to be vacant. If an apartment building consists primarily of very large apartments, the risk of vacancy increases. Tip: reduce the size of large apartments.

Ability to pay

Your creditworthiness is carefully checked by the potential lender. A sound financial situation and good solvency are basic prerequisites for obtaining a mortgage. Anyone with debt enforcement proceedings or large debts will find it difficult to secure a lender.

Own funds

As a rule, banks require you to raise part of the investment from your own funds. This serves as a safety measure and shows that you are bearing part of the financial risk.

How much of your own funds is needed?

The amount of your own funds required varies depending on the bank and property. As a rule, the equity component amounts to at least 25 to 30 % of the purchase price. UBS, for example, mortgages residential investment properties up to 75 %. Here’s an example: for an apartment building worth CHF 1 million, you should expect to put in at least CHF 250,000 to CHF 300,000 of your own funds.

As the amount of the loan is determined by banks using the capitalised earnings method, the amount of rental income is decisive in calculating the maximum mortgage amount. UBS offers fixed advances during the course of the year with terms of 1 to 12 months and fixed loans over the course of the year with terms of 1 to 10 years.

Properties with below-average returns: more of your own funds needed

Florian Schubiger from the comparison platform Hypotheke.ch adds: ‘For investment properties with below-average gross yields, many lenders require more than 30 % in own funds.’ In order to have sufficient equity capital, it is important to check whether the rental income is proportionate to the purchase price.

Pension funds from pillar 2 and pillar 3a may not be used to buy investment property – unless you live in one of the properties yourself. In this case, a pro rata deduction is possible. In addition, the mortgage must be 65 % repaid within 10 years. By comparison, for owner-occupied residential property, the amortisation period is 15 years longer.

Affordability of the investment property: how the banks do their calculations

The affordability calculation for investment properties differs from that for owner-occupied residential property. In this case, it is not the income of the mortgage borrower that is relevant, but the rental income. In addition to rental income, all costs incurred are included in the affordability calculation.

These costs include mortgage interest, which is calculated using an imputed interest rate of 5 %, as well as ancillary, maintenance and amortisation costs. The annual rental income minus the imputed costs incurred should result in the highest possible surplus.

The total annual costs (CHF 93,150) are therefore lower than the annual net rental income (CHF 95,000), resulting in a positive affordability reserve of CHF 1,850. This means that the property would be affordable with the specified parameters.

Some mortgage lenders look at a property’s gross yield as well as calculating the surplus. This compares the annual net rental income to the purchase price. In the above example, the gross yield would be 5.33 %, which is a very good figure by Swiss standards. However, each lender has their own guidelines depending on the provider, canton and location of the property. Due to the different assessment methods, interest rates can also vary widely.

Tip: For investment properties, it is essential to obtain several offers and compare interest rates. A difference of a few percentage points can add up to an enormous amount of money over the holding period, which is sometimes decades.

In summary

Financing an investment property requires thorough preparation and careful planning. A good location, stable rental income and a solid credit rating are critical factors for successful financing. Your own funds also play an important role in securing financing. Use subsidies and renovation loans to reduce the costs of necessary refurbishments and benefit from your investment in the long term. With the right strategy and a clear financing plan, there will be nothing standing in the way of your real estate investment.