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Lowering the high cost of housing and construction.

Renting accommodation in Switzerland is considerably more expensive than in other OECD countries with high per capita income, especially for households on modest incomes. High costs in the construction industry, where geographic fragmentation still restricts competition, are one contributing factor. Moreover, legislation limits rent adjustments to market conditions for incumbent tenants even over long periods of time and restrictions to increases in rents also apply when there is a change of tenant. These rules are likely to privilege incumbent tenants compared to more mobile parts of the population and may distort rental prices of old relative to new housing stock, keeping the former relatively low. Hence they may distort incentives to invest in the maintenance of existing housing. Supply of affordable housing also appears to be held back by a relatively low building density in sub-urban areas. Strengthening sub-national governments' incentives to attract more population with low or medium income levels could help increase density, for example, by mitigating the incentives to compete for high income households resulting from tax competition and by increasing the share of municipalities' tax revenues raised from taxation of real estate.

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As argued in Chapter 1, high rental prices of housing contribute significantly to the overall high prices for goods and services in Switzerland. The negative impact of high rents on welfare is significant, as households spend, on average, almost 25% (1) of their disposable income on housing services, and this share is considerably larger for low-income families, with households up to the 40th percentile of income spending close to 40% on average on housing (OFS, 2009). This chapter analyses the most important policy settings that keep the level of prices for housing services high. It also investigates causes for the relatively high level of construction costs, which contributes to the high rental prices of housing. Moreover, with construction being an important intermediate input for many other goods and services, high costs in this industry--for example, as a result of barriers to competition--have adverse effects for productivity downstream. Indeed, the effect of distortions of prices of goods and services on aggregate productivity performance are magnified if they are used as inputs in other sectors (Conway et al., 2006).

The high level of rents is partially explained by construction costs

The level of rents is high in international comparison ...

The level of prices of housing services is high in international comparison (Table 4.1). A number of reasons can explain the differences, including factors related to regulation of housing and residential construction. Quality differences are only partially controlled for, including only differences in dwelling size, number of rooms and availability of central heating. Rents are computed using a household survey that gathers information on rents paid by tenants and on imputed rents attributed to owners, computed using information on rents paid on similar dwellings.

... which can be partially explained by high construction costs

Construction prices in Switzerland were more than one fifth higher than the average of 27 EU countries in 2007, despite a low VAT rate, according to the OECD-Eurostat database. The only countries with a significantly higher level of construction prices than Switzerland were Denmark and Sweden at 63% and 51%, respectively, where the VAT rates are significantly higher. According to this unstable time series, the relative price of construction has come down over the period 2003-2007 (Table 4.2). Quality controls are introduced by gathering data for each country on the cost of more than 400 items (2) needed to build 23 fairly detailed, standardised models of residential, non-residential and civil-engineering structures (OECD, 2006b) (the relative prices shown in Table 4.2 are adjusted for these differences in quality). (3) Prices for residential construction and for civil works are particularly high. Reflecting differences in building specifications and norms across countries, construction costs appear to be particularly high in Switzerland.

Tenant protection is also a factor explaining the high level of rent

Increases in population have been reflected in the prices of new homes only

The population has grown substantially over the past decade (by around 3/4 of a percentage point per year on average between 1998 and 2007), caused by robust immigration inflows (see the previous OECD Economic Survey for immigration developments). Nonetheless, housing investment as a share of GDP remained modest (Figure 4.1). Price developments have been markedly different for new and old rental apartments on the other hand. Indeed, the asking rental price for new apartments has increased by 50% between 2000 and 2007, around 25 percentage points more than asking prices for existing rental apartments, for which changes in rents are regulated (Figure 4.2), as discussed below. Prices of apartments have increased more strongly than prices of detached single-family houses.

[FIGURE 4.1 OMITTED]

[FIGURE 4.2 OMITTED]

Tenant protection contributes to limiting housing supply

Regulation of rents may prevent full adjustment of rents to market conditions over time for existing tenants. (4) Rent regulation is based on the principle that rents should be sufficient to allow the owners to fully recover their costs. Thus, rent increases are allowed only in cases where they are justified by improvements, an increase in costs (mortgage interest rates, for example) or to maintain the purchasing power of the investment (compensation for inflation). In addition rents may occasionally be adjusted to the level prevailing in the area for example due to a change of ownership. The contracting parties need to take the initiative to prevent breaches of regulation (following the abuse principle). In practice, most adjustments are linked to changes in mortgage interest rates; for example, an increase of 0.25 percentage point in the reference mortgage rate allows for an increase of 3% in rents. (5) The parties can, instead, also opt to index the rent to a consumer price index in contracts signed for a minimum of five years (6) but these contracts are relatively rare. Although landlords and new tenants are in principle free to set the terms of a new lease for a new tenant, including the rent, it is possible for new tenants in existing housing to contest rents as excessive relative to previous tenants' rents in the first 30 days of the contract. Criteria used in the resulting arbitration procedure include the average rents in the area or excess returns to the tenant's investment, which has in practice been deemed to be 10 basis points above the mortgage interest rate. Since the average level of rents is also affected by regulation, adjustment to the rents prevailing in the area does not necessarily allow rents to adjust to market conditions. Although rents are only contested in very few contracts and these cases are concentrated in the Geneva region, it is likely that this rule has an indirect effect if landlords restrict increases in anticipation of them being contested.
Box 4.1. Most housing is rented

Nearly two thirds of all residential units in Switzerland are
rented, more than in most other OECD countries. This is likely to
reflect the relatively neutral stance of tax policy with regard to
housing tenure status, the high share of immigrants living in the
country (who are more likely to rent than Swiss households, Office
federal du logement, 2005) and the high cost of purchasing a home,
which makes it more likely that credit constraints are binding for
households (Bourassa and Hoesli, 2008). Indeed, among the 20% of
households with the highest incomes, only 40% rent their home (OFS,
2009). Despite the fact that most households are not
owner-occupiers, home ownership is still dominated by private
households. Institutional owners (for example, pension funds and
insurance companies), and federal, cantonal and municipal
governments play only a secondary role in the housing market.
Overall, social housing (provided mostly by co-operatives) only
accounts for less than 8% of the total number of dwellings in
Switzerland. *

* There is, however, significant heterogeneity in the share of
social housing among the cantons. For instance, in the Canton of
Zurich, the share of social housing is around 25%.


Deregulation in the housing sector could help reduce the rental and construction costs

The government reform of rental regulation must go further

For a long time, the indexation of rents to mortgages interest rates has been a contentious issue, mostly because of the induced volatility of rents. A new draft reform project was drawn up by the Confederation in 2008 with the support both of the Swiss Association of Tenants and Landlords' Associations. The most important proposed changes are the following. First, the close link between rents and mortgage interest rates would disappear. Instead, rents increases would be indexed to a consumer price index that excludes housing and energy prices. In case rents increase by more than 5% per year for two consecutive years, the government can suspend the automatic adjustment of rents (Conseil federal, 2008). Second, the criteria used to determine whether the initial level of rent for a new tenant in an existing dwelling is excessive will be modified by taking into account the dwelling's characteristics and local housing market conditions in a more systematic manner through the use of hedonic models. Third, other changes include the possibility of determining fixed rent increases at the beginning of the contract under the following conditions: i) the contracts has a duration of three or more years; ii) there is at most one increase in rent per year; and iii) the amount of the increase is fixed in Swiss francs. The draft reform has been rejected by one chamber of Parliament but discussions may resume.

Current regulation may distort the rents in old apartments relative to new apartments. This occurs because rental prices are determined by market forces only for new dwellings whereas subsequent changes in the rent are restricted by regulation even when there is a change of tenant. As interest rates are stationary, indexing rents for existing tenants to mortgage rates might not even compensate for inflation in the long-run. However, rental prices are likely to need to rise even in real terms, over and above inflation, to reflect market forces for two reasons. First, as land is a scarce resource, and is subject to regulations that further restrict its availability (see below), population growth may well require house prices to rise in real terms. Indeed, the requested rental prices for new dwellings have been particularly marked in recent years, reflecting demand pressures. Second, productivity growth is lower in construction than in other industries (Thalmann, 2008). Since rent regulation may depress the level of rents of old homes relative to new ones, it may distort incentives to invest in the maintenance of existing housing. A reduced economic lifetime of dwellings would reduce the overall stock of rented housing on offer, raising the overall average level of rental prices.

The legislative proposal to end the indexation of rents to mortgage interest rates, requiring instead the indexation to a measure of consumer prices, would have allowed yearly adjustment of rents for incumbent tenants in line with inflation, which would reduce distortions in prices between rents in new and existing dwellings. However, it does not allow these rents to adjust fully with market forces even over longer periods of time. It does not appear likely that the provisions regarding the setting of rents for new tenants will allow market forces to play a more significant role. There is a risk that the envisaged rent comparisons would remain strongly influenced by regulated rental prices in other dwellings.

Competition in construction and in its ancillary industries can be improved

Construction laws, regulations and norms are necessary to ensure that construction meets certain reasonable performance and safety standards. However, construction laws and regulations in Switzerland are perceived to have high compliance costs as compared to other countries. For instance, a Survey conducted in the 1993 found that construction standards and the required furnishings of dwellings were more demanding in Switzerland than in Germany and could account for almost 80% of the differences in construction costs (these differences in standards are not necessarily accounted for in Table 4.2). The level of restrictiveness of construction norms and regulations has also increased over time. A new study comparing the construction costs of a building in 1969 and in 2005 in Switzerland suggests that more than 20% of the increase in costs is due to more stringent construction norms and regulation (fire, heat and noise standards) and to the standards of fittings (kitchen and bathrooms) new tenants require. While some aspects of the more stringent requirements may be justified to meet the particular physical conditions of Switzerland and social preferences, countries with similarly high per capita income have high quality dwellings without such onerous norms.

Heterogeneity of regulations among cantons and municipalities affecting construction limit competition, besides imposing high compliance costs, and make these industries susceptible to the exercise of market power by cartels. Differences in regulations are also in place regarding the labour market. For example, a recent attempt to harmonise cantonal standards used to measure construction surfaces has not yet been successful. Regarding construction products, progress has been made via increased coordination with the EU (Balaster and Schupbach, 2008). A new agreement with the EU that homologated the technical and safety standards of construction products appears to have helped to diminish the differences of standards across cantons as well as with EU countries. A few cantons have required firms from other cantons in a limited number of professions to abide by local labour market conditions, which prevent firms from other cantons with lower labour costs from taking advantage of this competitive advantage. More generally, in the construction sector, collective wage agreements are extended to all workers in the sector, which may risk putting up wages.

The Internal Market Act strives to guarantee the free movement of goods, services and labour across cantons. It also guarantees businesses established in one canton to establish themselves in other cantons even if regulation in the destination canton would prevent it. The Act was most recently amended in 2005, when the conditions under which the equivalence of titles and professional experience acquired in other cantons can be refused were tightened (OECD, 2006a). However, the implementation of the Act is limited as Cantons can claim exemption in cases of "overriding public interest". Although the Competition Commission, which is in charge of enforcement, had some success by taking legal action against cantonal decisions violating the internal market act, it lacks the necessary resources to enforce the law effectively. One option to reduce the pressure on the resources of the competition commission would be to allow private parties room to take legal action against violations of the internal market act. While such a provision exists, it is not clear whether this right can be invoked when approved plans for dwellings are not accepted when reused in a second location.

Public procurement policies, especially at the lower levels of government, may also contribute to high construction costs. Recently decisions by courts have required local authorities to make public the criteria that are used to choose among different suppliers. However, much scope remains to lower costs of public procurement at sub-national levels of government by removing barriers to competition, as highlighted in the last OECD Economic Survey, and no progress has been made with respect to harmonising procurement rules across cantons, lowering threshold values for public tendering and benchmark public procurement costs at lower levels of government (Annex 1.A1).

Municipalities lack financial incentives to allow denser building

Land planning responsibilities are placed at different levels of government. Federal law regulates the use of non-buildable land, while the cantons and municipalities regulate the use of the buildable areas. The cantons are in charge of zoning restrictions, separating building areas according to the type of use. For each individual zone, regulations are issued that define, among other things, the maximum allowed dimensions of the buildings and the distances between them. In addition, cantonal law regulates the provision of public utilities for parcels of building land, a prerequisite to start construction. The municipal authorities issue structural plans for their own municipality and have control over the planning process at local level. In particular, they can set maximum levels of construction density of buildable land.

While there appears to be no scarcity of buildable land in the country as a whole--it is estimated that around one quarter of the total area already zoned for building (7) is yet to be built on (Office federal du developpement territorial, 2008)--most of it is located in rural areas, where housing demand is low and access to public transport deficient. (8) On the other hand, while construction density is high in the main urban centres, it is relatively low in suburban areas. (9) One significant factor explaining the low construction density in suburban areas seems to be the lack of financial incentives for municipalities to increase it. Taxes on real estate contribute relatively little to the total tax income of the cantons and municipalities, while only two cantons have a tax to be levied when land is rezoned for building. While the revenues from the tax on capital gains in real estate transactions accrue to municipalities, the rates are relatively low. As municipal governments rely on personal income and wealth taxes that are accrued locally, which account for almost 70% of their total revenue, they have incentives to attract relatively wealthy residents by favouring single-family constructions over multi-storey buildings, which could be detrimental to high density housing. It is generally accepted that tax competition affects local income tax rates. Transfers appear to equalise differences in tax bases to some extent. However, little information is available about how well redistribution among municipalities takes into account changes in the composition of local populations.

Increased population, especially lower income households, carries with it additional social spending by cantons and municipalities. Social assistance programmes in particular are administered by the cantons, although most of them have passed financial responsibility to their municipalities. Social assistance expenditure accounts for close to 15% of the municipal budget for the average municipality. In addition, municipalities also face expenditures for primary schools, early childhood education and childcare (see also Chapter 4). Municipalities may therefore have incentives to selectively attract high-income households, which would reduce the density of residential development. Such incentives could also contribute to geographic segmentation of the population according to social strata, which could have adverse effects for education outcomes for children with low socioeconomic background. Efforts should be concentrated in aligning the revenues of municipalities more closely with the demographic determinants of the demand for services they are required to offer.

Legal barriers to the foreign ownership of real estate in Switzerland are significant, and may prevent foreign developers from investing in new residential construction. This may be an unintended consequence of quotas imposed by cantons on foreign owned dwellings and land to limit the demand for secondary dwellings, fearing that it could push up real estate prices and drive residents out of desirable areas, particularly in tourist zones.

Housing supply could be much improved by making a more judicious use of already urbanised lands, particularly in suburban areas. Local zoning laws that do not allow high density buildings could be behind the low presence of for-profit firms in the housing market (only around 15% of housing is owned by for-profit entities), which could prevent economies of scale of big projects and the expertise of institutional investors from being fully exploited. In order to achieve this, municipalities should benefit directly from increasing their population.
Box 4.2. Recommendations to reduce the high cost of housing
and construction

Allow rental prices for used housing stock more room to adjust to
market forces

* Restrictions on the setting of a new rental price when a new
tenant moves into a dwelling should be removed.

* It should be ensured that yearly rent increases for existing
tenants can at least compensate for inflation, regardless of
contract duration. Moreover, over longer periods of time,
adjustment to market prices should be achieved for incumbent
tenants while protecting them against high increases over short
periods of time.

Lower the high costs in construction

* Construction norms should be reviewed so as to reduce costs.

* Regulations set by cantons and local governments affecting
construction projects should be harmonized.

* The practice of requiring firms to pay the wages for certain
professions prevailing in the canton where the construction project
is located should be ended, for example, by applying the Internal
Market Act to such cases

* Enforcement of the Internal Market Act should be strengthened,
for example by raising the competition commission's resources,
giving room for private parties to take legal action on the basis
of the Act when construction plans used in one canton are rejected
elsewhere and by reducing scope for exemptions.

Densify residential construction in existing buildable land

* Reduce municipalities' incentives to selectively attract
high-income households for example by better ensuring that demand
for social services is taken into account in intergovernmental
transfers received by municipalities.

* Strengthen municipalities' incentives to attract population, for
example, by raising the weight of real estate tax revenues in
municipalities' budgets.


Bibliography

Balaster, P. and J. Schupbach (2008), "Des marches publiques largement liberalises entre la Suisse et l'UE", La Vie Economique, revue de politique economique, 11-2008.

Bourassa, S. and M. Hoesli (2008), "Why do the Swiss rent", Journal of Real Estate Financial Economics.

Conseil federal (2008), "Message relative a la modification du code des obligations", Message du 5 decembre 2008.

Conway, P., D. De Rosa, G. Nicoletti and F. Steiner (2006), "Regulation, Competition and Productivity Convergence", OECD Economics Department Working Papers, No. 509, OECD, Paris.

Glaeser and Gyourko (2008), Rethinking federal housing policy, AEI Press, Washington DC.

OECD (2002), Territorial Development Reviews: Switzerland, Paris.

OECD (2006a), Economic Review of Switzerland, Paris.

OECD (2006b), Eurostat-OECD Methodological Manual on Purchasing Power Parities, Paris.

OECD (2007), Economic Review of Switzerland, Paris.

Office federal du developpement territorial (2008), "Statistique Suisse des zones a batir 2008", Bern.

Office federal du logement (2005), "Briefing--Combien de menages suisses sont-ils proprietaires del eur logement et pourquoi ne sont-ils pas plus nombreux", Bern.

Office federal du logement (2008), "Rapport explicatif sur la revision du droit du bail dans le CO", Bern.

Thalmann (2008), "Des couts aux loyers", presented at the Journees du logement de Granges 2007.

Notes

(1.) Including expenditure on energy.

(2.) These items can differ in each country, but they are chosen so they are of comparable quality across countries.

(3.) However, these estimates are based on specialists' quotes and should therefore be interpreted only as indicating broad orders of magnitude.

(4.) Luxury dwellings and those with an extension of more than 150 [m.sup.2] are exempt from the tenant protection legislation and thus are not restricted by rent controls.

(5.) The parties can also opt instead to make the adjustment to rents every six years, under the same conditions. In addition, rent increases are allowed when a dwelling is sold to a different owner.

(6.) Rental leases are in most cases signed for one year but can be renewed, and a contract is considered of indefinite duration, unless otherwise agreed at the formation of the contract.

(7.) This would be enough, assuming a constant population density in constructed areas, to house up to 2.1 million inhabitants.

(8.) More than half of buildable land receives only marginal public transport service (Office federal du developpement territorial, 2008).

(9.) For instance, per person residing in the downtown area of one of the big cities there are 135 square meters of buildable land, a person residing in the periphery of a big city can enjoy an average of 312 square meters, a difference of 130%.
Table 4.1. Comparative dollar price levels in housing services
EU27 = 100

                 1999      2003      2007

Switzerland     182.1     187.1     159.5
Denmark         142.4     153.2     146.5
Ireland         119.2     147.2     142.2
France          122.7     124.5     124.1
Netherlands     114.6     123.2     121.1
Belgium         113.5     120.4     117.8
Sweden          137.4     122.7     114.1
Germany         131.4     119.9     113.2
Euro area       113.0     112.8     111.2
Italy           98.5      103.0     105.0
Spain           81.0       90.0      96.4
Austria         96.7       94.8      94.4

(1.) Comparative price levels are defined as the ratios of
purchasing power parities to exchange rates. They indicate
for a given aggregate the number of units of the common
currency needed to buy the same volume of the aggregate
in each country. Housing services includes data on rents
and water, electricity and other fuel and maintenance
charges.

Source: DECD-Eurostat PPP database.

Table 4.2. Comparative dollar price levels in construction
EU27=100

               1999     2003     2007

Denmark        140.0    137.1    162.5
Sweden         132.7    139.9    151.2
Austria        110.6    111.2    123.5
Switzerland    136.8    156.2    123.3
Netherlands    125.3    131.1    122.9
Germany        121.6    111.1    115.9
France         126.6    129.2    112.3
Ireland         99.1    121.5    107.3
Belgium        104.5    100.3    101.9
Euro area      103.9    103.4     98.4
Italy           77.3     80.7     82.8
Spain           82.0     95.4     78.7

(1.) Comparative price levels are defined as the ratios of
purchasing power parities to exchange rates. They indicate
for a given aggregate the number of units of the common
currency needed to buy the same volume of the aggregate
in each country.

Source: OECD-Eurostat PPP database.
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Title Annotation:Chapter 4
Publication:OECD Economic Surveys - Switzerland
Geographic Code:4EXSI
Date:Dec 1, 2009
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