Real estate as an investment alternative offers Swiss investors interesting advantages. On the one hand, real estate generates a stable cash flow in times of low interest rates. On the other hand, in times of rising inflation, real estate offers a certain level of protection due to the link of rents to the consumer price index. Real estate investments have a low correlation with other classic investment products such as stocks or bonds and have demonstrated remarkable performance over several economic cycles in the past. Real estate as an additional asset class is therefore particularly suitable for risk diversification within the portfolio.

Investment Alternatives Involving Real Estate Currently Available for Swiss Investors

In principle, investors can decide whether they want to invest directly or indirectly in real estate. With direct investment, the investor directly purchases physical real estate, such as office buildings, residential buildings, logistics centers, hotels, etc. The investor can either use the directly held real estate himself or rent it out to third parties as an investment property. Although holding real estate directly often offers higher returns than holding it indirectly, it also has some disadvantages. Real estate which is directly held is characterized by low liquidity while tying up a lot of capital in a single property, which leads to low diversification with higher risk exposure. Furthermore, directly held real estate can represent a lot of effort for the investor and requires in-depth market knowledge.

With an indirect real estate investment, the investor invests via an instrument such as a collective investment scheme with direct or indirect real estate ownership (also known as a real estate fund) or an Exchange-Traded Fund (ETF). These investment vehicles offer investors a series of advantages over direct investments in real estate. For example, it is possible to invest in highly diversified real estate portfolios even with smaller initial investment amounts.  Furthermore, collective investment schemes and real estate ETFs have far greater liquidity than directly held real estate and do not require active involvement or in-depth market knowledge from the investor. Instead, collective investment schemes and real estate ETFs are structured and monitored by experts, and the investor benefits from regular distributions.

While real estate ETFs sometimes have lower costs than collective investment schemes due to their passive management, ETFs correlate more strongly with developments on the stock market, which weakens a key advantage of investing in real estate. In addition, the range of available real estate ETFs in Switzerland is very limited.

In particular, collective investment schemes with direct real estate ownership also offer significant tax advantages for private investors with tax residence in Switzerland, which will be discussed in more detail below.

Investing in Real Estate through Collective Investment Schemes

Collective Investments with Direct Real Estate Ownership

Collective investment schemes with direct real estate ownership are characterized by the fact that they – as their name suggests – hold domestic or foreign real estate directly or invest in other collective investment schemes with direct real estate ownership. In order for the Swiss tax resident investors of a collective investment scheme with direct real estate ownership to be able to profit from tax advantages, it must be structured as a contractual investment fund, SICAV or LPCI.

While the law expressly allows investments in foreign real estate, there is currently no collective investment scheme with direct real estate ownership in Switzerland which invests in foreign real estate. At the level of collective investment schemes with direct real estate ownership, income from direct real estate ownership is subject to corporate income tax in Switzerland, while reduced tax rates apply compared to corporations.

The net assets of the fund, which consist of direct real estate ownership, are subject to capital tax. Distributions from collective investment schemes with direct real estate ownership are not subject to Swiss withholding tax, provided the income distributed derives from direct real estate ownership and is distributed via a separate coupon.

At the level of the private investor with tax residence in Switzerland, distributions from the collective investment scheme with direct real estate ownership are largely tax-free for income tax purposes.

 Only the portion of income of the collective investment scheme which does not come from direct real estate ownership is taxable at the level of the investor and is subject to income tax. For wealth tax purposes only the fund assets which do not derive from direct real estate ownership are taxable at the level of the investor. Therefore, the wealth tax value of the fund shares in collective investment schemes with direct real estate ownership is generally negligible.

Collective Investments with Indirect Real Estate Ownership

Collective investment schemes with indirect real estate ownership invest in real estate companies or other collective investment schemes with indirect real estate ownership.

In the case of collective investment schemes with indirect real estate ownership, the income is usually collected by a real estate company. Therefore, the income from real estate is subject to profit tax at the ordinary tax rate applicable to corporations at the level of the real estate company. In addition, the equity of the real estate company is subject to capital tax.

As the income from the collective investment scheme with indirect real estate ownership, unlike direct real estate ownership, has not already been taxed at the level of the collective investment scheme itself, the distributions from the collective investment scheme with indirect real estate ownership are subject to income tax at the level of the private investor. For wealth tax purposes, the tax value of the shares in the collective investment scheme with indirect real estate ownership corresponds to the net asset value (NAV) of the previous calendar year.

In addition, distributions from collective investment schemes with indirect real estate ownership are subject to Swiss withholding tax.

As shown above, the taxation of collective investment schemes with direct real estate ownership differs greatly from that of collective investment schemes with indirect real estate ownership for investors who are tax resident in Switzerland. In particular, the largely tax-free distribution for income tax purposes and the reduced assessment basis for wealth tax purposes are very attractive for private investors.

Table 1 compares, by way of example, the tax burden and the disposable income after taxes at the level of the investor for three collective investment schemes with direct real estate ownership and three collective investment schemes with indirect real estate ownership for an investment of CHF 1,000,000.

The calculations presented above are based on information provided by the bank and publicly available data on a selection of collective investment schemes with direct and indirect real estate ownership. The calculations estimate the tax burden (income and wealth tax) in connection with holding the shares and the current annual distributions. The calculations were carried out using the approximate highest effective tax rate applicable in the Canton of Zurich. The effective tax rate may vary depending on the investor’s place of residence and personal circumstances. The past and future performance of the fund products and their costs were not considered in the calculations; only the tax burden is shown.

Conclusion

The analysis outlined above shows that collective investment schemes with direct real estate ownership should be examined in detail as a tax-interesting investment alternative, particularly in the following cases:

1. As a private investor with tax residence in Switzerland, you would like to mitigate the impact of your wealth tax burden because the assessment basis for wealth tax purposes of collective investment schemes with direct real estate ownership is marginal.
2. Your income is subject to a high marginal tax rate because the distributions from the collective investment scheme with direct real estate ownership are largely tax-free.

While the tax consequences of investments such as those presented herein may be less significant for investors who are resident in tax-attractive Swiss cantons; investors with tax residency in high-tax cantons should carefully consider the differences between opting for real estate funds holding such assets directly or indirectly. Unfortunately, banks do often not integrate the tax considerations into their asset management decisions. Therefore, at P&P Family Office, we support our clients in assessing the tax consequences of the products suggested by their bank taking into consideration their particularities and personal tax situation. Since we do not engage in asset management ourselves, we can support our clients independently and without conflicts of interest by optimizing all aspects relevant to success and after-tax returns – including investment returns, taxes and fees.