Finnish and Swedish real estate market trends of 2023
Following several busy and record-breaking years of transaction volumes, the Nordic real estate market slowed down significantly towards the end of 2022 and especially during the first half of 2023. Roschier elaborates on the trends in the markets and the impact we acknowledge the general downturn in the markets has had on deals during 2023.
Inflation puts pressure on real estate markets
There had perhaps been signs, and they had perhaps not been too subtle. The massive government spend, central bank quantitative easing and low lending rates during and following the corona pandemic launched the Swedish real estate market into a surge of investments and transactions, peaking in 2021, with volumes much like in 2007.
This development has come to an abrupt end, with very modest transaction volumes recorded during H1 2023 and low activity noted at the beginning of this fall, as deal volumes have fallen in all Nordic markets by up to 70% in comparison to 2022 (depending on the market area and sector). For example, in Finland, as at August 2023 the rolling transaction volume of the last 12 months was only slightly above EUR 3bn, which is roughly on a par with the volume in the early corona pandemic transaction slump and slightly above that in the post-GFC years.
From our clients and other market participants, we note several perspectives on the developments: uncertainty about new market price levels, limited funding opportunities and the increased attractiveness of other – especially fixed-income – instruments. High inflation throughout the euro area and interest rate hikes have resulted in higher rent levels but also increased borrowing costs and, consequently, reduced funding opportunities for investments. Many are now looking to the central banks and their signals regarding interest rates and the possibility of a slowdown in rent rises, which would support increased activity in the real estate market.
Over the end of 2022 and beginning of 2023, light industry, logistics and warehouse assets turned out to be particularly sought-after as buyers and sellers appeared to have been able to bridge the gap in price expectations that arose in 2022. For example, Roschier advised Patrizia in connection with its acquisition of a logistics portfolio from Alta Fastigheter, and KKR and Mirastar on their investment in a last-mile logistics property in Stockholm.
The market for traditionally more low-yielding assets such as residential, on the other hand, has remained strained with limited activity, especially in Sweden. In the Swedish market, various factors, such as the withdrawal of state financial investment aid (Sw. statligt investeringsstöd), restrictions imposed on raising rents for newly produced rental units, sharply increasing production costs and rising financing costs have built up to a perfect storm, making it difficult for developers and investors in the residential sector to agree commercially.
In spite of exceptions, such as the acquisition of the residential portfolio from K2A on which Roschier advised Savills Investment Management, the residential sector of the Swedish transaction market definitely appears to require more time to pick up speed. The inquiry ordered by the Swedish government to evaluate the Swedish rules governing the rent development for newbuilt apartments may ease the pressures put on rent as a result of recent case law (see our comment on that case law here). The inquiry has been launched with the express purpose of creating good conditions for the production of new residential rental units.
On the other hand, as far as Finland is concerned, residential portfolios have been among the most traded asset types both in 2022 and 2023. The second quarter of 2023 saw some individual larger residential portfolio trades, such as KKR’s entry into the Finnish real estate market with the acquisition of a 1,200-apartment portfolio from Kruunuasunnot. However, the residential sector is facing its own uncertainties in the Finnish market as well.
Yield levels have risen in key submarkets, while severe difficulties in the construction sector have significantly reduced new housing production, leaving many construction companies struggling as a result of the slowdown in housing sales and their own financial situation. However, we anticipate the residential sector deal flow to remain steady, with a slight upward trajectory, given that many portfolio sales that were put on hold in late 2022/early 2023 will probably get a second look.
There is also a healthy number of new products that are on the market or expected to hit the market relatively soon. Some notable examples are Kojamo’s contemplated portfolio sales program (see their recent press release) as well as potential upcoming divestments by Finnish special investment funds to secure liquidity.
As regards the traditionally attractive and liquid office sector, the post-corona pandemic years have been challenging; 2023 has been no exception to this. Many investors are still getting to grips with the prospects of this asset class. In Finland, for instance, the annual investment from German investors, who have been typically very active on this asset class, was still at 0% in August 2023.
On the other hand, the outlook for this sector is not as gloomy as it may seem at first glance. There have been several notable recent transactions by Nordic investors in particular, such as Nrep’s acquisition of TietoEvry’s HQ on the former Nokia Campus in Finland (in which Roschier advised the seller). There seem to be a number of assets currently for sale or coming to the market in the near future that are likely to attract broad investor interest during the fall.
Swedish listed companies leading the “net sellers”
Some of the driving forces behind the 2021 surge in transaction volume were a number of Swedish listed companies who contributed to market consolidation, such as SBB’s takeover of Offentliga Hus, Corem’s buy-out of Klövern, and Castellum’s acquisition of Kungsleden.
The financing of these transactions was fueled to a large extent by the issuance of bonds. For the issuers of these bonds, the rapid rise in interest rates has significantly increased financing costs. We now see that several of the listed players have expressly communicated that they are net sellers throughout this year. The specific purpose of a large number of transactions carried out during this year may have been to reduce debt in order to regain control over the cost of finance. Other operators have expressed in various contexts that they retain a positive view on refinancing their bonds by way of bank loans.
It remains to be seen how much of an appetite the Swedish banks have for this financing. It appears that many of the listed companies are still trading at a discount to NAV and we speculated in last year’s outlook that we would see some POT activity to follow. So far, we have not seen developments of that kind.
Focus on construction companies and special investment funds in the Finnish market
In Finland in particular, the recent rise in construction costs and the subsequent sharp increase in credit costs has slowed the housing market, pushing many construction companies into distress. Various companies have a large number of unsold apartments on their balance sheets, both completed and under construction, putting pressure on their cash position. There has also been a decline in the number of new development projects, and in some cases construction companies have not launched projects that have valid building permits.
The difficult situation for construction companies has already had tangible effects, with a number of companies having to lay off personnel. In addition, a number of companies operating in the construction sector have become insolvent. This has included not only smaller firms, but also recent examples of larger, nation-wide companies, such as Siklatilat and Jukkatalo.
In addition, one of the country’s listed construction companies, Lehto Group, has been suffering from financial difficulties for some time and, in early September, the company’s shares were given observation status by Nasdaq Helsinki due to the current financial condition of the company. Lehto itself has previously announced its intention to find industrial or ownership partners for the company, which may involve a partial or complete restructuring of its businesses.
In summary, in the current economic climate, it is possible and, in many cases, even likely that the construction sector will see further ownership restructuring and insolvency proceedings in late 2023 and in 2024. For other operators in the sector, this means in particular an increased need to select partners for potential renovation or new construction projects carefully.
In addition to the plight of the listed sector and the construction companies, the Finnish market in particular has seen many special investment funds reduce their acquisitions or even, in many cases, sell their real estate assets to maintain sufficient liquidity. This is mainly due to the fact that, after many years of net subscriptions and strong positive cash flow, the tide has now turned, with many investors seeking to redeem their shares in the funds in search of better returns elsewhere.
In some cases, the liquidity need is so pressing that the funds are forced to divest their prime assets, preferring buyers with the strongest deal security at the expense of maximizing the purchase price, or even to limit redemptions of their own fund shares or to postpone the payment of redemption prices, as Ålandsbanken recently decided to do.
Availability of financing and the emergence of private credit solutions
The change in the market situation has made many Nordic banks in particular more cautious about financing real estate transactions. However, traditional debt financing has still been available for properties that are considered good, lower-risk investments by lenders, although the importance of existing relationships between banks and investors has increased.
The Nordic real estate market has long enjoyed dynamic and innovative financing options. Bank financing has increasingly been complemented by alternative financing solutions which until now had received less attention in recent years.
In the Finnish market in particular, so-called vendor notes (i.e. an arrangement between the buyer and the seller, whereby the seller co-finances part of the purchase price by granting the buyer a loan with an interest rate that is often higher than that under traditional bank financing and a security package agreed between the parties) have become more common. By way of a recent example in the public sector, in a transaction between the City of Jyväskylä and Infranode regarding a social infrastructure portfolio, 40% of the purchase price was financed by a vendor note with a 3.75% p.a. rate and 3.5 year maturity.
Various other vendor note arrangements have been agreed or are being contemplated in the ongoing sales processes by the relevant parties. Some players have turned their attention to debt funds and the rest of the private credit sector, which can offer new opportunities for both those seeking funding and those operating the funds. In a differentiated market, asset managers have been able to contribute to the orderly resolution of defaults.
In current market conditions, the tradition of creativity and dynamism is likely to stand the real estate sector in good stead. Privately negotiated restructuring of balance sheets and business models, this side of formal insolvency or reconstruction proceedings, is being explored and successfully implemented. Roschier takes an active part in these developments and engages proactively with both sides of the market.
Decreased deal certainty and other market trends
As sellers and buyers have struggled to meet at new price levels, little room has been left at either end to adjust to unwelcome surprises such as findings in the due diligence process. As a result, we have found a higher rate of transactions being paused or even prematurely terminated.
According to parties involved in the sales preparations, the success rate is even lower in the initial commercial stages. Buyers are also found to be more on the offensive in requesting price deductions and indemnities. This strategy may not always be played out just because the buyer can, but because the buyer needs to do so in order to get financing approved.
We also see this tendency reflected in the number of claims under warranty and indemnity (W&I) insurance policies, for example. As far as the W&I insurance market is concerned, the increased sales pressure from different types of – and even distressed – sellers has in some cases also increased the demand for previously less-used insurance products, such as so-called synthetic W&I insurance, where the main liability terms of the transaction are negotiated entirely between the buyer and the insurer.
In general, we have also seen financing banks taking further steps to actively engage in the transaction process. On the sell-side, on the other hand, the presence of the lending bank may be viewed as a positive, as the buyer has at least demonstrated a financing alternative. Otherwise, we see sellers to a larger extent requiring buyers to demonstrate their funding in order to approve exclusivity.
We therefore see some opportunities for all equity buyers who are not dependent on external financing and also for a buyer to come in “late” in a process and take over and complete a deal that has come to a halt. For those sellers who are not able to get such early comfort in the process, over the year it has become more common to accept that the deal is made conditional upon the buyer’s financing.
Despite the challenges posed by the current market situation, market activity as such has remained quite buoyant, although it has not ultimately materialized in terms of completed transactions and is therefore not reflected in the transaction volume statistics. However, traditional core real estate assets and hot sectors such as light industry remain attractive to both buyers and financiers, especially if the changed market fundamentals have been successfully reflected in the economic parameters of the transaction. We therefore believe there to be many expectations in the real estate market as to when more active trading will resume.