Real estate deals in Finland – Social infrastructure properties
Despite the current economic uncertainty, social infrastructure premises keep on attracting significant investor appetite and will be among the most traded segments in 2022.
Transaction activity has been boosted by several Finnish municipalities acting on the sell-side, as they have been divesting various service properties to real estate and social infrastructure investors ahead of the healthcare and social services reform taking place in the beginning of 2023. The buyer universe has been predominantly Finnish, but the segment has also drawn interest from various Nordic investors. Foreign investor appetite, on the other hand, has potentially been somewhat hampered by the mandatory break option in some of the leases.
That being said, many of the social infrastructure premises are crucial for the supply of the relevant services and cannot be easily replaced or relocated, which has given investors sufficient comfort to acquire the premises despite the existence of a break option.
In times of uncertainty, investors are typically attracted to assets with the lowest perceived risk characteristics. Accordingly, social infrastructure premises with stable demand, long-term and index-linked leases and strong tenant covenants, combined with better visibility to the effects of healthcare and social services reform, will probably remain attractive to investors in 2023 as well.
Transfer of premises for healthcare, social care, and rescue services
Starting from 1 January 2023, the organization of various healthcare and social services (public healthcare, social welfare, special care and rescue services) will be reformed in Finland so that the responsibility for organizing these services will be transferred from municipalities and joint municipal authorities to the 21 new individual wellbeing services counties (Fi: hyvinvointialue), with the exception of the City of Helsinki, which will continue to be responsible for organizing healthcare, social and rescue services within its own area, in cooperation with the new HUS consortium.
The possession (but not ownership) of premises used for basic healthcare, specialized healthcare, social welfare and rescue services currently organized by the municipalities will be transferred from the municipalities to the new wellbeing services counties with effect from 1 January 2023. This applies to premises currently occupied by municipalities regardless of whether they are owned or leased by the municipalities. The premises and lease agreements to be transferred were specified in the decision-making processes of the relevant entities earlier in 2022.
The mechanism by which, and the terms on which, the relevant premises and lease agreements will be transferred to the wellbeing service counties vary depending on, e.g., the ownership of the premises, but transfers will generally take place as follows:
- The occupation of premises that are under the ownership of the municipalities will be agreed in lease agreements to be entered into by the municipalities and wellbeing service counties. By default, the lease agreements will be valid at least until the end of 2025. In addition, each wellbeing services county will have an option to extend the lease term for one year, which must be exercised no later than 12 months prior to the expiry of the lease term.
- If the relevant premises have not been under the ownership of the municipalities but are leased from third parties, the existing lease agreements will be transferred to the wellbeing service counties, save for certain exceptions, such as agreements under which the municipality has undertaken to purchase the premises at the end of the lease term. For such agreements, the municipalities and wellbeing service counties may enter into temporary arrangements, according to which the main agreement remains with the municipality, which sub-leases it to the wellbeing county for the interim period of three years (and a possible one-year extension).
In conclusion, from 1 January 2023 onwards, most municipalities, but also many private investors or property owners, will become landlords of the wellbeing services counties. The new lease agreements concluded by the municipalities and the wellbeing service counties will be valid by default for at least for three years (plus an option for the wellbeing service counties to extend the term for one year), whereas the terms and conditions of existing lease agreements with third parties will remain the same, save for certain exceptions.
Statutory break option in public healthcare and social welfare lease agreements
Further, certain lease agreements concerning public healthcare and social welfare premises contain a mandatory break option by virtue of applicable law. Accordingly, any lease agreements relating to these kinds of premises, which have been entered into by the municipalities between 1 July 2016 and 31 December 2022, also include a break option allowing the tenant to terminate the lease agreement in 2024 or 2025 on 12 months’ notice. Therefore, the break option affects a large proportion of the lease agreements that will be transferred from municipalities to wellbeing service counties.
The break option is based on the Act on Restriction of Certain Transactions by Municipalities and Joint Municipal Authorities (548/2016, as amended) (the Restriction Act), its purpose being to enable the wellbeing services counties to organize and, if necessary, make changes to the services they offer without being bound by long lease terms initially agreed by the municipalities. The break option only applies to lease agreements concerning public healthcare and social welfare premises, and not, e.g., rescue services premises. However, its applicability always requires a case-by-case assessment, as several different activities may often be carried out on the same premises.
However, as part of the enactment of the new legislation relating to the wider healthcare and social welfare reform, the Finnish Parliament decided that the Restriction Act will be repealed as of 1 January 2023. Therefore, while the break options that have already been agreed and included in the lease agreements will continue to be valid, there is no statutory requirement to include such an option in any new lease agreements as of 1 January 2023.
Reflections on the reform from an investor’s perspective
It has been estimated that the upcoming lease arrangements between municipalities and wellbeing service counties concern approximately 4,500 municipality-owned buildings with a lettable area of more than 4 million square meters.
Given that the ownership and leasing of social and healthcare properties is typically not one of the key duties of municipalities, and the municipalities need funds to operate their core services, there have been many transactions concerning the sale of such properties by the municipalities to investors. The majority of these sales have been carried out by way of a Finnish language non-insured SPA, and the municipalities have been typically willing to offer a relatively standard set of warranties and other terms (and in some cases even a vendor note/deferred purchase price arrangement to facilitate the transaction).
The aggregate annual transaction volume on the Finnish property market at the beginning of December 2022 amounted to approximately EUR 6.8 billion and it is estimated that the social infrastructure properties will be among the most traded segments in 2022, with the estimated volume exceeding EUR 1.5 billion, effectively doubling since 2021. The majority of the buyers have been Finnish real estate funds, but also several Nordic real estate and social infra investors have made significant acquisitions.
Rising investor interest in this asset category is based, among other things, on long lease terms (often 15-20 years) and solvent tenants. The statutory break options applicable to some of the lease agreements have (at least so far) potentially limited the appetite of most international investors to acquire these properties. However, presumably due to the location of the relevant premises and foreseeable need for the services in the future as well, the relevant Finnish and Nordic investors have considered the risk of the wellbeing service counties exercising their break options to be very low.
Further, given the decision to repeal the Restriction Act as of 1 January 2023, the statutory break option will no longer apply to any new lease agreements concluded directly with the wellbeing service counties as tenants, which may also affect the investors’ view of the market. It remains to be seen whether there will be more foreign investors acquiring such properties in the future and whether this will happen before or after the expiry of the relevant break options.