As UK pension fund investors in real estate move out of their overpriced domestic market and sceptically eye mature Europe, their continental counterparts are looking for a combination of robust macroeconomic growth and the next big thing. If Finnish real estate did not exist, both groups would have to invent it.
Part of the reason for enthusiasm for Finnish property market is the contraction of real estate investment opportunities in more mature European markets. But pension funds’ enthusiasm also reflects a combination of strong macroeconomic growth - widely forecast to continue - and a predictable, transparent investment environment. David Seddon, Europe chief investment officer with property firm Teesland, cites as pull factors macroeconomic performance “probably for the next five years”, dispersed affluence and a strong occupier base in the small and medium-sized enterprises that make up 60% of employers in Finland versus a European average of 50%.
The upshot is a familiar one: too much cash chasing too few opportunities. In fact, the current Helsinki hustle seems to be a peculiarly Finnish mystery. The market has virtually no major portfolios up for sale yet real estate investors appear to be chasing them with a passion. It is precisely this issue of buyable real estate that points to the potential limits of Finland as a real estate market in the medium and long term. To maintain investor interest at its current levels, the contours of the Finnish market will have to expand outside retail and logistics - into office, even residential, and crucially, beyond the capital.
Investment outside Helsinki is already beginning pick up. In October Finnish private equity firm Capman Oyj announced that seven European pension funds had committed €67m to its Finnish property development fund - focused, predictably enough, on retail and logistics. Markku Hietala, head of real estate at the firm, said the new fund reflected the growing momentum of the international investor outside the capital.
“Generally, interest is widening,” he says. “There are many places across Finland where the economy is concentrating.”
Seddon likewise points to higher yields in secondary markets - a trend Finnish and international investors have been quick to exploit. Teesland’s target €750m Nordic Active fund, which has just closed its second Finnish deal involving 63 separate properties, invests not in prime real estate but in conurbations across the region, though it will consider “high-yielding office” in Helsinki. For Danish investment broker Ejendomsinvest Denmark, location is irrelevant to attractiveness. “We don’t care where we invest if it gives a good return,” says investment manager Henrik Andersen. “If it’s outside Helsinki, and it delivers significant yields, then we’ll invest in it. One place is as good as another.”
The issue, then, is less whether there is sellable property outside Helsinki than whether real estate markets in second-tier cities and regions are sufficiently developed to be investible. Not only the demand created by the overflow from the capital but the dispersal of domestic wealth indicate that they are.
“It has been a one-city market. It’s changing now as volumes increase,” says Jőrgen Osterberg, investor relations head at Swedish pension fund Sveafastigheter, which has invested in Tempere, Pori and southern Finland. “Deals outside the capital had been quite localised. Now they’re nationwide. If they have the volumes, fine.”
“It seems always to happen in developing markets - look at the Baltics,” he adds. Investment starts in the capital. Then it moves outside, driven by foreigners. Increased demand increases supply. As investors move in, that’s how it develops.”
Mention of the Baltic states is more than coincidental. Just as Scandinavian growth provided the impetus for European investors to look northwards and alight on Finland, the current Finnish cache may well be linked to the fact that it provides a sturdy bridge from Scandinavian economies to central and eastern Europe.
When Varma Mutual Pension Insurance, the country’s largest insurance firm, sold 116 of its retail properties to Sveafastigheter for €74m earlier this year, part of Sveafastigheter’s motivation was that the acquisition provided a beachhead into the Baltics. Likewise the pan-Nordic SICAV launched in the summer by Aberdeen and targeting European pension funds. “It has a western European profile but with better returns,” Philip Ingman, managing director of Strutt & Parker Real Estate Finance Services, which advised Aberdeen on the launch, told IPE Real Estate at the time.
To date, retail, logistics and office have been the most attractive real estate segments. But Svaefastigheter, which has acquired only retail so far, denies that it is the result of “a conscious choice to avoid other sectors”. Rather, says Osterberg, “after the first acquisition, it’s easy to continue in that path”.
Timo Kankuri, former real estate head of Finnish pension fund Ilmarinen and now real estate president at consultancy Pouri, sees logistics taking off, with new and significant developments in Helsinki satellites.
“There’s a significant opportunity in the harbour development. There’s even been some discussion about foreign investors looking at residential,” he says. “It isn’t happening yet but it’s interesting. There always has to be someone who takes the big step first, and that accelerates the whole process. Now we’re looking for the first investors in residential.”
For cross-border investors to continue to be attracted to Finnish real estate, there needs to be more of it to invest in - especially across these growth sectors.
Jones Lang LaSalle’s most recent report on global real estate capital1 noted a doubling of transaction activity in Finland for the first half of 2006 from the same period the previous year. Yet, according to Kankuri, the impetus will come not from sellers catching the market at its near-peak but from investors revamping existing portfolios. “There are no major portfolios on the market but the 30-40 international investors in the market will restructure portfolios,” he says.
Andersen claims to be seeing evidence that demand is already increasing supply, although he argues that the scope is still not large portfolios but in single properties. Certainly, more people are selling properties, and there are indications that the portfolios will get larger. The impact will be higher transaction values.
“It’s easier to offload stuff and you’re looking at a better price,” says Osterberg.
A significant attraction of the market for pension funds - apart from macroeconomic growth - is the relative transparency of the Finnish investment environment.
“From a European perspective, it’s no easier and no more difficult than anywhere else,” says Seddon. “The business culture is becoming rapidly Europeanised. It’s relatively transparent.”
Yet for all the market’s alleged transparency, there are gripes over the process of investment. Osterberg points out that, in contrast to Sweden, multiple Finnish brokers deal with the same portfolio - which means pension funds talking to brokers can never be sure they have exclusivity.
The transparency issue goes beyond savvy when it comes to local ways of doing business - significant when you consider that Finland offers investors a narrow course between squeezed mature (but relatively transparent) markets on one side and riskier emerging European markets on the other.
Investors must resign themselves to a cumbersome acquisition process, with properties offered by brokers for auction. “They ask investors to bid and either reject the bids or go with multiple investors,” says Andersen. “Negotiations begin only after indicative bids are in.” This process has led, he alleges, to unfair practices in the sale of state-owned assets.
“There is nepotism in the Finnish market, and you get a sense of protectionism.” Yet boosting the market’s attraction for Scandinavian pension funds is the fact that Finland has the familiarity factor: it works in the same way as their own.
“Finland is somewhat similar to Norway in terms of its business environment,” says Osterberg, which made its first cross-border acquisition in Finnish retail in April. “It’s easy to make a deal. Danes are more gung-ho. But when we made the decision to look outside Sweden, we saw opportunities to make good deals. The Finnish market has come to life pretty fast, though it lags the Swedish market in yields and transaction volumes.”
Add to investor gripes the issue of double taxation. “It seems to have a long tradition in the Finnish market,” says Andersen. “I’ve never met a seller who was willing to pay the buyer’s tax - well, only in my dreams.”
Tax comes up in another context, too - this time in indirect real estate investment. It was probably inevitable that real estate investment trust (REIT) mania in the UK and Germany would reach Finland. Hence pension funds’ disappointment over recent regulatory changes that failed to remove double-taxation on Finland’s REIT-like structures.
“The reforms are going forward. We’re positive but they don’t go far enough,” says Matti Leppälä, director of international and legal affairs at the Finnish Pension Alliance (TELA).
On the one hand, TELA supports the reform of investment rules to require ‘real risk assessment’ of indirect real estate, which had previously been classed as higher risk than direct investment. On the other, they stop short of reforms that would make Finnish real estate indirectly investible.
Positive changes in the REITs legislation “would have a definite impact on pension funds”, says Leppälä. For one thing, it would remove the issue of double taxation which he blames for discouraging pension funds from investing in them. For another “they would enlarge the market by making property liquid enough and attractive enough”.
In the process, he argues, reform would drag into the investible universe “real estate that isn’t attractive enough or central enough to attract direct investment from domestic or international investors. It would mean the whole market would grow and everyone would benefit.
“We’re lobbying for it,” he adds.
If European institutional investors can’t get enough of Finnish real estate, it seems Finnish pension funds are becoming more cautious about their domestic market.
TELA’s Leppälä identifies a trend for Finnish pension funds to move out of the market in search of diversification. “Really, in comparison, it’s still a small investment. The majority of Finnish pension funds’ real estate investment is still in Finland - but there is a new focus developing,” he says.
The beginnings of the trend become evident in the summer, when public sector pension fund Fennia announced a three to five-year plan to switch 30% of its 11% real estate allocation into overseas indirect property because of concerns about potential volatility in the Finnish market. It wasn’t a crisis move - director of real estate investment Timo Stenius pointed out at the time that “we can wait for some years” - but it did signify concerns that property values, which tend to change more dramatically in smaller markets, could create volatility. It marked the first time Fennia’s first cross-border investment.
Then, in September, the Finnish State Pension Fund (VER) announced that it would accelerate a targeted increase in its allocation to alternative investments - including real estate - from 2.5% to 10% as it reported first-half investment returns down to zero.
Managing director Timo Löyttyniemi said that the fund would scout real estate and infrastructure instruments. Iikka Tomperi, portfolio manager at the fund, has indicated interest in European retail, and the UK and Germany as specific markets.
There are further reasons for caution. With increased international investor interest, yields will likely contract. Finland is hardly Europe’s most liquid real estate market.
For all the hype around waterfront developments and logistics, investors are looking at the Baltics (based on the neighbouring Finnish market’s strength) for logistics opportunities. Investors in residential will likely also be investors in property development, especially in the capital’s satellite towns as supply of housing struggles to meet demand for it.
Are international investors squeezing domestic pension funds out of their own market? Capman Oyj’s Markku Hietala is sanguine about the chances for change.
“Already there are around 40 foreign investors in Finland. New players are coming up all the time. Will it change? It’s difficult to say,” he says. “Lower yields are possible, and the pressure may create price increases. But I don’t know whether the changes will be dramatic.”
Until that happens, says Ejendomsinvest’s Andersen, “the very, very wise will earn a lot of money”.
1Record volumes, record globalisation, September 2006