Allocations are edging upwards in spite of the turmoil. The introduction in Finland of REITs, scheduled for next year, may boost prospects, as Gail Moss reports

Real estate investors in Finland are playing a waiting game in the wake of the biggest global financial crisis for more than 70 years."At the moment, there is a lot of leverage on real estate, which means that real estate funds will have problems with debt," says Timo Ritakallio, deputy chief executive and chief investment officer, Ilmarinen Mutual Pension Insurance Company. "This suggests there will be some distressed selling. But property is still a good asset class, and in the coming months there will be good opportunities to buy."

About 9% of Ilmarinen's €25bn portfolio is invested in property, almost all of it in Finland. But the fund is planning to increase this proportion to 12%, with a target split of two-thirds direct and one-third indirect. At present, the indirect segment is invested in up to 20 funds.Most of any additional property holdings, however, will still be concentrated in Finland.Ritakallio says: "Real estate is generally very local, so it is important that we know it very well."

Half the fund's portfolio is in offices and 20% in residential, with smaller percentages in hotels and other commercial, and these sectors will be maintained at similar levels when the portfolio is expanded.Returns, however, are slowing - from over 9% last year to 6% or 7% this year.

"A greater number of Finnish pension funds are now looking at real estate in a more earnest way than previously," says Adam Calman, partner, capital markets, Cushman & Wakefield. "We're finding many more opportunities to advise them on how to follow the success of Danish pension funds. And they have some very meaningful capital to commit to the sector."He adds: "Some of them have started allocating already and some have grand plans to go forward. It's clearly a good time to be considering new strategies, with the asset class currently experiencing a fall in value across many sectors and geographies."

According to TELA, the Finnish Pension Alliance, €12.2bn-worth, or 10.2%, of fund portfolios - including those of pension insurance companies and other pension funds - was invested in real estate as at 30 June 2008. This percentage represents a slight increase over the previous two years, the figures being 9.1% and 9.3% at 31 December 2007 and 2006 respectively. However, even further back, the percentage reached as high as 11% or 12%.

Of the total real estate portion, €10.8bn, or 88.5%, was invested in Finland, with the other €1.4bn placed abroad, including €1.1bn in the euro-zone.One development that could stimulate the local property market is the introduction of REITs legislation, which is likely to be enacted in early 2009."I think that everybody is looking for more opportunistic investments which will benefit from the coming distressed markets," says Timo
Stenius, director, real estate investments, customer finance, Pension Fennia, the public authority pension fund.

Fennia considers real estate to be an essential part of its portfolio, using it to diversify risk, give a continuous cash return and provide low volatility. Its optimum allocation to real estate is around 15%.Fennia invests directly, but only within Finland. It also invests indirectly via funds and listed companies or REITs. In the domestic market, it selects its own investments, but for other EU countries it retains an adviser to search for funds that match its investment strategy and to perform due diligence.

The pension fund's investments are largely in the EU, with a few in the Asian and global listed real estate sector.Stenius says that Fennia's priority is to achieve as steady a return as possible from its property investments, rather than maximising returns. The target annual return is 7% with low volatility, and this has been achieved every year for the past five years.

However, Stenius believes that this will be challenged in the medium term. "Over the past few years, excess money has spoiled the market, with yield demands and risk margins which are too low," he says. "The deleveraging will affect values, and the next two to three years will be times of negative or low returns. At the same time, national economies will suffer from a probable recession, which will lead to increasing vacancies and decreasing rent levels."

And he warns: "Indirect real estate fund investments are exposed to the credit crunch, and are even more vulnerable in these circumstances."However, he says that Fennia is unlikely to make drastic changes to its strategy. "We are satisfied with our present investment portfolio," he says. "We will gradually increase the share of foreign property, probably through REIT markets. Very little has changed in our thinking, except that we are perhaps more critical when investing in unlisted real estate funds."

Meanwhile, multi-employer pension fund Tapiola is also planning to increase its allocation to property investments. Real estate forms part of the alternative assets segment within its portfolio, and the current allocation to real estate investments is about 12%."Real estate investments have always been part of our asset allocation - they diversify our overall portfolio and hedge against inflation," says Hanna Hiidenpalo, investment director at Tapiola. "Our strategy is to diversify further our property portfolio globally, diversifying between different sectors as well."

The fund invests both directly and through fund vehicles. The great majority of its property portfolio is currently located in Finland as direct holdings. The rest of the allocation is made up of private equity real estate investments in Europe.
Property research starts with macro analysis and economic fundamentals, as well as valuations for every asset class.

For private equity real estate investments, Tapiola uses a strict proactive fund manager approach. "We aim to maximise return by using a top-down approach and a proactive manager process," says Hiidenpalo. "Our managers must have long experience in the real estate industry. That means they have seen and survived the earlier cycles, and have a proven track record in enhancing value."

Like her counterparts in other Finnish pension funds, Hiidenpalo dismisses the prospect that the current financial turmoil has dented enthusiasm for real estate.
"It has not changed anything - in fact, we are committed more than ever in our investment approach to stick to fundamentals," she says. "The challenge is only to find the right fund managers."
 

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