After the downturn Finnish pension funds are maintaining or increasing their real estate allocations. Their focus remains on the established, core markets, with an emphasis on alignment, as Gail Moss reports

Finnish pension funds are returning to the real estate marketplace, unfazed by the financial problems of the past two years.

"Finnish institutions were among the first out of the blocks after the 2008 crash," says Mike Morrison, member of the corporate finance team, Cushman & Wakefield. "They were able to look at indirect investments in Europe far quicker than the Swedish, Dutch or Germans were able."

As a whole, however, the amount invested in real estate across all Finnish pension funds has remained fairly stable, at around €14bn, nearly 11% of portfolio values, according to the Finnish Pension Alliance, TELA.

Of the total real estate assets, around 12% is invested outside Finland.

"Following the financial crisis, we plan to increase our exposure to property, the main target areas being Europe and Asia," says Timo Stenius, director, real estate investments, corporate finance and private equity at Pension Fennia, the public authority pension fund.

"We are increasing our pan-European re-investments for diversification reasons. The target allocations are between offices, shopping centres, logistics and residential properties, in equal amounts."

Fennia invests in property largely because of its low volatility and low correlation to equities and bonds. Its investment objective is moderate return for low risk. The target allocation is 15% of its overall portfolio.

Like many other Nordic investors, Fennia's real estate assets in domestic markets are mainly held directly (except for hotels), while - again like its peers - it uses the indirect route to diversify abroad.

Fennia uses private equity funds to invest in property throughout the rest of Europe, but in Asia and the US it invests only in listed real estate companies and REITs.
It prefers core funds specialising in one country and one property type. It also prefers low leverage.

However, the pension fund has not succeeded in diversifying as much as it had intended.

"At the moment, it is a seller's market on core properties, with too much investment money on offer," says Stenius. "The private equity funds are poor, and are expensive vehicles for long-term property investments, while the listed sector doesn't have the necessary low volatility, and low correlation with other assets."

Core properties in Finland itself are also in short supply, says Hanna Hiidenpalo, investment director, Tapiola Mutual Pension Insurance Company.

"Domestically, the most attractive sector at the moment is commercial buildings in growth areas," she says. "Growth expectations have increased because of the economic recovery, and supply is limited."

The fund's real estate allocation is slightly over 10% of total assets, around 80% of which is in directly held, domestic investments. Overall, the average annual return for the past five years has been 6%.

"Geographically, the focus of our direct investments in Finland is mainly on offices in the metropolitan area and in other growth areas," says Hiidenpalo. "Direct investments give us good control, low costs and relatively good liquidity. But the small size and volume of the Finnish market is a drawback."

"Finnish pension funds have generally been maintaining or increasing their allocation to real estate," says Michael Schönach, managing director, Catella Property Oy. "The return is perceived as quite attractive, especially compared with fixed income."

According to Schönach, Finnish pension funds investing abroad favour stable markets in the developed world, with some investments in Asia to provide extra growth.

"So they prefer northern Europe - France, Germany and the UK - with some holdings in southern Europe, and are also interested in the US," he says. "In Asia, they are particularly focusing on China."

But he says the pace has slowed down in the past couple of years. "Foreign property has tanked, Finnish property has not."

Even so, he says that valuations in Finland have come down in the recent past.
"But this year we expect to see positive growth," he says. "Yields have started to compress in the last three to six months, and income yields are now down at around 6%."

He says that in Finland, the retail sector is more popular with investors than offices.
"Consumer confidence is at an all-time high, while unemployment has been falling," he says. "But in the office sector, vacancy rates are quite high. However, we expect the situation to stabilise and get better over the next 12 months."

"Low interest rates will keep values in the core sector unchanged, with rents the main source of return," says Stenius. "But the riskier properties will still suffer, both in values and in rents."

Morrison says that the post-crash environment has established a natural order of priority for Finnish pension funds when investing abroad.

"In general, to complement their domestic real estate portfolios, they have looked to the UK, which adjusted quickly and returned to ‘market value' quicker than other European countries, although it still represents value," he says.

"The next port of call is mainland Europe, where they are looking at French funds, German funds and pan-European funds. There are some who are looking at the US as a pure equity play, or can include mezzanine debt funds as well."

But the return to investing abroad is tempered by lessons learned from the financial crisis.

"It is a flight back to established markets such as the UK and France," says Morrison. "They are unlikely to go back to Poland, Spain or Greece, for example. Some still have indirect investments there which they continue to hold, to avoid crystallising a loss."
A further lesson they have learned is to use more rigorous criteria for selecting managers.

"They are looking for alignment, corporate governance and key man clauses," says Morrison. "Furthermore, they don't want the threat of counterparty issues, so they look for strong, well-established names."

Finnish investors are generally active in both the primary and secondary markets when investing overseas. They use the fund of funds route for secondary markets because they do not generally have the local knowledge, says Morrison.

"But they are not afraid of leverage," he says. "They are very clear about its uses, and understand what leverage can do when markets are set to recover. For instance, in some UK office funds and UK-wide funds, they are expecting to enhance their return by using leverage, because although they expect a softening of yields in the next year or so, they are bullish in the medium term."