Although relatively resilient, Norway has been unable to avoid an overheating property market. And now the country's biggest investor is about to test the water, as Gail Moss reports

While the Nordic region as a whole has not escaped the travails of the global financial crisis, it is Norway which is emerging relatively unscathed.

"The Norwegian economy is growing again, and we expect the recovery to be strong as the fundamentals are sound," says Lars Ohnemus, chief executive officer at Baltic Property Trust. "The property market is in a league of its own - yields went up to 7% and 8% at their peak, but are now back to 5.5-6% and there is no sign of crisis."

As a result, Norges Bank - the country's Central Bank - raised interest rates by 25 percentage points to 1.5% on 28 October 2009, the first European central bank to do so since the financial crisis started.

The subsequent press release justified the increase in terms which some other countries can only admire with envy. "Inflation has been slightly higher than expected. Unemployment is considerably lower than previously projected. [Seasonally adjusted unemployment in September was 2.8%.] Activity in the Norwegian economy has picked up more rapidly than expected."

The reason for this is buoyant oil prices.

"The economy is a commodity economy, reliant on petroleum, the timber industry and base metals, and that has shielded the country from this current financial crisis," says Nadja Savic de Jager, senior analyst, research, at CB Richard Ellis Investors. "While Norway has seen two quarters of declining growth this year, growth is expected to rebound in 1010 and 2011, driven by strong private consumption. In particular, retail sales are growing by 1.5% year on year."

However, Norway has gone through its own property mini-crash.

"We saw large increases in rental values between June 2008 and September 2009 - for instance, 45% in Oslo's central business district," says Savic de Jager. "After that, rents just crashed, falling by 33%. They have stabilised now, but there are a large number of leases due to terminate next year, and this will put further pressure on vacancies and rents."

She says there is a similar picture in the retail and industrial sectors, although rents have fallen by smaller amounts - around 13%, peak to trough.

According to Savic de Jager, the crash was partly a result of an overheated market, especially in the office sector, where rents had almost tripled. At the same time the correction occurred, companies were downsizing, making more space available.

This potentially affects those Norwegian pension funds that invest in property because they have substantial domestic holdings.

For instance, Norsk Hydros Pensjonskasse's exposure to real estate is through direct ownership of office buildings in Oslo. One of the buildings in the Oslo area is let to Hydro (the pension fund's sponsor), while the others are let to companies of various sizes. The fund says the properties generate a stable cash flow that contributes to part of the pension payments.

However, while the domestic market is usually the first port of call for those Norwegian pension funds investing in property, it has its limitations.

"Norway is relatively small from the investable universe standpoint, and the market is owned by a few large pension funds which buy and hold for a long time," says Mark Meiklejon, investment director, Standard Life Investments. "The biggest funds are therefore forced to diversify overseas. Strategically, most schemes will want to do this within Europe initially, and we expect more investment capital to come out of Norway in the next 12 months."

The biggest scheme of all - the Norwegian Government Pension Fund - is about to dip its toe in the water. Previously barred from investing in real estate, it benefits from a law passed last year allowing it to invest up to 5% of its assets in property, and will do so on a global basis.

The fund is still waiting for an investment mandate from the ministry of finance but hopes to start allocating funds in the New Year.

Those funds that do invest abroad often have direct holdings in Sweden and Denmark, but farther afield they usually go down the pooled route. One restriction however is that investments in leveraged funds are classified alongside equities and alternative investments, which reduces the scope for holding other equity assets, as their total allocation within a portfolio is limited.

Meiklejon says the UK is a popular destination for Norwegian investment.

"The market has fallen furthest and fastest, so the perception is of fair value and an attractive entry point," he says. "In addition, sterling is perceived to be cheap."

According to Meiklejon, the relatively long lease structures and upwards-only rent reviews - which together offer security of income stream - together with the transparency of markets in terms of valuation frequency and methodology, make the UK particularly investor-friendly.

He says that Norwegian funds are also eyeing the Baltics and eastern Europe for the longer term, but are likely to look to more core western European markets first.

"Before the crash, pension funds were far more willing to take that beta risk in those countries," he says. "And we think the long-term trend will continue, especially as different access routes are being made available by different fund managers. But Norwegian pension funds have low-risk profiles, and in the short to medium term we won't see a big appetite to go back there. Core markets are perceived to offer better value in pricing terms."

"Activity in Norway is picking up," says Christoffer Sundin, head of acquisition and strategy, Storebrand Eiendom. "The rental market has been relatively strong due to the solid economy and there has not been a large increase in vacancies."

Sundin says the next 12 months will likely see increased investment. He says the main reason for this is that banks are again starting to lend to real estate investors.

"At the same time, credit margins are being reduced, but the effect is partially offset by an increase in swap rates," he says. "The net effect is likely to be a relatively stable yield environment, but increased activities."

Savic de Jager is less optimistic. "In the next 12 months we can expect more vacancies in the office sector and probably more falls in rental values. In the industrial sector, leases are now being signed for a shorter term, often just two years," she says.

But the retail sector is more resilient, she says. "Consumption is picking up already and that is what is going to drive the economy over the next two years."