The rebound in equities means Danish investors are now underweight in real estate and looking to rebalance with new allocations. Gail Moss reports

In the aftermath of last year's financial earthquakes, Nordic pension funds are emerging from the rubble and tentatively making plans for the future, according to Lars Flåøyen, head of Nordic research and strategy at Aberdeen Property Investors.

"They are again in dialogue with us, if not actually investing in our funds yet," says Flåøyen. "They are also starting to look for directly held properties. Many of them took large write-downs on equities in 2008 and early 2009, so there was a relative over-allocation to property, as other assets fell in value. But now after the rebound in equities, other asset values are back to where they should be, and funds once again have room for allocating capital to property investments."

He says: "A stable direct income, diversification benefits and inflation hedging are characteristics pension funds find attractive with property as an asset class, and pricing relative to other asset classes has become more favourable."

In Denmark some individual funds are not quite as optimistic. Michael Nielsen, managing director at ATP Real Estate - the real estate arm of ATP and the biggest property investor in Denmark, with a portfolio worth DK€2.2bn, around 5% of the fund's total assets - says: "The decrease in values over the past 18 months has more or less stopped, but there is still a big issue about where both vacancies and rental levels will go."

ATP's domestic holdings are largely concentrated in office properties in Copenhagen and other big cities. "We believe in the next 12 months we will see vacancies go up and rental levels under pressure, and these two factors will have an effect on our real estate return," says Nielsen.

The fund holds property as a long-term inflation hedge, and its target return is 8-10%. "Three years ago, the return was fantastic, but we have seen returns going down in the last two years," Nielsen says. "We should be happy to get a positive return at the moment."

Like other Danish investors, ATP is dragging its feet somewhat over domestic acquisitions. "We might be interested, depending on the terms, but if we buy a vacant property, we have to risk a two- to three-year void period, and it is very hard to predict rental levels," says Nielsen.

ATP does, however, have a number of new office developments scheduled to start within the next two years, depending on the level of pre-leases.

"The Danish market, like other Nordic countries, is not very deep," agrees Lars Ohnemus, chief executive officer, Baltic Property Trust. "There have only been two transactions in Denmark above €20m this year because you need willing sellers and buyers. When you have a crisis, there is always the question of expectation and resetting different price tags, and the calibration of expectations takes time."

According to Ohnemus, well-located prime properties in Copenhagen are currently valued at a 6% yield, while those outside the city have fallen to 8% or 9%.

"In the next year or so, it will still be a very difficult environment, but the number of transactions will slowly increase and market normalisation will continue," he says.
There has not been much demand from outside investors either.

"I don't see Denmark or the rest of the Nordic region as a major destination for capital, as there is enough unspent liquidity there," says Adam Calman, principal, head of Europe, at The Townsend Group. "While there are some diversification benefits to outside investors from investing in the region, there is some uncertainty about how decoupled their economies are from the rest of Europe."

However, while the opportunities for investing may not be immediately obvious, Calman says: "We are seeing an increased appetite from US pension funds to invest in Europe in the next few years. This would be on a pan-European diversified basis and the Nordics would have their share of that."

But conversely, Calman does say small- and medium-sized investors in the region want to invest internationally. "We are talking to Danish pension funds about the US - the case for investing there and in the UK is much more compelling. In the UK prices are off 50%, and there are more opportunities under the surface."

Calman says that even with an impending economic flatline for the UK, clients understand that there are recovery opportunities.

"There is enough distress in the UK to give new capital a chance to earn compelling returns over the next two to three years," he says. "In contrast, the US has some way to go - the market is still only down by 25-30%. But that means pension funds can plan their entry over the next six months, and pick up opportunities as prices adjust properly."
Nielsen agrees: "In the next three to five years, we expect to achieve a better balance between Europe and the US - at the moment, our indirect real estate portfolio is dominated by European investments."

Even so, the fund has been caught up in the current ‘wait-and-see' attitude to investing in its international exposure.

Outside Denmark it invests in funds, accepting some leverage in order to cover the exchange rate, and also to create the most tax-efficient structures in each fund.

"We have substantial commitments which have not been called for, but we are not hurrying to get into new funds," says Nielsen. "We have also seen funds which are reluctant to invest our money and haven't made any calls yet."

PKA is another pension fund which has put most of its foreign activity on hold, except for existing holdings. The fund's real estate assets make up 12% of its total portfolio, with 1% (ie, one-twelfth) held abroad.

But in Denmark, it is still investing, and has spotted buying opportunities in the residential market, which makes up the bulk of its domestic portfolio.

Nikolaj Stampe, head of property at PKA, says: "There is an oversupply of condominiums, which means we have a chance to buy for yield because prices have fallen drastically. However, we are looking only in the big cities, as rental levels for small cities are too low."

The pension fund is also poised to resume its commercial property acquisitions, mainly in the office sector.

"We have been waiting for the market to adjust, but we are close to starting again, focusing more on the commercial sector as a counterbalance to the residential side," says Stampe.

However, residential properties also feature in the fund's international portfolio, via direct holdings in Berlin, which Stampe says were bought at the right price with very little leverage.

PKA also has a stake in the Stuyvesant Town/Peter Cooper Village complex in Manhattan, held in a highly leveraged fund run by Tishman Speyer Properties and BlackRock Realty.

In October, a New York State court upheld a judgment that rents on some apartments had been illegally raised. This judgment, against a background of falling property values, has raised speculation that the fund could default on interest payments. Stampe says: "It is still much too early to say anything about the implications of the court ruling for the whole real estate market in New York. But it will definitely not make it easier for the city to renew the old housing stock as fast as wanted, if it is possible at all. As for the Stuyvesant Town/Peter Cooper Village complex we are currently discussing possible impacts and reactions with our partners. But the fundamentals for this specific investment no doubt have changed significantly."

Other PKA holdings are in funds which give exposure to Europe, Russia and the US.
"We went into the Russian fund - a commercial property vehicle - because of low prices," says Stampe. "On the other hand, investing in Manhattan was a very specific strategy. Over the long run, there is always a market for residential in Manhattan."