Investors in Stockholm are waiting on the sidelines. Sub-prime fears persists but the city's strong fundamentals may well see it weather the storm, as Lynn Strongin Dodds reports
For the past couple of years, Stockholm has been one of the jewels in the European real estate crown. It ranked as one of the top five destinations alongside London, Paris, Madrid and Frankfurt. International investors flocked to the city as part of their quest for diversification while domestic institutions took advantage of strong returns and reasonable prices. This year, of course, will prove more challenging but Stockholm is expected to weather the sub-prime storm better than many of its neighbours.
The latest Investment Property Databank (IPD) Nordic figures show that overall returns in the region hit a five-year high in 2006, with a total return of 15.6% in local currencies. Denmark performed the best at 17.8% followed by Norway (17.6%), Sweden (16.2%) and Finland (10.1%). Although the returns for 2007 are not yet published, property analysts predict that they will come in around the 14.8% mark for Sweden.
IPD does not break down figures for cities but Swedish-based property advisor group Newsec estimates that Stockholm's total property market sales for 2007 should be SEK147bn (€15.59bn), down from SEK153bn in 2006. Although it varies according to sector and location, the overall vacancy rate in greater Stockholm last year hovered around the 10.4% mark, the lowest levels in years. In the Stockholm central business district, vacancies were about 7% while prime office rents in the CBD area increased by about 5%.
The landmark transaction, and one that generated the most talk in 2007, was the sale of CentrumKompaniet, owned by the City of Stockholm, to Boutlbee, a private property investment firm, for €1.1bn. About 70 investors were thought to have bid for the portfolio, which consisted of 10 premier shopping centres in the city.
The enthusiasm generated underscores Sweden's strong economic fundamentals which have been fuelled by falling unemployment and buoyant consumer spending. While other shoppers may have been tightening their belts at the end of last year, turnover in Sweden's total retail trade in December 2007 jumped 4% compared with December 2006, according to the Swedish Research Institute of Trade.
Stockholm has been a major contributor. It is not only the Nordic region's largest financial services centre but also home to burgeoning service, healthcare, technology and telecom sectors. Investors have also gained comfort from "Stockholm being one of the most liquid and transparent real estate markets in the world," says Lars Almquist, director of business development for Protego Real Estate, which last year launched its €1.65bn Nordic retail fund. "It is one of the best-located cities in that it is one hour's flying time from all other Nordic capitals, which explains why many domestic and international companies choose Stockholm as their regional base."
The other and equally as important factor is that Stockholm's real estate revival is later in the cycle than many other cities'. The financial crises of the 1980s and 1990s certainly took their toll, but it was the dotcom collapse in 2001 that dealt the final blow for its real estate market. At the time, the city was brimming over with fledgling technology companies and excess space was being built as fast as prospectuses were being issued. It took Stockholm a longer time than expected to recover not only economically but also in terms of investor confidence.
Matthew Ryall, director, real estate at BlackRock, comments, "The Stockholm office market was annihilated at the turn of the century following all of the new supply that had been built on the back of the TMT (technology, media, telecoms) boom. The technology companies reduced their demand for office space at such a rate that prime vacancy rates in some areas were as high as 70%. There was no demand for office space and rental growth fell dramatically."
Institutional investors started to test the waters again in 2005/06 as the economic picture started to brighten. The UK was also becoming too frothy and Stockholm offered attractive prime commercial and retail assets at relatively reasonable prices. Their renewed interest also reflected a more general trend of fund managers looking beyond their national borders for potential prospects.
Figures from Newsec Analys reveal that international investors in 2007 accounted for a staggering 70% of Sweden's total investment volume last year, up substantially from 43% in both 2005 and 2006, and 32% in 2004. The most active players in the country as well as the city range from the local pension funds such as AMF Pension, AP Fonds and Alecta to regional firms such as Norway's Acta, a savings and investment firm; Vital Eiendom, an insurance group; and Ekop, Denmark's largest listed property group.
Outside the Nordics, North American groups such as GE Real Estate and private equity giant Blackstone in the US have been busy as well as Oppenheim Immobilien, a German fund manager, which is part of private banking group Sal Oppenheim.
Not surprisingly, one of the biggest risks facing Stockholm is the same as for every major city in Europe - the impact a US recession or deepening economic downturn will have on its real estate fortunes. This uncertainty perhaps explains why funds across the globe are currently sitting on the sidelines waiting to see how the first half of 2008 unwinds. Transactions are being discussed in the Swedish market and numbers are being calculated but many prefer to keep their cards close to their chests until a clearer picture emerges.Overall, market participants are optimistic that Stockholm as well as Sweden will withstand the financial turmoil thanks mainly to strong private consumption, sound public finances and a tight labour market. However, growth is expected to slow and the double-digit property returns of the past two years are unlikely to be repeated in 2008.
Economists expect the Nordics to generate a growth rate of about 2.5% this year, a relatively healthy comparison to the 1.6% forecast for the euro zone. Sweden's GDP is predicted to be about 3.4% in 2008, slightly down from an estimated 4% in 2007.
As for property, Sweden did not repeat the mistakes of its past and kept a tight lid on new development. As a result, demand continues to be greater than supply, which should keep vacancy rates low and rental growth stable. Yields are also set to remain steady at between 4.25-4.5%. Robert Johnston, head of transactions - UK and Scandinavia, Invesco Real Estate, notes: "Investors have become more cautious but there are still strong fundamentals underpinning the property market in Stockholm. A controlled pipeline of new projects coupled with a good outlook for the economy suggests that rental and occupier levels will be sustained at current levels."
Despite the promising forecasts, Stockholm will not be immune to current volatile market conditions. The city is likely to feel the pinch from a prolonged downturn in the US or extended slowdown in Europe.
Mats Hederos, head of real estate at AMF Pension, is not alone when he says: "Investors are waiting and watching to see what happens. So far, Sweden has not seen the turmoil that London has experienced but it is difficult to predict what will happen. One of the trickier questions is whether business from Asia will offset the slack if business from other countries declines."
There is a debate as to how much Asia will cushion any blows if business from the US and Europe wanes. Christina Gustafsson, managing director of IPD Norden, comments: "The financial problems will have an impact because the country is much more correlated with the European Union than it was 10 years ago. Also, although the Swedish banks in the country do not have exposure to sub-prime loans, those with branches in the Baltic states have been affected."
Overall, the Scandinavian banks have largely avoided the huge write-downs of some of their European peers and have maintained balance-sheet liquidity without having to turn to foreign sovereign wealth funds. The previous property crises forced Swedish banks to develop strong risk management systems and this has held them in good stead.The macroeconomic situation in the Baltic countries, though, continues to be a concern, particularly for Swedbank and SEB, which derive a substantial part of their revenue from the region. Credit losses in the Baltics rose in the third quarter and analysts are keeping a careful watch to see if there was further deterioration in the fourth quarter.
Emmi Wahlstrom, investment analyst at ING Real Estate in Stockholm, believes, though, that: "Even if a US recession has an impact, the Swedish economy looks good in comparison to more mature European markets. However, overall, investors ranging from banks, insurance and pension funds do not show any signs of reducing their exposure to property and they may increase their asset allocation if equity markets remain volatile. I think the Nordics, and Sweden in particular, will benefit as a diversification play."
The difference in 2008 is that investors will become more selective and property transactions will be laden with equity and not debt. As in most markets, banks, regardless of their sub-prime positions, are maintaining stricter lending criteria. Swedish loan to value ratios - the ratio between the size of a mortgage and the mortgage lender's valuation of the property - have dropped to about 75% from about 80-85% since the summer.
Brenna O'Roarty, head of European strategic research at RREEF Alternatives, notes: "There has been an impact on liquidity across the whole European landscape and Sweden is no exception. Before the credit crunch, it was not unusual to see one bank financing a large part or the whole deal. Today, we are seeing an increase in the appetite for syndication, with three to four banks clubbing together."
Alessandro Bronda, head of investment strategy at Aberdeen Property Investors, agrees, adding: "There has been a switch from the leveraged to the equity players being more active in the Stockholm market. We are also seeing signs of a flight to quality. While there has been no significant movement in yields, unlike in other international markets such as the US & the UK, investors are becoming more discerning between the different assets on the markets."
Prime offices are expected to remain popular due to the imbalance in supply and demand. Rolf Grönstedt, head of investment management, Aberdeen Property Investors, Sweden, says: "So far, the larger corporates have published good year-end results and there continues to be strong demand for office space. The construction companies learnt lessons from the past and did not add a lot of volume after the last property crash so the market is in a stable state."
Retail will also continue to be in sharp focus as consumers continue to dig deeper into their pockets. The sector is also in need of refurbishment and opportunities abound to add value. As O'Roarty puts it: "There is a lot of ageing stock in the retail sector that is ripe for redevelopment and repositioning. In general Sweden is a highly consumer market where the percentage of retail sales as a percentage of consumption is high. It stands at about 46% versus, for example, 25% in Germany."
According to Lennart Stel, managing director of GE Real Estate Nordic, some of the most notable transactions of 2008 could emanate from the privatisation of state-owned Vasakronan, one of the country's largest property companies. Its portfolio, which is full of prime properties, was worth SEK45.2bn at the end of 2007, up from SEK38.1bn a year earlier. Not surprisingly, investors are waiting with bated breath but so far the government has not set a date. It is also unclear as to whether it will sell the group to a single buyer, through a division of assets or a share issue.