Domestic real estate is still the safe option for Finnish investors. But they are beginning to look overseas for further core, growth and opportunistic investments, says Gail Moss
For Finnish pension funds, one of the big disappointments of 2009 has been not so much the performance of their real estate portfolios as the apparent closing-off of a potential investment vehicle.
New legislation setting up a real estate investment trust (REITs) regime was introduced earlier this year, but frustratingly restricted investment to the housing sector.
"From the point of view of Finnish pension funds, this legislation is not very good, and few of them have invested in REITs," says Reijo Vanne, head of research and development at TELA, The Finnish Pension Alliance, whose members hold 85% of all pension assets in Finland. "Their portfolios already contain a high proportion in housing, either as buildings rented out or as shares in house building companies. Pension funds would have preferred REITs where offices and manufacturing could be included."
As at 30 September 2009, €13.4bn, or 11%, of pension fund portfolios was invested in real estate (directly, such as equity and loans to real estate companies owned by the pension funds, and indirectly in the form of shares of domestic and foreign real estate mutual funds).
This percentage has remained stable for years, according to Vanne. "Real estate investment has been the best-performing asset class over the long term," he says.
Interestingly, company and industry-wide funds were proportionately bigger investors in property, which made up 16.7% of their overall portfolios, compared with the big pension insurance companies, which on average held 12.4% of their assets in real estate.
The overall average was lower than either of these because of less real estate investing by the public sector pension institutions.
As at the same date, overseas investment made up just under 12% of overall portfolios, with around 80% of that invested in the Eurozone countries.
According to Vanne, it is the bigger funds that have been keener to invest abroad, while the smaller funds have concentrated more on Finland.
"Finnish institutions have invested abroad in the last five years using international property investment funds and other indirect vehicles," says Charlotte Stromberg, chief executive officer, Nordic region, at Jones Lang LaSalle. "The reason for this was to dilute the risk and also get the desired exposure in property when they had problems finding core product domestically."
But Stromberg says the domestic market is still overwhelmingly the most important, and although the Helsinki region is the most favoured location, other major cities are also on their radar. "Whereas in Sweden, everything is concentrated on Stockholm, the picture is the opposite in Finland," says Stromberg. "Instead, pension funds are looking for core product outside Helsinki, in medium-sized towns."
She says: "They feel it is all about local knowledge, and feel comfortable with the long-term growth prospects of these towns. There is less volatility than in bigger towns. And if you have local knowledge ¬ such as what side of the block is the right one to invest in, then you have the edge over other institutional investors."
But she warns: "The challenge for pension funds will be to find enough product to meet their allocation targets."
In contrast with Sweden, Finnish institutions do not always carry out external annual valuations on their real estate portfolios and therefore retain them close to their book value, so they get the yield as the return.
However, the real estate funds they invest in are valued regularly. Stromberg says this difference in approach has a noticeable impact on property strategy. "Last year, capital values fell, but for directly-held investments, Finnish institutions could still have expected returns of 5-6%," she says. "On the other hand, they would have seen values and returns decrease rapidly for indirect investments. So there is less appetite for investing via funds at present."
Varma, the pension insurance company, is the biggest institutional real estate investor in Finland, its property holdings making up 14% of its €28bn total assets. Of that, the great majority, €3.5bn, is invested directly, all of it domestically. The balance of €0.5bn held indirectly is invested overseas, mainly in Europe.
Returns so far this year have been polarised; as for most other real estate investors, the direct holdings lost some value but still returned 3.8% for the first nine months, compared with a 10.5% loss for the indirect holdings.
Overall, the real estate portfolio made 1.7%. This is slightly better than the average return of 0.5% for January to June achieved by the pension insurance companies as a whole, according to TELA.
"We have been very active in real estate so far this year, and we plan to increase the absolute amount of investments by over 10%, solely in the domestic market," says Risto Murto, chief investment officer at Varma.
"For us, the opportunities are better than in 2006 and 2007," he says. "Many of the leveraged players are out of the market at the moment, and price levels are more realistic from the buyers' point of view. But we don't expect there to be so many opportunities next year."
Murto adds: "We will probably have a record year in terms of investments. But we are concentrating on the domestic market, which we know best."
The domestic holdings are diversified, the biggest sectors being offices and retail. At present, the vacancy rate is 5%. "Good client relations is the key, and we cultivate our clients," says Murto.
"The Finnish market is the same as most other places - a bit stuck," says Michael Schonach, managing director at Catella Property Oy. "However, while valuations have dropped a bit, a certain gap between buyers' and sellers' expectations remains, meaning fewer deals are being done."
Schonach says that while there has been an appetite to invest outside Finland over the past few years, many pension funds have more recently had cold feet, as values have fallen.
But there is still interest in specific markets.
He says that Finnish pension funds investing overseas are investigating the US and UK, as core markets where there has been a price correction and they see good value, and Russia, as an opportunistic play.
"Then for growth, everybody's looking at Asia," he says. "In particular, they are interested in China, because many pension funds take a macro view that the west cannot match the east for growth. Some are also looking at Latin America, for the same reason."