Swedish real estate has been a quiet haven on a continent rocked by economic and market turmoil. As Richard Lowe discovers, this means the country's pension funds have had little reason to venture beyond the safety of Stockholm

For global real estate investors, the past three years have been anything but business as usual. The global banking crisis, subsequent market dislocation and economic downturn have damaged returns, brought about a liquidity crisis and posed serious questions about the assumed benefits of global diversification and the use of indirect fund vehicles.

But the phrase ‘business as usual' may not be far removed from the experiences of many Swedish pension funds when it comes to their real estate investments. The country's institutional investors have not been as quick to embrace global diversification through real estate funds as many of their Nordic neighbours in Denmark and Finland. A stable real estate market in Sweden has also meant that these domestic-only pension funds have seen very little in the way of market turmoil or realised losses from their real estate portfolios.

"For the last five years we have had the best returns from property," says Maritha Lindberg, chief executive at AI Pension, the pension fund for Swedish architects and engineers. AI Pension currently has a real estate allocation of 5%, invested entirely in Sweden, and it is planning to increase this to 8%.

"Yes, it is business as usual for the Swedish pension funds," says Ubbe Strihagen, director at Schroders, based in Stockholm. "They're not seeking international exposure through property funds. They will continue increasing their allocation to real estate, which is positive, but they are seeking to do it in Sweden."

Why Swedish pension funds have been less eager to invest internationally compared with other Nordic funds is open to debate - it may have something to do with having a larger domestic market or the negative experiences in the 1980s when some Swedish pension funds made some direct property acquisitions abroad.

Whatever the reasons, the stability and positive performance of the Swedish market has given them very little incentive to change the status quo. Strihagen says the past few years have not provided any new evidence to suggest pension funds will be going global.

"The forecast for property returns is very good in Sweden compared with other European countries, and therefore the argument why Swedish pension funds should go international isn't there right now," he says. "You have the benefit of international diversification, but if that equates to a lower performance than a Swedish portfolio, it's not as appetising or attractive at the moment."

Kristina Najjar, head of business development at Aberdeen Property Investors, agrees that this picture remains true for Sweden's largest pension funds, but she says there is more eagerness to invest globally among the medium-sized and small segment of the investor community. Najjar says this was a trend already in motion before the financial crisis and one that has begun to re-emerge.

"There certainly is a big change in interest in the asset class compared with a year ago. Eighteen months ago the market was very quiet and really the only thing you would see were the big pension funds holding their own portfolios and being active in the direct market," Najjar says. "This year interest is picking up and a few more manager searches have been undertaken. But the market remains relatively quiet."

Lars Flåøyen, head of Nordic research and strategy at Aberdeen, adds that with government bond yields at historical lows, Swedish pension funds are looking to alternative asset classes to provide higher income returns. "Property is one of the asset classes that is benefitting from that," he says.

Lindberg confirms this is the case for AI Pension. "You have very good cash flows from real estate investments," she says. "Nowadays, when you have these low interest rates, real estate is interesting."

Najjar says pension funds are comparing real estate to the other alternative asset classes more strongly than before. "They are considering a range of alternatives, including timber, infrastructure, hedge funds, direct real estate and funds of funds. So there are no major trends."

But while pension funds see the attraction of real estate, their biggest concern about committing to the asset class is liquidity. Najjar says that allocating to real estate can have a positive impact on the risk profile of their overall multi-asset portfolios, but they prefer to do so without locking up their capital. "Is there any way of capturing the benefits of this asset class through a more liquid investment format? This seems to be a critical issue," she says.

SPP Livförsäkring has both domestic and international real estate investments, which are managed by Storebrand Fastigheter. The institutional investor has been active over the past 12 months, but the vast majority of investments have been made in Sweden.

Tomas Svensson, CIO at Storebrand Fastigheter, estimates that 90% of the €200m made over this period was domestic. "We are primarily looking at Swedish investments, with the main objective of securing a hedge for domestic inflation, but we are also investing internationally through funds," he says.

"The investments have been done in logistics, food-anchored retail and offices. Two of the investments have been carried out through joint ventures with an operating partner. We expect to continue investing at the current pace over the coming five years to build a property exposure of some €1bn."

AI Pension, meanwhile, invests only domestically and entered into a joint venture with Swedish pension provider Alecta and the Swedish Church's pension fund to invest in retirement homes in the country. The three institutions have established a joint investment company that will invest more than €200m over the next three years.

It is quite rare for Swedish pension funds to enter into joint ventures with each other, but Lindberg says the three parties all had similar investment horizons and requirements. She says AI Pension was too small to have made the investment on its own.

Sweden's third state buffer fund, AP3, is one institutional investor that was active in the global real estate markets between the second half of 2009 and the first half of 2010. It made commitments to three funds during that period: Lend Lease Real Estate Partners 3, which invests in Australian retail properties; Morgan Stanley AIP Phoenix, a global fund of funds vehicle, and Threadneedle Strategic Property Fund IV, a UK-focused fund.

AP4, the fourth state buffer fund, has not invested in real estate outside Sweden. This is primarily for historical reasons but also because of the costs that come with indirect investment. "We are sensitive to fees," says Mats Andersson, chief executive at AP4. "We have looked abroad but so far we have turned them down because usually you come into a structure where you have to pay too much in fees. I would prefer to have a direct partnership or a joint venture with someone like ourselves in that case rather than investing through a fund vehicle."

Both AP4 and AP3, along with fellow buffer funds AP1 and AP2, own Sweden's largest real estate company, Vasakronan, which is estimated to have some €7bn of property assets under management. AP4's stake in Vasakronan is 25%, but this year the buffer fund increased its exposure to real estate by buying a large portfolio of residential assets directly from Vasakronan in what was one of the largest residential acquisitions in the country's history. The acquisition of the so-called Dombron portfolio was worth more than €550m. It also allowed Vasakronan to divest entirely of the residential sector, which represented around 10% of all assets, to focus specifically on commercial sectors. Andersson says AP4 is intending to use Dombron as a platform to expand the fund's residential sector.

The deal was preceded by another investment towards in 2009 when AP4 acquired a 15% stake in another Swedish real estate company, Hemfosa. The firm makes opportunistic investments in the domestic market and will allow the buffer fund to diversify its real estate exposure.

While AP4 made one of the largest residential portfolio deals in Sweden's history, pension company AMF made the biggest single commercial property acquisition in Stockholm for more than two years. City Cronan, a building encompassing 40,000m2 of offices, shops, restaurants and homes in central Stockholm, was bought from German open-ended fund manager DEKA Immobilien for an estimated €300m.

"It was a piece of property we had been looking at for a while," says Mats Hederos, managing director for property at AMF. City Cronan was identified as an attractive asset in its own right, but it also serves a strategic purpose in that it is adjacent to AMF's Salénhuset shopping centre redevelopment and neighbouring Europe House, which AMF also owns. Hederos says AMF was keen to establish a presence in this area of Stockholm, between the older eastern section of the city and the newer western part. By owning and redeveloping several properties in the region, AMF is hoping to make the area increasingly attractive as a business location for both trade offices and retail.

However, what really made the City Cronan deal so significant was its rarity. "A major transaction has not been done in the city of Stockholm for a while," Hederson says. At the time, the deal dwarfed the other 128 transactions in Stockholm over the previous 12 months, which when combined had an average deal size of €24.4m, according to Real Capital Analytics.

Hederos says that while the stability of Swedish market has been positive for pension fund returns in recent months and years, it has made it increasingly difficult to find new investment opportunities in the prime market. "People in the property sector are quite optimistic in Stockholm," he says. "And for that reason I think it will be hard to convince many investors to sell their properties, because it is hard to find new opportunities."

Storebrand Fastigheter's Svensson agrees. "The Swedish market is rather expensive today, and I can't really see the rationale for it being on the same price level, or even higher, than cities like Paris or London. It doesn't make sense."

Hederos admits that he has been surprised at how well the Swedish market has held together despite all the economic and market developments in Europe over the past 18 months. "The fundamentals we see everyday are stronger than should be expected if we are part of Europe," he says. "If we look in many other markets it's another situation."

Despite opportunities being thin on the ground in the domestic market, Hedersos says AMF has no plans to look outside the borders of Sweden. "The reason for that is that we think it is healthy to be in the market that we know," he says. "If we need global exposure we find that through listed shares, through equity and bonds. When it comes to property, we are local."

Schroders' Strihagen says most buildings in Stockholm's central business district are already owned by Swedish pension funds, and with institutional investors generally seeking to increase their real estate exposure there has been very little in the way of motivation for investors to sell and release assets to the market. This is why AMF's City Cronan purchase made such a big impact.

If most Swedish pension funds want to increase their real estate investments but are not comfortable looking internationally, something has to give. "It is making Sweden a crowded market," Strihagen says. The yield gap between prime and secondary assets in the Stockholm office market has widened, and the gap is even wider if you include other geographical locations and sectors. Strihagen expects pension funds to begin to increase their risk appetite and look further beyond prime. "They will broaden their scope outside the very core Stockholm office CBD," he says.