Expectations of buyers and sellers are narrowing as the region approaches the bottom of the cycle. Lynn Strongin Dodds reports

Although the Nordic region has not escaped the severe economic downturn unscathed, the four main contenders are in better financial shape than many western countries. Lars Flåøyen, head of Nordic research and strategy at Aberdeen Property Investors, says that although the countries of the Nordic region are sufficiently different to offer investment diversification benefits, together they form a coherent region that has a substantial position in the European property market. In fact, he forecasts that the Nordic region will deliver 7.4% per annum between 2010 and 2014, which is 0.6 percentage points higher than for the euro-zone."

Flåøyen says: "Investors must understand the dynamics of each country. The downturn in the Nordic property markets was not synchronised, which demonstrates the difference between the individual Nordic markets in terms of economic drivers, market structures, occupier markets and investor bases.

According to IPD figures, the region is the fourth largest commercial property investment market in Europe accounting for approximately 14% of the total market size. Sweden is by far the largest, constituting 45% of the investable stock. Over the past few years, the country has attracted the most international interest from investors, who not only liked the returns but also the transparency, professionalism and liquidity. In fact, Jones Lang LaSalle 2008 Real Estate Transparency index ranks Sweden as the eighth most transparent market in Europe followed by Finland, Denmark and Norway, 13th, 15th and 17th respectively.

The main challenge today is finding the right pricing level. "There are opportunities and we have seen increased demand for mainly prime low risk assets, but one major hurdle to overcome at the moment is that there is no clear view of pricing," says Flåøyen. "Transaction volumes in the first half of 2009 were down 70-80% compared with the corresponding volumes in 2008. Property investors in general only have appetite for core assets with low income risk, but owners of these assets have been reluctant to sell under current market conditions."

This is supported by research from CB Richard Ellis (CBRE), which reveals that transaction volume in Nordic property came in at around €3bn in the first six months of 2009, down 76% on the same period in 2008. All capital markets in the region have experienced sharp declines since the third quarter of 2008. Cross-border transactions have also dwindled, particularly in Denmark and Norway where domestic buyers have so far dominated. This is also the case in Sweden, except for a couple of notable deals, including Norwegian investor KLP and German open-ended fund DEKA's €160m purchase of a group of hotels, and Germany's IVG Immobilien's €37m acquisition of office buildings from Skansa, the global project development and construction company.

Ubbe Strihagen, head of property at Schroders in Stockholm, also points out that sales have been thin on the ground due to "risk aversion and difficulty in getting bank financing, which has dampened investor appetite. The other key factor is that there has not been the level of distressed sales that we expected. Instead, we have seen broken loan-to-value covenants but the banks have been willing to restructure the loan as long as the tenant can cover the rent and interest rate payments. This has been made possible by the low interest rate environment but this could change if rates increase."

Mikael Glud, director at CBRE, agrees. "We are only seeing few sales outside the foreclosure auctions and mainly distressed sales from former Icelandic investors. The banks are refinancing the loans on properties generating a cash flow servicing the loans. This is in order to keep the property away from their balance sheets. From the corporates we are seeing a growing interest in sale and lease-back in order to maximise values and at the same time to generate relatively cheap cash for the operation. In Scandinavia 65-70% of the corporates own their property and only 30-35% lease. In the US 65-70% of the corporates lease their property and only 30-35% own.

Looking ahead, some analysts are cautiously optimistic given economic improvements. Peter Helfrich, country manager of the Nordics at ING Real Estate, says: "There has been a mismatch between the expectations of buyers and sellers but this seems to be disappearing as we near the bottom of the economic cycle. Property markets are still not deep and we were finding for nearly two years that institutions did not want to sell under the property book values and buyers were looking to pay much less than these book values. However, in the second half of 2009 the mismatch starts to disappear. For example, there was a prime property in Stockholm central business district up for sale at a yield of around 5.5 and buyers were willing to pay this price but the seller ultimately decided not to sell at this price. Everyone is waiting for these kinds of signs that the economy is recovering, and yields stabilising in transactions rather than in valuations before activity picks up."

Government statistics predict growth next year, but each country at its own pace. Finland is set to fall the hardest with a 6.9% drop in GDP this year before returning to growth of 0.9% in 2010 and 1.6% in 2011. Sweden is next in line with a predicted 4.9% fall in 2009 with growth rebounding to the 2% level in 2010 and 3.4% in 2011. Both countries rely heavily on exports and the manufacturing sector is only now beginning to see the green shoots of recovery.

Denmark's economy, however, is expected to shrink by 4.5% in 2009 as consumer demand and house prices fall. Predictions for 2010 and 2011 are 1.5% and 1.8%, respectively. As for Norway, the country is in relatively good shape but this is the first time that the economy has shrunk since 1982. GDP will dip by 1.3% in 2009 but is forecast to grow by 1.9% in 2010.

Traditionally, investing in the Nordics has been either directly or via a fund and this is likely to remain the case given the sharp declines and high volatility in the listed marketplace. Helfrich says, "If you look at Sweden, the vast majority of listed property companies have suffered huge discounts. Even if your company did not carry high leverage, if there was just a just a hint that it did, then the stock would be negatively affected. Prices have begun to rebound and the ones that were highly leveraged and fell the most are the ones that have recovered first. In general, major institutions in the region are traditionally direct real estate investors in their home countries."

While the direct market has taken a beating it did not plumb the depths of some other countries such as the UK, which suffered a 40% drop in commercial property values. Strihagen says: "The region has been hit by the economic downturn but it has not been as severe as in the UK, Spain or the US. Property valuations in the region are down by 15% to 20% on average from the peak of the market to now with the increase in yields accounting for about half of that figure."

According to a report by Aberdeen Asset Management, weak rental markets have been the key driver behind these capital declines this year. Prime office rents in the Nordic capitals fell by 8% on average in the first three quarters of 2009, led by Oslo and Stockholm, where prime rents slid by 15% and 9% respectively. Rents are expected to fall even further in 2010, before bottoming out in 2011 with a relatively strong recovery predicted in 2012 and 2013. This will be due to limited new supply entering the market at the same time as labour markets are improving because of a better economic climate.

Sweden's size and position mean it offers the most potential. According to Stefan Wundrak, research manager Europe for property at Henderson Global Investors: "The outlook for Sweden's economy, which was hit by a slowdown in exports and banking losses relating to the Baltic nations, should be brighter next year. Exports, business confidence and consumer spending should all benefit from the cuts in interest rates, healthy government finances and the competitiveness of Sweden's hi-tech industries."

The retail sector looks promising in Sweden, as well as in Norway and Finland. Wundrak points out that prime Nordic retail markets were among the first in which yields corrected in the current downturn. Because of limited supply, international investors were bidding yields down to unsustainable levels in 2006 which, coupled with the credit crisis, led to a marked softening in 2007. "Having seen an early correction, we think that the Nordic retail market will be over the worst by the end of 2009. We forecast retail yields to stabilise imminently and possibly move in during 2010. The Nordic region is expected to outperform the European average in terms of total returns next year."

Strihagen notes that "while demand for retail premises in Sweden's city locations has dropped in general, there is still interest in prime units in prime locations. Surprisingly, consumers in Sweden have continued to spend throughout the financial crisis. Vacancy rates and rental rates have held up better than offices because most of the tenants, although they may not be as profitable as they once were, have continued to operate. Investors should focus on popular retail assets with good customer flows and tenants."

Norway's retail also offers good potential. Well established larger shopping centres have proven to be the most resilient while the recently established luxury niche concepts and smaller shopping centres without an anchor have been the worst affected. The prime yield has held steady at 6.75% in the first half of 2009, according to figures from CBRE.

Investment in the retail sector in Denmark is limited because of tight government restrictions on the building of shopping centres while in Finland there is room for development as there are several large-scale retail projects in the pipeline by local and international developers waiting for the economy to recover.

As for industrial and logistics, the current view is that they are too illiquid and the tenant base uncertain, and while prime office is generating a great deal of interest industry experts advise investors to wait. "The office sector has been the hardest hit," according to Håkan Blixt, director of investments at Cordea Savills."I don't have the same confidence in office tenants as I do in retail although we could see yield shifts outside the major city centres. It is also the one area with the biggest mismatch between buyers and sellers. For example, there are good-quality office buildings in Stockholm but there is little activity."