Looking at the figures from first half of 2019, we see the trend that began in 2018 is continuing, with an increased appetite for the logistics/industrials segment while at the same time retail is suffering, also with the investors that have traditionally been more exposed to office and retail. Logistics have now surpassed retail as the second largest segment. Should international players start to ride the “logistics wave”, this trend may become even more pronounced. However, they have thus far been virtually absent as they find that rent levels are high and yields low when compared with the rest of Europe.
Central office property prices are at historically high levels, and many players are choosing to diversify their portfolios by adding logistics/industrial properties. Prime yield continues at 3.75% for the most attractive office properties in Oslo, which results in both domestic and international investors looking for opportunities with higher yields in secondary cities such as Bergen, Trondheim, Stavanger and Tromsø.
Newsec observes that international buyers have not been as active in participating in structured acquisition processes for prime properties as they have been in previous years. Volatility in the Norwegian currency resulting in high currency hedging costs means that prime properties with a 3.75% yield will be too expensive to meet the required returns. On the other hand, international investors with value-add and opportunistic mandates are continuing to spend time Oslo for such opportunities, but also looking outside at other locations (e.g., Stavanger) for opportunities.
In addition to the abovementioned, the Norwegian government is proposing a further tightening of the interest rate limit rule in the State Budget for 2019, which may affect some international stakeholders. The calculations and the rules for exceptions are somewhat complicated however in short, the effect of a reduced possibility of deducting interest costs may significantly impact the return on equity for some investments. (It is important to specify that these will typically only come into effect on larger sized investments where interest costs amount to more than NOK 25 million annually). That said, it is currently unclear how severely the new rules will affect both existing and future investments, as well as for the opportunities to make capital structure adjustments. We are eagerly monitoring in order to see what implications this may have on the market in the future.
There is good momentum in the Norwegian economy that in turn will benefit the rental market for the current year. Low unemployment and a high capacity utilisation rate are expected, which in turn increases employment and thus the need for office space. Lower growth prospects in 2020 and 2021 will gradually reduce the growth somewhat.
Newsec observes that office vacancy rates continue to fall in Oslo and remain stable in other major cities. Rental prices continue to increase, especially in Oslo and central Trondheim. In Oslo and Bergen, newer buildings with proximity to the public transit hubs/light rail systems are in high demand and are winning the battle for the largest lease contracts. In Oslo, we see such demand pushing price levels upwards particularly in the west region. In Stavanger, construction is increasing in line with the price of oil, but the internal absorption of space already under contract means that we have not yet seen a positive impact.
How will the remainder of 2019 be? The macroeconomic fundamentals for Norway, seen in isolation, are positive for the commercial real estate sector. Employment figures are strong, core inflation rates are keeping steady and we have now digested the interest rate hikes of March and June; however, the prospect of further rent increases signalled by Norges central bank is weakening. Signals from key international central banks bear witness of a more proactive stance, and a better-safe-than-sorry approach, as we see an increased trade war, uncertainty concerning Brexit and troubled financial markets. Thus, it appears that the yield will remain stable in the near future, as the pressure from increased financing costs is weak.
Furthermore, we will continue to see good access to financing in both the bond market and the bank market. Many bank loans have been refinanced in the bond market, which in turn has freed up capacity at the banks. In turn, this creates a healthy level of competition among the banks, who are continuing to provide loans to lenders.
Expectations of higher rental rates also mean that more properties are changing owners as investors are in search of greater returns when renegotiating contracts. We also see a continued positive interest in residential projects, even though residential prices seem to be stabilising. Particularly in areas outside of Oslo with considerable population growth, there will be greater demand. At the moment, these locations appear to be more stable than the Oslo market which in turn is driving the interest.
Finally, we also believe that the turmoil in the stock market in recent time will continue, giving increased interest for stable cash flow type of investments such as property. Newsec has spoken with a number of stakeholders over the summer, and there is nothing that indicates that this will taper off in the near future. There is plenty of capital seeking returns, with availability of both equity and debt. Overall, Newsec believes that the volume in the Norwegian transaction market will be around the same levels seen last year.
The fly in the ointment that could hamper market growth is the recent introduction of an increased number of formal requirements for the syndicates. The syndicates have been very active and comprise approx. 33% of the transaction value during the first half of this year, and thus is currently the largest player in the market. A challenge that has now emerged is whether SPV’s organised by the syndicates are subject to the AIF Act. The Financial Supervisory Authority of Norway, in a circular from June 2019, writes that its clear understanding is that project financing companies (SPV’s) should often be considered as alternative investment funds and will therefor need to comply with the AIF Act. If the company is subject to the Act, this triggers a series of formal requirements such as, inter alia, a formal prospectus and the approval thereof, which in turn results in increased costs, a higher number of hours and resources spent on each deal and implicitly lower returns for investors. The greatest challenge seems to be the syndicates’ opportunities to “pre-sound” the market’s interest in specific projects and deals ahead of a formal prospectus, in order to increase competitive advantage for the syndicates in bidding rounds associated with e.g. conditions to raising equity. The circular is likely to come as a consequence of the less serious players that have been active in the market in recent years, and we feel that the large and more professional players are well prepared to deal with these new regulations and requirements. Nevertheless, this will potentially cause some of the liquidity in the market to be reduced in the short term While the market finds its solution to the new requirements introduced and how to best adapt.