If you build it, they will come

Tucked as it is at the far northeastern corner of Europe, Finland is often forgotten by its larger Western European neighbors. After all, it's only been an independent country for 90 years. Until recently it was the only country in the EU to speak a non-Indo European language (Hungary and Estonia have now joined it in that honor) and that, combined with its geographic isolation, has always made it seem like a foreign, distant place.

Yet throughout the past 50 years the country has had one of the most impressive economies in the world. Today its per capita output is equal to that of larger countries like Sweden, France, Germany and the UK. The World Economic Forum declared Finland to be the most competitive country in the world three years in a row from 2003 to 2005. It's a far different picture than just 15 years ago, when the country was in the midst of a severe depression brought on by the collapse of the Soviet Union, which had accounted for 20 percent of its foreign trade while it operated as a free market ‘grey zone’ trading with both the USSR and the West.

“The market has been very good for some time. If you're building a big commercial shopping center you will not have a problem getting tenants in there. More people are coming to the cities, so there's been a big need for shopping center development for many years.”

Finland's economic recovery since then has coincided with a period of impressive growth in the Nordic region as a whole. But the rapid recovery has yielded a country with increased economic activity and few commercial centers to support it.

Helsinki in particular is poised for growth. According to Nordic analyst Newsec, the Helsinki metropolitan area is one of the strongest-growing metropolitan areas of Europe, with its population forecast to reach 1.3 million by 2020. With a nationwide demographic trend toward metropolitan areas, the country's secondary cities are also banking on growth in the coming years. These expanding cities like Espoo, Vantaa and Tampere will need new properties to be developed, particularly in the commercial space, while existing commercial centers will also need to be modernized and expanded.

Capman's strategy
CapMan, a domestic private equity firm based in Helsinki, is targeting this demand as part of a new development strategy. Already actively investing its first real estate fund, which has been limited to core assets in Helsinki, the firm recently launched a new development fund in April with €600 million ($833 million) in firepower. This second fund—which will target the whole country and use a more opportunistic strategy—is the first private equity fund to exclusively target development opportunities in Finland. Markku Hietala, head of CapMan Real Estate, says the firm is particularly focusing on shopping center development projects, because the need for retail space in Finland is so great.

“The market has been very good for some time,” he says. “If you're building a big commercial shopping center you will not have a problem getting tenants in there. More people are coming to the cities, so there's been a big need for shopping center development for many years.”

In June CapMan acquired an 11.5-hectare development site in the Kivistö area of Vantaa, which it plans to develop into a commercial center. The fund has also acquired sites in the cities of Hömeenlinna, Tampere and Möntsölö, all of which are in southern Finland and within 200 kilometers of Helsinki.

The fund's main focus is on developing commercial properties, but it also has a remit for construction projects and redevelopment projects in logistics, hotels and offices. The firm's plan is to develop the properties during a period of three to seven years and then sell them.

“This second fund was taken very positively by our investors,” says Hietala. “They were interested in the opportunistic development part, but it's quite impossible for them to do that themselves. There are a few [institutional investors] who have a big enough organization, but not many. They've expressed their interest to us because we have a strong track record.”

This interest in development projects isn't entirely limited to Finnish investors. Stockholm-based Niam, the largest private equity firm in Northern Europe, is also actively targeting shopping centers in Finland for development or add-ons. The firm recently acquired Kesko, a large Finnish retail chain, for €200 million.

“We acquired Kesko with an eye for add-on projects,” says Niam managing director Johan Bergman. “They have grocers and a brand for home improvement stores. Within that portfolio there are lots of opportunities to do add-on projects by either extending the existing store area or building totally new stores next to existing ones. That's a portfolio with some 80 or 90 assets all over Finland, so there are quite a lot of possibilities there.”

Same need, different supply
Private consumer consumption in Finland is forecast to grow by 2.5 percent during 2007, according to Newsec. This growth is also mirrored next door in Sweden. The Swedish Research Institute for Trade predicts that retail sales in Sweden will grow by 5 percent in that country in 2007, having already grown by 7.5 percent in 2006. The factors causing this growth are similar in both countries: Lower unemployment, wage increases, minor tax cuts and a healthy economy have all helped these numbers rise.

The big difference between the two countries is that Sweden already has the commercial properties to handle this growth, while Finland does not. Finland actually has one of the lowest rates of shopping centers per inhabitant, roughly one third that of Sweden, according to Newsec. Construction has been heavy to make up the difference, with retail construction activity in Finland peaking in 2003 at the highest level since the late 1980's.

Most of these projects have consisted of retail parks, shopping centers and hypermarkets along the main highways and ring roads in southern Finland. Currently the total retail stock in the Helsinki metropolitan area consists of just 3 million square meters of space. This number is rising fast to meet the huge need. In the first three quarters of 2006 alone, 100,000 square meters were approved for retail building permissions in Helsinki.

“In Finland, there isn't much risk of oversupply,” says Bergman. “But I think Sweden is the country in Europe with the largest amount of square meters of shopping centers per capita. Private consumption's been growing very healthily, and is forecasted to continue to do so. But still, I think in Sweden you should be a bit more cautious with retail. There's already so much stock, and if you look at Stockholm, there's a very impressive pipeline of more shopping centers coming up. So we would be on the cautious side there.”

Barriers to entry
As much as the commercial development is needed, foreign investors are saying it is still a difficult play without a significant local presence.

Christian Fogelholm, head of the real estate transactions practice at Finnish law firm Borenius & Kemppinen, says he has seen much interest from foreign investors in development projects, but such acquisitions can be complicated enough to scare them off.

“As yields compress and foreign investors see less opportunity to buy cheap, they're looking at development as a good opportunity,” he says. “But it's difficult because it requires a lot of knowledge of the local market.”

“It's a lot of work and the risks are very difficult to evaluate,” agrees CapMan's Hietala. “You need local connections to make things happen. It's important to know how the different communes are working.”

Hietala also says that although the Finnish market has become more open recently, there are still some hang-ups about foreign ways of doing business.

“Foreign investors have new business habits and ways that older people may not be used to,” he says. “They may not like Anglo-Saxon business methods, or agreements all in English. There is a part of the market that is not interested in working like that, and of course it's a possibility for us [as a local firm] not to.”

But while foreign investors have mostly shied away from development projects, they've been actively snatching up existing retail properties throughout the country. Doughty Hanson got in on the game early. In 2004 the firm acquired a portfolio of eight shopping centers from Ilmarinen Mutual Pension Insurance Company in Finland. In August the firm sold the last of the properties, the Iso Omena Shopping Center in Helsinki, to Citycon Oyj for €329 million. Now completely divested from the Finnish retail market, total returns from that portfolio were 7.6x on the fund's equity investment, with a gross IRR of 100 percent. Doughty Hanson sold three of those portfolio properties to ING Real Estate in May for €186 million.

The firm undertook an active management strategy while it held the properties. At Iso Omena, it obtained 7,000 square meters of additional building rights to extend and redevelop the center, increased the rental income and increased the occupancy to 100 percent.

Other transactions in Finland's retail sector in the past year include JER Europe Fund II's €42 million acquisition of a retail portfolio from Finnish company RealInvest; Kenmore Property Group's €74 million acquisition of 76 retail and industrial units from Citycon Oyj; and the sale of Helsinki's Kamppi shopping center to a partnership of Britain's Boultbee Construction and Royal Bank of Scotland for €345 million. Kamppi shopping centre, built above Helsinki's new underground bus and coach terminal, opened in March 2006 and tallied more than three million visitors in the first month.

Given the high level of retail construction, it may be only a matter of time before foreign players decide to move into a development mode or undertake significant redevelopment at some of these properties. Hietala suspects that, like Sweden, it will not be long before the foreign funds become comfortable with retail development plays.

“A big difference between us and Sweden is that foreigners have been there so long they are now already selling,” he says. “They've come here and they've stayed here, so I suppose our liquidity will stay also. Sixty foreigners have already made acquisitions here, but many have only done one or two deals. Only a few have a long track record. But I do think those investors will stay.”