This article is sponsored by NREP
Governments in the four Nordic countries reacted differently to the novel coronavirus. Denmark and Norway locked down quickly, but are among the first European countries to open up. Finland was late in applying restrictions, but has been less impacted by the virus, while Sweden has taken a distinctively liberal approach. As life and business slowly begin to return to normal, Claus Mathisen, chief executive officer at pan-Nordic manager NREP, gauges the impact on residential real estate investment in the region, and considers the scope for future institutional activity in the sector.
How well have Nordic economies coped with the pandemic?
Compared with many parts of Europe, and also in a global context, the Nordic economies are supported by strong macro fundamentals. Governments are very well-capitalized with the region accounting for three of the 11 countries worldwide with AAA-ratings, and have operated low public deficits while maintaining quite large public sectors and robust welfare systems, so they are in a strong position to provide economic stimulus.
GDP across the Nordic economies is expected to fall by 5-10 percent this year, but much of that impact so far has been mitigated by public guarantees and subsidies. Those programs have been ramped up into the tens of billions very quickly. For example, the Norwegian government has increased the draw-down from its sovereign wealth oil fund by 50 percent, which represents a massive infusion of capital into the public finances. A very strong starting point economically was then bolstered by quick, and quite substantial, action and that has created a sense of calm.
What were the main drivers in the Nordic residential sector pre-covid-19?
Well-funded welfare systems help family formation and family formation drives population growth, which is expected to be comparatively rapid in the Nordics within a European context. On top of that we have seen rapid urbanization and the reinvigoration of city centers in all four countries over the past decade, which means that metropolitan areas are growing above the average, and are attracting more single households, young professionals and students.
That has increased the demand for smaller units and led to a greater emphasis on experience-enhancing factors such as community, sustainability and access to services. Meanwhile, there has been very little supply delivered into the rental market, both for economic and regulatory reasons.
Municipalities have struggled to zone enough land to meet demand, while rent control and design regulations have further restricted new construction. In markets where capital appreciation has been quite rapid, the business model for most residential property providers has been to develop to sell, not to rent. The supply-demand imbalance is particularly extreme in Stockholm, where the waiting list for a private rented apartment is almost 10 years.
And how has that been affected by the pandemic?
The immediate reaction has been a drop in development volume, more marginal players shaking loose, and increased investor demand and higher pricing for safe, rented assets. Developers who were mid-project or seeking financing when the pandemic hit are finding it a bit harder to complete sales and finance their developments. We were ready to step in and acquire projects, but we have only seen one or two opportunities of that kind.
More surprisingly, we have seen yields compress on rental products. Nordic urban residential has ample liquidity from banks willing to finance it, and demand that is underpinned by demographics. Furthermore, many lower and middle-income families in the region live in rental housing, and if they become unemployed governments will pay most of their rent, so delinquency rates are much lower than in the US, for example.
There has been a flight to safety, and it is seen as a very safe asset class to be in, so values have increased. We expect that residential for sale will take a hit because unemployment and uncertainty will increase, while buyer equity and the availability of mortgage finance will be reduced. However, we anticipate increased demand for rental residential, particularly for smaller units at the affordable end of the scale.
What has been the impact in the senior care and student housing sub-sectors?
We have investments in both, and some of our overseas LPs have been asking us if those sectors have been hit hard. They assume that students who cannot pay their bills are going home because universities are closed, or care operators are going bankrupt because their tenants are dying or tenants’ payment capacity goes down in the downturn. However, in the Nordics both sectors are underpinned by either municipal rent payments or guarantees.
University education here is free, the student population is almost entirely domestic, and the rent that students pay comes from the stipend they get from the government, as opposed to being paid for by their parents, so we have seen no students leaving. To the contrary, university applications and the demand for student housing tends to go up in a weak labor market. Against a backdrop of an extreme lack of supply, for those investors that can provide affordable student housing, it offers a non-cyclical cashflow as tenants remain unaffected in a downturn and by law the investor’s income is government-funded and tracks inflation.
In the care sector, municipalities are legally obliged to provide senior care and they typically pay 85 percent or all of the cost. Even if families become more reluctant to place people in care homes because of the risk of contracting the virus, there is already an immediate shortage of provision in close to 50 percent of municipalities, while 25 percent of the existing stock needs to be replaced by 2030, and over the same period the number of people aged 80-plus is set to grow by 50 percent.
What are the most effective strategies for investors to access the market?
Because Nordic rented residential can be seen as a proxy for bonds there is huge demand from institutional investors, particularly for portfolios of €200 million or more, but markets are very fragmented with a lack of the right product at large ticket sizes so pricing of those opportunities is very keen. Investors looking for higher returns are deterred from buying standing assets because much of the existing stock is rent-regulated and trading at yields so low that there is little value left to extract. And investing in improving standing stock needs to be done with a local approach and local support. For example, when Blackstone tried to buy existing residential stock in Denmark and carry out capital works to raise rents the government introduced legislation to prevent it.
For investors looking for a controlled path to higher returns, investing through forward purchases or developments are strategies where you will find less competition, and where you get the opportunity to shape the product to meet current trends in demand in a way that older rent-regulated stock does not.
This latter argument is a key reason for why a large part of NREP’s investment program is through forward purchase or development partnerships where we define the product. If you approach real estate not only as an asset, but also as a product, and consider what makes your projects more appealing to customers, then you can create significantly more customer value and investor value per square meter. We very often see opportunities to significantly improve the value equation in regular rentals, but the benefits are even stronger for our product lines aimed at addressing specific sub-sectors such as student co-living, serviced living for young professionals, senior community-living, and care homes.
What are the challenges for overseas capital?
It is important to be aware that the Nordics are four different countries, each with its own distinct set of regulations and distinctly local real estate markets. Even more so than the UK, France, and Germany, the way to approach the Nordics is to be truly local in each market or have a local partner.
Moreover, if your business is not perceived as a good long-term citizen, and you do not have a strong relationship with municipalities you will find it difficult to navigate the regulatory constraints on improving or developing properties. Past attempts by foreign investors to circumvent the highly-regulated nature of the residential market or to push forward without local stakeholder support have back-fired.
Plushusene’s municipal appeal
At the end of May, NREP entered into a purchase agreement with local authorities in Aarhus, Denmark’s second-largest city, to secure a site for NREP’s mixed generation product Plushusene (“Plus-house”). The 226-unit scheme will provide row houses and apartments designed to appeal to a mix of 50 to 65 year-old “empty nesters” and young families, together with communal facilities and a community manager to organize resident events and activities. NREP is rolling out the concept across the country and its appeal to local authorities was crucial in securing the site, says Mathisen.
“There is a lot of demand for land so you need to differentiate yourself. Members of the local municipal council are now holding up Plushusene as an example of the way forward for residential development in the city. In markets as small as ours you cannot take a narrow short-term transactional approach – you need to be able to understand the needs of residents as well as other stakeholders, and you need to think long term.”