NPO Spring 2023

Newsec Property Outlook

Spring 2023

Newsec Property Outlook

Real Estate is long-term and local

The past year has reminded us to be careful about what we take for granted. Reality as we know it has changed significantly. A terrible war rages in Europe and has, among other things, made us aware of how global events impact our part of the world.

How international investors reason is always relevant, not least because Nordic and Baltic investors act on assumptions about global investment behavior. But ultimately, markets remain very domestic. They are not as affected by foreign investors as it is often claimed. For that reason, moving forward with a long-term perspective, we can focus slightly less on observing and making sense of how they act. Newsec’s assumption is instead that domestic investors will continue to drive the market in 2023. In the end, business is local.

We also know from experience that trends and markets tend to fluctuate, and that uncertain times call for long-term perspectives. With a projected 80% of buildings in use in 2050 already having been built, the property industry is stable and able to stand the test of time. Isn’t it somehow reassuring that significant parts of today’s global cityscapes will outlive most of us?

My belief moving forward is that maintaining, or increasing, property values can be achieved through a focus on consistency, where measures are driven long-term and with an eye on real, lasting investments. In-depth knowledge of tenant needs, movements in local markets and ability to adapt assets, such as real estate and premises, in an efficient manner will be crucial to continued success. Genuine management and development driven by

local knowledge, experience and above all, the ability to understand the market's needs will be essential going forward when yield compression, low interest rates and excessive access to capital will not be driving forces.

The Nordic and Baltic real estate sector and transaction year started out strong and, despite slowing down during the second half, the market is relatively stable. We look back on a 2022 which on the whole reminds us of many previous years, with the exception of the record-shattering 2021.

We tend to focus on the global real estate market, and while it is relevant to have a broad network of investors, focusing too much on the actions of the large global players is much less important than we think. Non-Nordic (and Baltic) investors will continue to have a presence on the market, often on the buyside of mega-deals. However, it is very unlikely that international investors will drive the transaction market in the coming year.

A changed environment, potential recession in large parts of the world, a devastating war in Europe –there are many reasons to reevaluate our view of the world today. But it’s always darkest before the dawn, and we will see positive events in the not-too-distant future. Despite sometimes rapidly changing circumstances, the market moves steadily forward.

Max Barclay, Deputy CEO at Newsec

Transforming real estate, and beyond

Newsec is a real estate and energy transition expert. We advise a wide range of clients in optimizing operations throughout their value chains – always with the crucial perspectives of sustainability and digitalization in mind. Around 2,500 experts serve our clients in seven countries across the Nordics and Baltics.

Through the large volume of real estate and renewable energy transactions, leases and valuations we handle, and the vast portfolio of assets and properties we manage, Newsec has market leading knowledge of Northern Europe and can provide the insights you need.

The first issue of Newsec Property Outlook was published in 2001.

Half full or half empty?

Headline inflation has peaked, but interest rates will stay elevated. The expected economic downturn will be milder than previously expected. However, the trough in property markets has not been reached yet. Among the Nordics, Sweden is the most vulnerable because of high indebtedness.

Klas Eklund, Senior Economist, Mannheimer Swartling

Central banks still in tightening mode

The global economy has been hit by severe shocks in recent years. Now, however, the outlook is gradually improving – but in uneven and uncertain ways. Headline inflation has peaked in the US and in the Euro zone. However, core inflation remains far above central banks targets, as inflation has spread to more goods and services. The labour market has remained surprisingly strong, particularly in the US, which is seen as an outstanding inflation risk.

Future inflation and monetary policy paths are uncertain. The Russian war of attrition may escalate

with dangerous implications. The base case is nonetheless that headline inflation in most countries will come down sharply this year, courtesy of base effects and cooling economies. But central banks will keep monetary policy tight until they are convinced that core inflationary pressures are defeated longterm.

Thus, the Fed will continue with a couple of small hikes and likely keep its key rate at a high level for the rest of this year. The ECB and the BoE will also hike more. As a result, the present rate hike cycle will be one of the strongest in modern times.

“Headline inflation has peaked in the US and in the Euro zone”

The tightness of policy is actually more pronounced than indicated by interest rates alone, since central banks also are unloading some of the bonds they took on during the period of QE.

This holds for the ECB – i.e Finland and the Baltic countries – and for the independent national central banks of Scandinavia as well. As a result, Nordic property markets in general have not seen the trough yet. They will continue down until markets are convinced that rates have peaked and the next step is down.

A mild recession

The tightening of monetary policy will have negative effects on growth and employment – which is exactly what policy makers want, in order to cool the economy. Even though we have not yet seen the full effects of the tightening process, the downturn is seeming to become milder than previously anticipated.

In Europe, the main reason is that the economic fallout from the Russian invasion in Ukraine has been less harmful than projected. In particular, energy prices have not skyrocketed as expected. Gas and electricity prices are high, but much less so than forward prices indicated last fall.

Still, a recession is likely. Household demand is falling, and tighter monetary policy will exert a drag on activity also in the coming months. External demand is likely to be weak as the US and UK fall into recession. China’s growth prospects have improved and will marginally improve Europe’s outlook. But the Chinese uptick will be led by the services sector and will not have the same strong stimulative effect on the Western economies that it used to have. An obvious source of uncertainty in Europe is the development of the war in Ukraine – and the effects of an escalation.

Even when a possible recession ends, growth may be weak. Central banks will not go back to the experiment with ultra-loose policy. On the contrary, they may keep rates slightly higher than neutral since long-term inflation may stay higher than targets (see box to the right). Fiscal policy will also need to be more disciplined after large deficits for several years. Last year’s turbulence in the UK, where the “mini-budget” led to sharply rising bond yields, was a warning. While gas prices have fallen recently, they will remain well above pre-Covid levels – and the costs of energy transformation will be huge.

The forces determining economic developments on the European continent dominate also the Nordic and Baltic area. The Baltics show higher inflation and are more vulnerable to the Russian threat, but nonetheless they will perform better than the Nordics after a brief dip in H1. Sweden, Norway and to some extent Denmark are suffering from overstretched property markets.

Financial markets

Global equities have rallied as markets expect central banks to reach the key rate peaks soon; they prefer to look beyond the tightening cycle and instead focus on the upturn which will come later. The same optimism seems to have caught the bond markets. At the beginning of 2023, prospects of falling inflation caused bond yields to come down from the peaks last autumn.

However, there is a clear risk that markets have been moving too fast – as they did several times last year. The tug-of-war with hawkish central banks is far from over. Both the Fed and the ECB have signaled more than one additional rate hike. This suggests a bumpy ride for some time yet, as new rate hikes will make investors worry again, from time to time.

Photo: Shutterstock

So, inflation will come down in 2023. But then what? There are several reasons to believe the “new normal” inflation rate is higher than in the last decade. China is not exporting deflation anymore. Globalization is retreating somewhat, due to protectionism, industrial policy and shortening of value chains. This will slow down productivity growth and consequently costs will rise. The greening of the economy will also cause cost increases in the medium term. The IMF has estimated that “greenflation” may add another 0.3-1.2 percentage points yearly to global inflation. Without making any precise forecast, my guess is that the new “normal” level of inflation will be 3 rather than 2 per cent.

Neutral interest rates are, consequently, also on the rise again. The nominal rate will increase due to inflation, but it is also possible to make a case for rising real rates. The global neutral rate has been trending down in recent decades. Important factors were slow productivity growth and an aging population with increasing propensity to save.

But now, China’s population has stopped growing and is starting to shrink. To some extent this may be balanced by increased

savings in countries like India, Nigeria and Indonesia, but for the foreseeable future the net effect is that a savings glut will weaken. At the same time, increasing public debt may eat into savings. Increasing investments in energy transition will increase demand for capital. As a consequence, markets' views of long-term real interest rates have shifted up by almost 2 percentage points in the past year. A common view among forecasters, as collected by Svenska Handelsbanken, is that neutral nominal policy rates in the new normal will be around 2.5% for the US and the UK, 2–2.5% for Sweden and 1.5–2% for the Euro zone.

So, once we are out of the pandemic and war shocks, in the “new normal” central banks may face both higher inflation and higher neutral rates. This means that the extremely low nominal rates of the 2010s will not return. Hopefully, in this situation the central banks will relax their monetary policy framework rather than use overly tight rates to press down inflation below its new normal. The same conclusion can be drawn from the failed experiment with ultra-loose policy: when strong global forces move the neutral rate, central banks should allow more flexibility rather than apply strict inflation targets.

The Nordics and Baltics

In recent years, Norway, Sweden and Denmark have all been strong-performing economies, while Finland have seen slower growth. Now, this trend is somewhat reversed: all countries are hit by rising inflation and rates, but the fallback is relatively mild in Finland while Sweden in particular suffers from high leverage and household indebtedness. House prices have fallen sharply in Sweden and Norway and private consumption has been reduced after several good years.

The Baltics have been growing rapidly during a period of catch-up. However, they were severely hit by higher energy prices, bottlenecks and geopolitical tensions after Russia’s invasion of Ukraine. The effect has been very high inflation – in the 20s in all three countries – which sharply has cut into real disposable income. Since interest rates are set by the ECB from the perspective of the entire monetary union, the result has on a national level been a loose monetary policy. This year inflation will fall rapidly in all three countries, despite high wage increases. House prices will fall and H1 will see a rather mild recession, moderated by low levels of private indebtedness. An upturn will begin in H2 of 2023.

Sweden

After economic resilience last year, 2023 began with falling GDP. This year’s decline will be clearly harsher than the EU average. Important drivers are falling real incomes and a brutal downturn in housing construction. High inflation will lead the Riksbank to hike its key interest rate at least once more, before cuts begin in 2024. Tighter monetary policy hurts Swedish households more than in most other countries, since mortgage debt is of short maturity. Fiscal policy has been tight, compared to other European countries, and government debt is projected to fall further. However, it is likely that fiscal policy will

The “new normal” will be higher inflation and higher rates than in 2010s

be loosened during 2023, with tax cuts and higher expenditure at the same time.

The Swedish krona has been falling precipitously, as it is regarded as unstable in turbulent times. The Riksbank’s previous low-rate policy also contributed to a weak currency. The new Riksbank governor has, however, clearly stated that he sees the weak krona as a problem and that he wants it to strengthen. One measure will be to unload some the central bank bond portfolio which also will slow down the projected fall of bond yields.

Home prices will continue to fall. Home prices had fallen by almost 15 per cent from the peak by year end. They will continue to fall during H1 2023. The consensus view is that the overall home price downturn will reach 20 per cent. The average interest rate on a home mortgage loan with a three-month fixed interest will triple during 2022-23. Interest expenses will increase from 2.5 per cent to an estimated 5.5 per cent of household incomes, as a result of many households having short-term debt.

Norway

Growth in mainland GDP has held up well, but economic activity indicators still point to stagnation ahead. Households will be able to sustain their high level of consumption only by depleting some of their savings. Cautious businesses will weigh on mainland investments. The labour market is still tight, but unemployment will rise slightly, from low levels. Despite the slowdown, Norway will probably record positive growth in 2023, the only country in the region to achieve that, courtesy of swift increases in energy investments.

Inflation is still high; both headline inflation and the target measure of Norges Bank reached new peaks in January 2023. A further hike is expected this spring, but the Bank has signalled “a more gradual

approach” to rate setting, meaning that further hikes will be small.

Home prices rose in H1 2022, but prices have fallen recently in the wake of rate hikes. Although the sector has been quite resilient, the outlook for 2023 is weaker, since tighter money probably has not fed through the system yet. Higher mortgage rates, restrictive bank lending and expectations of home price declines are weighing on housing demand, which indicates price decline in the near term. Analysts expect a 10 per cent peak-to-trough fall, with prices bottoming out around sumenmer.

the current account surplus puts pressure on the currency. Thus, the Danish central bank may need to keep its key rate slightly lower than the ECB; the spread, however, will still be small, within the set trading range.

Construction activity has fallen, putting downward pressure on housing investment, which will see sharp declines in H1 2023. Higher interest rates and tighter credit caused a decline in real estate transactions in late 2022. After several years of hefty growth, prices of both houses and apartments have fallen and will continue to do so during 2023. But the level of household debt has decreased after many households refinanced long-term mortgage loans to reduce their debt. This should make the Danish market less vulnerable than the Swedish. A recovery can be expected in 2024, at the latest.

Finland

Denmark

After several years of strong performance, Denmark’s GDP weakened in Q4 2022 due to high energy prices and falling private consumption. H1 2023 looks to be weak as well, with falling real wages, lower home prices and tighter credit conditions. Consumer confidence fell sharply in the fall and has not recovered yet. As a prominent shipping nation, Denmark profited from high freight rates during the pandemic, but as freight rates fell last year exports took a hit.

Headline inflation will gradually fall, but as with her neighbours, Denmark’s core inflation has not peaked yet. Denmark’s krone is tied to the euro, but

The Finnish economy has withstood the shocks fairly well. Last year, goods export rose despite a complete stop in trade with neighbouring Russia. Consumer sentiment has fallen, though, and as export orders fall, the economy will go through a shallow recession during H1 2023. Employment will weaken. Investments were strong in 2022, but business is becoming more cautious. Growth will gradually pick up again in H2, as lower inflation will lift private consumption. For the year 2023 as a whole, GDP growth will be more or less zero. In 2024 a modest growth rate will be recorded.

Residential investment rose in 2022. As in Sweden, the Finnish housing market is cooling, but the declines in prices and transactions have not been as steep. Household indebtedness is not as high as in Sweden. Since the upswing in the housing market was less frenzied than in the rest of Nordics, the downturn will now be softer.

“House prices fall sharply in Sweden and Norway and private consumption has been reduced after several good years”

Estonia

GDP fell in H2 2022 and the fall will continue in H1 2023. The economy is hurt by the downturn in Sweden, as wood processing and exports such as prefabricated houses and furniture have fallen. The labour market is in good shape, with strong wage growth, making domestic consumption resilient. Inflation will fall from some 20 per cent in 2022 to around 10 per cent this year, still probably the highest in the region. Estonia is expected to return to positive growth during H2, supported by resilience in domestic demand and improving exports.

The housing market is decelerating. Apartment sales in Tallinn are falling. However, a large drop in prices will probably be avoided since real estate developers are well capitalised compared to Sweden. Furthermore, household indebtedness in Estonia remains far below the levels seen in the Nordic countries, making it less vulnerable to rising interest rates.

Latvia

The economy is entering a recession which will reach bottom in H1 2023; during H2 an upturn will commence. For the year as a whole, GDP growth will hover around zero. Exports have been surprisingly strong, as trade with Russia has gradually been replaced by trade with Western Europe. But a downturn started in late 2022, and will continue during 2023. Consumption faces headwinds as disposable income shrinks. A rise of the minimum wage will, however, hold up wage increases and alleviate inflationary pressures on households. Falling energy prices will eventually cause high inflation to slow, but from a very high level. Receding inflation should eventually help consumption. Energy disruption and geopolitical risks will remain threats.

The real estate market has weakened during winter; home prices have fallen, and some segments will

face price decreases of 5–10 per cent. The fall will probably be smaller than in the other Baltic countries since price growth in recent years has been moderate.

Lithuania

Strong exports helped the economy in 2022, but lower exports will lead to a brief recession in early 2023. GDP growth will remain just above zero for the calendar year, helped by EU funds. Manufacturing has weak ened. Private consumption growth will remain negative for some time, but will gradually strengthen in H2 as inflation falls. The labour market has been strong, partly because of net immigration; but this year employment will fall. Inflation peaked in the fall of 2022 and will fall this year, but rapidly rising wages will mean rising costs in several sectors. A great challenge is to in tegrate the flow of refugees from Ukraine.

The housing market weakened in late 2022; the number of transactions dropped. After previous rises, property prices will face a decline in the first half of 2023, as interest rates will continue to rise.

Conclusion

The European economy is at a crossroads – again. Core inflation is still high, and even when it comes down, the ECB will keep rates high for a protracted period to root it out. The effect will be an economic slowdown, but as energy prices have come down significantly, it will probably be mild – unless an escalation of the war in Ukraine will create havoc. The ECB is squeezed between real economic

weakness and high inflation. The same goes for the independent central banks in Norway and Sweden.

Property markets are still falling. We may have to see the interest rate peak before they bottom out and start to rise again. Some sectors – retail – and companies – in particular highly leveraged developers –will encounter problems.

So is the glass half full or half empty? It is half full when it comes to the general economic situation, which is better than anticipated half a year ago. But as regards to the property market, it is still half empty.

Tomorrow Never Dies

What a year! We could have started the last Newsec Property Outlook with the same sentence, however, for 2022 “what a year” reflects perhaps one of the most turbulent years in the history of Nordic & Baltic real estate. The year started with guns blazing, and deal after deal was closed at record levels – the happy 10’s were becoming the happy 20’s, despite the pandemic. Early on in 2022, market sentiment however changed. By summer investors had grown cautious, and after the autumn the market had completely cooled off, with fewer deals noted and lower valuations – the annual doomsday predictor had finally hit right. Thus, we decided to dedicate this Newsec Property Outlook to investigate statements that have arisen from the downturn and assess which are true and which are urban legends. Before we dive in, remember – doomsday predictors are generally wrong in the long-term and thus in practice, tomorrow never dies.

Statement 1 & 2.

“Buy low, sell high”

& “Cash is king”

To have impeccable timing is nearly impossible, yet many real estate investors strive to do so. However, in the pursuit of perfect timing investors become blind to opportunity and instead fall into the “wait and see” trap. The “wait and see” trap is common in environments which are difficult to forecast. Instead of acting on opportunities, outsmarting the market and timing the bottom becomes the strategy. In practice, however, outsmarting the market and timing the bottom is difficult even for the most skilled investors. Thus, most investors wait too long and miss the window of opportunity. Looking back at the previous crisis in 2009, when the real estate

market in the Nordics & Baltics essentially stopped, and the transaction volume dropped by more than 50%, one type of investor remained a strong buyer –institutions. Institutions are by nature real longterm investors and buy throughout the cycle. Institutions are also highly liquid and as it has become both more difficult and expensive to get capital through debt, cash is again king.

In exhibit 1, the share of institutions of the total transaction volume in the Nordics & Baltics can be seen. It is apparent that the institutions’ share of the total transaction volume increased dramatically in the crisis year of 2009. Although the total transaction volume was lower than in 2008, it is evident that long term and cash strong investors such as institutions buy relatively more than other investors in downturns and relatively less than other investors in upswings. As can be noted in the graph, the monthly share of institutions has dramatically increased in

Definitions

Inter-Nordic investor: investor from a Nordic country investing in another Nordic country

Non-Nordic investor: investor from outside of the Nordics

Domestic investor: investor investing in their home country

the autumn of 2022 and is expected to remain at a high level this year.

In 2023, all investors will not be able to be net buyers, but the ones who can, should seize this opportunity by buying throughout the cycle, instead of shying away from investments while trying to catch a falling knife. Cash strong funds and institutions are forecast to be net buyers, while listed property companies will be significant net sellers. It is however, likely that listed property companies, strapped for cash, will try to both service debt and acquire new properties through large new issuances. Whether they will succeed or not, time will tell. Nevertheless, Newsec assesses that this type of investor will be a net seller in 2023. Thus, statement no. 1 is in fact an urban legend (at least in practice for most investors) and statement 2 is in fact true.

Statement 1 – “Buy low, sell high” – Urban legend

Statement 2 – “Cash is king” – True

Statement 3.

“Non-Nordic investors to save the day”

The above statement is perhaps one of the most spoken in the last months – claiming that international presence will increase and drive the market in 2023. Many claim that weakening currencies (NOK and SEK, and to some extent EUR) will lead to an increase in non-Nordic investors, in turn indirectly implying that real estate acquisitions will not be currency hedged and will include currency risk. It is probable that non-Nordic investors will continue to be noted on the market, as they often are on the buyside of mega-deals. However, it is very unlikely that this investor type will drive the transaction market to any meaningful degree in the coming year. This is especially the case since assets in many of the largest non-Nordic investors' home markets

have fallen sharply, thus allowing for many domestic opportunities and perhaps less capital allocation towards foreign markets such as the Nordics. In exhibit 2, the share of non-Nordic investors over time as part of the total transaction volume is displayed. The graph shows that on average, nonNordic investors account for approximately the same share as inter-Nordic investors – a relatively low 15% each (with the rest being domestic investors). It can also be noted that during the great financial crisis in 2009, non-Nordic investors dramatically decreased their share of the transaction volume. The same could be noted during the pandemic in 2020, where non-Nordic investors again dramatically decreased their presence due to instability and uncertainty. This time, however, inter-Nordic investors remained solid. Non-Nordic investors thus seem keener to stick around in good times. The graph also implies that the Nordic market is self-sufficient (at least since after the great financial crisis) and non-Nordic investors are nonessential to achieve liquidity – even in uncertain times. In 2023, Newsec expects nonNordic investors to have a presence on the market,

however not to an extraordinary high extent. Contrary to popular belief, non-Nordic investors have not to an apparent degree increased nor decreased their share of the transaction volume since the great financial crisis and their presence can to some extent be interpreted as white noise. Newsec assesses that domestic investors will continue to drive the market in 2023. Also, Newsec assesses it is more likely that inter-Nordic investors grab a higher share of the transaction volume in 2023 than non-Nordic. Thus, non-Nordic investors will not save the day and statement no. 3 is concluded to be an urban legend.

Statement 3 – “Non-Nordic investors to save the day”

– Urban legend

Statement 4.

“The residential asset class has become unattractive”

The residential segment has been one of the most popular among investors in the past few years, averaging an astonishing 27 % share of the total transaction volume annually in the Nordics & Baltics since 2016 (exhibit 3), making it the largest investment segment in the Nordics & Baltics. The segment has also noted substantial yield compression in the past five years, and e.g. between 2017 and 2021, the prime yield shrunk by 25% on average in the Nordics. This has made the segment one of the most lucrative investments in the last few years, having among the highest total return across all segments in Sweden, Finland, and Denmark. The playing field has however changed with the new macroeconomic climate. Rising financing costs and higher inflation

Exhibi t 2: Non-Nordic and inter-Nordic inve stor s as a share of the tota l tran sact ion volu me (%)

without, in many cases, CPI adjusted rents have made this investment class look less attractive. The segment is also subject to regulations across the Nordics*, which in some cases has resulted in unfavorable rulings or political decisions – in several cases related to rental growth. However, let us revisit why the segment was an attractive investment from the get-go. The primary reason for the attractiveness of the segment is the strong underlying long-term fundamentals which outperform the rest of Europe. In exhibit 4, the demographic outlook in the Nordics vs the rest of Europe is shown. The outlook is clearly superior in the Nordics with three out of four Nordic countries displaying the highest growth among the countries in the graph. Thus, the demand for residential is high and is forecast to remain on a high level, given the stronger demographic outlook than the rest of Europe.

There also exists a structural supply problem resulting in a shortage of housing and thus a low supply. In exhibit 5, the amount of required construction per 1,000 inhabitants in the Nordic capitals is compared to other European cities. As shown in the graph, the amount of housing needed is significantly larger in especially Copenhagen and Stockholm compared to other European cities. The shortage is also fueled by low construction levels, and the number of completions rarely reaches the required levels to meet annual housing needs. New housing is not only needed to meet new demand from demographic growth, but also to dampen the long-term supply shortage in the Nordics. The outlook for construction has also dimmed, with costs rising and thus the structural problem has been prolonged. In most of the Nordic countries the problem is also widespread

Exhibi t 3: Tota l tran sact ion volu me split by segment (MEUR) & resident ia l se gment as share of tota l (%)

*Residential regulation and market praxis differs significantly between the countries. For more information and tailored advice, please contact us.

t 4: Demographic fore ca st 2022–2040 (Index, 2022=100)

and not only centered to the capital cities, as can be seen in exhibit 6 which displays municipalities with a housing shortage in Denmark and Sweden. This can in many cases lead to mispricing of assets in smaller cities and in turn create opportunities to acquire high yielding assets which, in fact, carries low risk. Gaining similar exposure to the segment in the rest of Europe is difficult, which makes the segment a healthy option to diversify many portfolios.

All in all, although a temporary downturn in the market can be noted with values falling due to macroeconomic and regulatory factors, the longterm fundamentals behind the segment’s attractiveness remain unchanged. Newsec assesses opportunities will arise within the segment and investors who can see beyond the short-term drivers are in a good position to take advantage of the market sentiment. Thus, the fourth statement is an urban legend.

Statement 4 – “The residential asset class has become unattractive”– Urban legend

The so-called government bond of real estate – the public property – is an investment which remains attractive with strong underlying fundamentals (aging population and lack of modern properties) and credit worthy tenants. Many are turning to the segment because of its predictability and an increasing number of different investors – not only real estate investors but also infrastructure investors – have been entering the market. The segment is characterized by long leases with steady and inflation proof cash flows. However, what happens to the risk when the lease begins to mature? Naturally, the risk increases as you are discounting fewer guaranteed cash flows, but Newsec has studied the probability of a public tenant extending the lease. In the study, Newsec looked at 43 elderly

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Statement 5.

“Public properties with short leases also carry low risk”

Exhibi t 5: An nual housing constr uction needs (no. of houses) per 1,000 inha bitants

Copenhagen Stockhol m Helsinki B erlin Pari s Lo ndon Am sterda m Oslo Barcelon a Madrid

Exhibit 6: Assessed housing shortage in Danish and Swedish municipalities

Housing shortage

No housing shortage

care homes and 18 schools with contracts for elderly care homes starting in 1993 and contracts for schools starting in 1980. In the timeline to the right, the study is illustrated. By the end of the timeperiod, 14 out of 18 properties were still schools (78%), and 42 out of 43 properties were still elderly care homes (98%). In terms of extension, 122/126 (96,9%) leases were extended for schools and 209/210 (99,5%) leases were extended for elderly care homes. Compared to a commercial property such as an office, where the same number in an attractive location is assessed to be closer to 75–85% – the risk can be assessed to be low and thus this statement can be concluded to be true.

Conclusion

The long-term perspective for real estate

The common theme throughout almost all of the analyzed statements, to which our title also alludes, is the long-term perspective. The fact remains that in the long-term the outlook for Nordic & Baltic real estate is strong, the market still has potential, and many underlying fundamentals have not changed. In up and downturns, it is easy to forget that the current market sentiment will not last forever. In 2021 and the early months of 2022, the market reached its peak. During this period, people had the belief that interest rates would remain low indefinitely. However, by the end of 2022, people were instead predicting the doomsday for Nordic and Baltic real estate. This goes to show the volatility in market talks and sentiment and why engaging in the current mood is not a winning strategy.

One of the most pressing questions in the market today is how it will adapt to the changed cost of capital. It is worth noting that the Nordic real estate market thrived and remained liquid even during the early 2000s, when the cost of debt was comparable to what it is now. The expected required return in practice for investors has also not been perfectly correlated with changes in the risk free rate and the equity market risk premium is thus likely to note compression in 2023 for some investors. However, for activity to flourish, capital markets will need to become liquid again and price expectations will need to come down so buyers and sellers can meet. In the short term, Newsec forecasts that real long-term investors will stick to their strategy and be active buyers. Newsec also remains hopeful that other investors, with cash on hand, will act on opportunities, as in any other year. As several buyers turn to sellers and

many cash strong players are still searching for new acquisitions, Newsec assesses that the year will note significant activity and that the transaction volume for the full year of 2023 will be in line with the historic average of 40 billion euros – despite market uncertainty. The long-term outlook is still positive for the Nordic & Baltic real estate market; however, it is darkest before dawn, and this year is also likely to be characterized by a market that is difficult to navigate. To navigate the market and to distinguish an opportunity from a mirage, contact Newsec, and we will assist you with all your real estate needs, and

Ravi Barot, ravi.barot@newsec.se

Adam Tyrcha, PhD, adam.tyrcha@newsec.se

Statement 5 – “Public properties with short leases also carry low risk” – True

Ulrika Lindmark, ulrika.lindmark@newsec.se

extension of 3 years – 14/18 schools extend. Extensions of 3 years continue until 2019 ➞ 9 possible extensions in total First extension of 3 years – 42/43 elderly care homes extend. Extensions of 3 years continue until 2020 ➞ 5 possible extensions in total

Study of elderly care homes ends. 209/210 leases were extended.

Property Markets

The Swedish property market

New competitive landscape – opportunistic investors, cash strong players, and desperate sellers

The market has in the last decade been characterized by an almost uninterrupted bull run. This trend has been driven by an abundance of low-cost capital, which many had believed would be a permanent feature of the economic landscape. However, in 2022, the conditions shifted and returned to preexisting norms, as rising inflation and interest rates re-emerged in Europe. As we move into 2023, it is anticipated that the majority of Europe and the world will be facing at least a technical recession, although some analysts predict the possibility of positive GDP growth for the EU. In Sweden, GDP is expected to decrease by -1.5% and a recession is expected to be noted throughout the year. Additionally, in December, CPI came in at 12.3%, higher than November and than expected, despite declining figures being observed in other European countries. As a result, it is likely that the Swedish Central Bank will continue

to raise interest rates until, at least, the summer. By the end of 2022, the policy rate reached 2.50%, while in February 2023 a further increase of 50 basis points was noted. Despite this, the labour market remains relatively stable, though unemployment in Sweden remains at elevated levels of 6.7% with foreign-born unemployment still at even higher levels.

The Swedish real estate market arguably saw both its peak and fall in 2022. However, the transaction market remained relatively liquid throughout the year, although the autumn noted a steep decline in volume, especially when compared to 2021. The full year ended at SEK 219.5 billion, a historically high volume, however partially driven by the record high volume noted in both Q1 and Q2. The second half of the year was clearly weaker, and investors shied away from deals. Sellers and buyers did not meet, and distressed sellers started to pop up in the market, especially among publicly listed real estate companies. Yields rose across all segments and although CPI adjusted rents stopped values from sharply declining, all segments noted value declines by the end of the year. Moving forward, the transaction volume is expected to decline in 2023, however, Newsec is not expecting to observe any sharp break such as the one we noted in 2009 when the volume fell by 77%. Newsec expects the transaction market to be fairly liquid and for the average ticket size to shrink (could be offset by public buyouts or distressed mega deals).

Contact:

Adam Tyrcha, PhD, adam.tyrcha@newsec.se Ravi Barot, ravi.barot@newsec.se

“ The Swedish real estate market arguably saw both its peak and fall in 2022”

Interesting trends on the Swedish property market

Flip the switch

Public listed real estate companies which previously, to a large extent, drove the transaction volume and have been noted as net buyers in recent years are turning into sellers. More than half of the ten largest net sellers are publicly listed companies, while more than half of net acquirers are funds and institutions. Disregarding 2022, listed property companies were by far the largest net buyers in 5 out of the last 7 years since 2015. Private property companies, usually the second largest net buyers, have noted the same trend. This trend is expected to continue throughout 2023. The question remains how this trend will impact the transaction market. Newsec assesses that with large amounts of capital still floating around, willing sellers are likely to result in continued activity rather than an abrupt stop, but with a clear shift in who the buyers and sellers are.

Yield corrections and high foreign interest in light industrial/logistics

The logistics segment continued to see high interest, even at the end of the year. The segment has adapted rather quickly to new market conditions compared to other real estate segments and pricing in the latest deals often differs significantly from the peak. Activity also remains strong, and the segment was the second largest by the end of the year. International investors stood for over 50% of the logistics subsegment, which might be a

reason for the quick adaptation to new market conditions. The prime yield has risen from ~ 3.20% at its lowest to 4.50% at year-end 2022. Although the market corrected quickly, it is worth noting that it was only a few years ago, in 2018-2019, when yields were at current levels of 4.50%. Thus, this leads one to the question if the last few years have been a temporary fluke for the segment, with yields as low as those seen in 2021 perhaps being unlikely to ever be seen again.

Market rent vs CPI adjusted leases on the office market

The leasing market for offices remained strong and active throughout the year and newly signed leases noted rental levels way above market. Newsec has not expected the market rent to follow CPI as market rents usually are less linked to inflation and more linked to GDP growth. Real rental growth is thus expected to be negative, even in the prime locations e.g. Stockholm CBD, although high nominal growth will be noted. In outskirt areas which are battling vacancies, rental growth is expected to be low and small businesses renting smaller spaces might also receive discounts until the situation stabilizes. Thus, offices with those characteristics will most likely not reap the full benefits of high inflation. As the economy also is heading for a possible recession in 2023, rental growth will be put to the test. Tighter leasing markets and stronger office markets will be better off,

while opportunistic turn around office areas might find it even more difficult to keep up with the market’s rental growth.

The king is dead, long live the king

Though we touched upon the subject in the main text of this Newsec Property Outlook, it is worth underlining further. In Sweden, the residential segment has for many years been the largest on the transaction market, but interest dropped rapidly in 2022. By the end of 2021 and in 2022 the segment was hit twice, first with new regulation for new production apartments that restricted rental growth to half of the negotiated rental increase for the old stock. In practice, this means that real rental growth will be substantially negative in the high inflationary environment. Though rents are not CPI adjusted for housing, historically rental growth since 1969 has been more than twice as high as CPI. This suggests that the segment in practice will be well off in the long-run, despite rents not being CPI adjusted. For new production housing that is under construction, initial rental levels will most likely be attempted to be set at a higher level, and a lower increase will thus be priced into that rent. The low yielding residential segment has also been under pressure due to rising financing costs and the transformed macroeconomic environment, but as stated in the main text, Newsec assesses that the segment will continue to flourish in the long term.

SEK 220 billion

Total investment volume in 2022

SEK 180 billion

Total investment volume expected in 2023

–1.5% GDP contraction expected in 2023

The Norwegian property market

The transaction market has been characterized by high activity and record pricing of commercial real estate for the past few years. After a record strong start of 2022, market activity slowed significantly during the second half as the market underwent a repricing. Consumer prices have risen rapidly, and inflation is markedly above target, currently standing at 7% as of January 2023. To combat this situation, Norges Bank raised the policy rate six times in 2022. The policy rate currently stands at 2.75%, which is the highest it has been since 2009, and is expected to be hiked further towards the summer. The monetary policy has started to have a tightening effect on the economy and the activity is projected to fall in the near term. This affects both households and businesses, who will face even higher costs and lower purchasing power. Retail trade will face lower demand owing to weaker household purchasing power, the construction industry reports lower order volumes, manufacturing is facing dampened prospects, and only the energy sector sees strong demand. This is reflected in the forecast for GDP mainland Norway which is forecast to decline by 0.2% in 2023, while the total GDP is expected to grow by 0.6%.

Despite the modest growth in GDP, the unemployment rate in Norway is low. There

are still more than two available job positions per registered unemployed person, indicating a strong labor market.

Throughout the first half of 2022, the activity in the transaction market was high. In brief, a volume of almost NOK 65 billion was noted in the first six months, resulting in the second highest volume in the first half of a year that ever have been recorded, only beaten by the record year 2021. In the last six months of 2022, however, the market sentiment shifted towards gloomier days. SWAP rates peaked, inflation increased, yields started to hike for the first time in years and there was great uncertainty in the market. A transaction volume of NOK 30 billion during Q3 and Q4 is the lowest registered volume for H2 in eight years. In comparison, the average transaction volume for the second half of a year in the last eight years has been over NOK 60 billion. Going into 2023, market activity is slowly starting to return. Yields have stabilized at higher levels and there is less uncertainty among investors. Appetite has shifted towards shorter contracts in the office and logistics segments, both with strong growth in market rents in the past year.

Contact:

Øyvind Johan Dahl ojd@newsec.no

Both record high and record low in 2022, and a new equilibrium going in to 2023

“ Despite the modest growth in GDP, the unemployment rate in Norway is low”

Interesting trends on the Norwegian property market

Interest rates will stabilize, and uncertainty in the market will decrease

The Norwegian policy rate is currently at 2.75 percent after six interest rate hikes in 2022 — the highest it has been since 2009. These hikes are an attempt to halt the surging inflation. During the last rate decision in January 2023, Norges Bank’s Monetary Policy and Financial Stability Committee decided to keep the policy rate unchanged at 2.75 percent. The central bank was also one of the first in Europe to raise rates rapidly. Norges Bank also emphasizes that the policy rate most likely will be raised by an additional 25 basis points in March 2023. On the other hand, energy prices might fall earlier than expected, and global inflationary pressures also appear to be easing. The policy rate has been raised considerably over a short period of time, and monetary policy has started to have a tightening effect on the economy. This may lead to a less aggressive approach to policy rate setting further on this year.

Several of the closings that were postponed last year will reappear on the market in 2023

Regardless of a strong first half of 2022, the autumn was abnormally slow for commercial property. Liquidity in the market dried up and it was challenging to get buyers and sellers to meet. When buyers and sellers have got used to the new market conditions, some of the postponed transactions from last year are

expected to reappear on the market and be closed in 2023. There is still a lot of capital seeking return and a large interest for value-add opportunities close to the city center has for example been noted.

Strong activity on the rental market, especially for attractive, flexible premises that offer flexibility

Any trace of the pandemic has now vanished from the rental market especially in Oslo, and uncertainty related to the effects of home offices has been replaced with renewed faith in the office market. It is primarily the most attractive areas that have benefited from this trend, but the more average premises have also seen increased demand now when much of the A-Category premises have been filled. There is somewhat lower activity in the east and south of Oslo, while the activity is especially high in the center and the western parts of the city. However, the frequent interest rate hikes will sooner or later affect activity on the rental market. Many tenants are facing a difficult spring with inflation-adjusted rental levels and drastically higher operating costs because of the high prices for electricity. As such, flexibility either in the contract or by use of flexible space will be of interest on the market.

Reduced supply of new buildings will keep vacancy levels low and help to keep rent levels up in Greater Oslo

Activity and growth in market rents has been high, however, the positive market

sentiment will be put to the test as 2023 delivers declining employment and a low forecast growth. But inflation has also affected the construction industry and already low volumes of planned new buildings will become even smaller, as several projects are put on hold. Low demand for tenants will be offset by low supply of new premises and the rental market will thus stay relatively strong in 2023. Office vacancy in Oslo currently stands at a record low 5.4 percent which can be compared to the record-high level in 2015 of 8.6 percent. It is estimated that the vacancy level during the year will move slightly up towards 6.0, thus ending the year at a more normal level.

Green is good

According to figures from Arealstatistikk, the market. is still adjusting to the new universe of sustainability. Some legal requirements are already in place and more will come. We have already noticed a shift in yields, both due to requirements from the financial sector, but also from investors having the ESG aspect as part of their investment mandate. Lately, the market has started to see a shift in requirements from tenants. A few of the latest tenant searches in the market demand BREEAM certificated buildings, energy efficient premises and also requirements towards a circular economy and recycling of materials. Going forward, this will be important in order to maintain property values.

The Danish property market

The impact of rising inflation, surging interest rates, plunging business and consumer confidence, and massive reductions in asset values, from the stock market to house prices, has taken its toll. Despite these challenges, the Danish economy remained surprisingly resilient in 2022, growing at an annual rate of 2.5–3%. This growth was sustained by persistent employment, investment, and export growth, leading to strong demand for office and industrial facilities.

In 2023, economic growth is expected to slow and may even contract, due to numerous downside risks. Inflation is forecast to decrease from 7.7% in 2022 to 3.5–5.0% in 2023.

The Danish Central Bank, while closely monitoring inflation, raised its policy rate by 235 basis points in 2022 and more rate hikes are expected this year. Market interest rates have risen more than monetary policy rates, with the 10-year government bond yield rising from -0.2% in 2022 to 2.7% by the end of the year.

The Danish commercial property market was impacted by higher interest rates, uncertainty about the global economy, and a shift in asset pricing. Investment activity dropped 21% from its peak in 2021, leading to a noticeable slowdown in transactions. In 2023, weaker economic growth, higher interest rates, tighter credit standards, and low risk tolerance are expected to cause further decreases in transaction volume, potentially leading to a shift from leveraged buyers to equity buyers, such as international funds and institutional investors.

The long period of yield compression on the property market ended in 2022, leading to higher yields at the start of 2023. The extent of this change varied, but the market has adjusted to the new economic and financial reality. Transactions slowed as buyers and sellers adopted a wait-and-see approach, but yield shifts became stronger in Q4 of 2022. Further shifts are expected in 2023, depending on the economic and financial environment.

Contact:

Robin Rich robin.rich @newsec.dk

A challenging 2023 awaits – the property market is adjusting to a new reality

“ The long period of yield compression on the property market ended in 2022”

Interesting trends on the Danish property market

Residential downturn, likely to be temporary

Residential property remained the most traded asset class in Denmark with transactions worth nearly DKK 36 billion in 2022. The segment accounted for 47% of total transaction volume last year, but a sharp decline from mid-2022 led to investment in residential assets reaching a low level in H2. Transactions in Q4 dropped 84% YoY, with residential being dethroned as the most traded asset class in that quarter. Higher interest rates and tighter credit standards had a significant impact, as yields had declined to low levels due to plentiful access to cheap financing. This new reality will likely dampen residential investment in 2023, but the downturn is likely to be temporary and underlying fundamentals e.g. demographic and economic growth, will renew investor interest.

Will retail finally come back?

Retail property has struggled for several years, with rents under pressure and yields not declining as quickly as other property types, reflecting modest investor interest. Retail transactions reached DKK 14.6 billion in 2022, making it the second most traded asset type, its best performance in five years. This was largely due to a few large deals involving department stores, shopping centres,

and supermarket portfolios. Retail transactions reached DKK 7 billion in Q4, representing 43% of total transaction volume. It remains to be seen if this represents renewed interest in retail assets or a one-off quarter. When evaluating 2023, key factors such as retail sales, earnings, vacancy, and rental growth should be carefully weighed against risks and opportunities.

Will logistics maintain the interest of international investors?

Logistics properties have recently attracted much attention from international investors due to potential for healthy rental growth and yield compression. In 2022, international investors accounted for 72% of industrial and logistics properties transaction volume. Investment in this segment also saw a substantial decline in H2. Although both local and international investors reduced their purchases, there is no evidence yet that foreign buyers are backing away, and in fact, the share of international investment in this property segment rose to 75% in Q4.

New government ditches proposed tax on notional gain

In December 2022, Denmark elected a new government. One of its first acts was to abandon a tax proposal put forward

under the previous government. The bill (commented on in “Newsec Property Outlook Spring 2021”) aimed at changing the taxation of large commercial properties from a tax on actual capital gain to a tax on notional gain. As the implementation of a notional tax was expected to increase the effective taxation, the political reversal has been welcomed by the Danish Property Federation.

The Finnish property market Finding balance

The growth of the Finnish economy started to slow down at the end of 2022. The Bank of Finland predicts that Finland's economic growth will slow to -0.5% in 2023. However, a strong start to 2022, post-pandemic austerity, and the employment situation will provide a foundation for resilience during the upcoming recession. The weak economic growth will slightly reduce labor demand in 2023, but the labor market still has a high number of job vacancies, cushioning the impact.

Inflation is expected to reach 5% in 2023, according to the Bank of Finland. Inflation is expected to decrease from current levels as economic growth slows in the short term. This slowdown will be caused by lower fuel and goods prices and a slowing aggregate demand. Inflation in Finland is lower than the Euro zone average.

The European Central Bank has raised the policy rate rapidly and in H2 2022 they raised rates by 2.5 percentage points. The ECB expects further rate hikes but at a slower pace. The ECB is not easing monetary policy quickly as it predicts inflation will remain above its 2% target for years to come. Market sentiment does not support high interest rates in the medium term, and interest rates are expected to reach their peak in the summer.

The Finnish real estate market had a record-breaking H1 2022, with transactions totaling 4.3 billion euros. There were 10 mega-deals worth over 100 million euros, which is more than any single year prior. In total, there were 14 mega-deals in 2022. The real estate transaction market shifted towards the end of the year, and the total transaction volume for 2022 was 7.0 billion euros. Q4 2022 saw 1.1 billion euros worth of deals, the lowest since 2012. A weak H1 2023 would be relatively unsurprising.

Contact:

Valtteri Vuorio valtteri.vuorio@newsec.fi

“ The Finnish real estate market had a record-breaking H1 2022, with transactions totaling 4.3 billion euros”

Interesting trends on the Finnish property market

Market liquidity improves amid repricing

In Q4 2021 and H1 2022, the Finnish real estate market rebounded towards pre-pandemic investment levels. However, due to monetary policy tightening, rising bond yields, and more expensive lending, the market became uncertain, leading to a low transaction volume in H2 2022. Buyers became more selective and unwilling to pay previous prices, while sellers held onto their expected prices, causing a price mismatch and low volume. As the yield gap between bonds and real estate returns shrank, this prompted a reevaluation of asset prices. Capital costs are unlikely to decrease significantly in 2023, creating an opportunity for selective buyers. As the market adjusts to interest rates, property values will adjust and support deal volume. When interest rates decline, market liquidity will increase, leading to a pickup in the market in H2 2023 after low transaction volume in Q4 2022.

Social welfare reform accelerating investments into public properties

The new Social Welfare Reform in Finland, which took effect in 2023, increased interest in Finnish public properties. 21 new regions took over social services from municipalities, causing an acceleration of property sales from municipalities to private investors. The safe

inflation-hedged cash flows from these properties attracted high investment demand, and rents rose in line with inflation and yields. Property funds focusing on public properties entered the market earlier due to interest in serviced apartments. In 2022, the transaction volume for the segment reached €1.7 billion, with 56% from healthcare and 77% from international investors, up from 73% in 2021. The Helsinki Metropolitan Area accounted for 27% of the volume, the lowest share for the capital city region among all property segments. It is expected that activity in the Finnish public property market will continue, although some deals may not go through in H2 2022 due to price differences between buyers and sellers.

Temporary downturn for the residential segment

Investment volumes for Finnish residential properties declined in Q4 2022 but still ended the year as the third highest on record, accounting for 29% of the total market volume. 2022 saw acquisitions of large portfolios and four megadeals of over €100 million. Higher interest rates affected prime residential yields and decreased the transaction volume for the segment. However, several deals are in the pipeline for 2023.

Continuing polarization on the office market

Office transaction volumes continue to decline in Finland, with investors becoming more cautious with investments. High-quality, certified, and well-located office buildings are preferred for both investments and occupancy. Occupiers seek efficiency from their premises which many times have led to relocations, deepening the polarization of the office market and creating opportunities for opportunistic investors to identify undervalued assets overlooked by the market.

EUR 7 billion

Total investment volume in 2022

EUR 6 billion

Total investment volume expected in 2023

–0.5%

GDP growth expected in 2023

The Estonian property market

Smaller deals keep the real estate investment market active

While Estonia saw the fastest growth among the Baltic countries in 2021, 2022 brought rising prices instead. Inflation in Estonia reached record levels, not even seen during the financial crisis, and began increasing towards the end of 2021 due to rising energy prices. The situation worsened in H1 2022 when Russia launched a full-scale war in Ukraine, causing further energy supply issues and driving up the cost of other goods. Inflation reached 19.4% in 2022, with the highest price increases for food and

non-alcoholic beverages (20%) and housing (nearly 51%). The economy is estimated to have shrunk by -0.5% in 2022 and is expected to grow by just 0.4% in 2023, mainly due to increased government spending, while other components like consumption and investments stay stagnant. Inflation is expected to decelerate to around 10% in 2023.

Estonia's real estate investment market saw a decline in volumes in 2022 compared to the previous year. Total investment dropped nearly 50% from its 2021 high, a trend seen in all Baltic countries. 23 deals over 5 million EUR were made in 2022, with 17 transactions in H1 and 6 in H2. Investments in H1 amounted to 129 million EUR, while H2 saw 96 million EUR. The most active sector was industrial, accounting for almost half of transactions and volume. H2 2022 also saw a sharp increase in interest rates, reducing investment activity.

“ Estonia's real estate investment market saw a decline in volumes in 2022 compared to the previous year”

Interesting trends on the Estonian property market

Residential market, change of scenery

Residential property prices, which started to rise in H2 2021, accelerated in 2022. The high demand for residential properties came mainly from individual buyers. In Tallinn, the most active market in Estonia, prices increased by almost 25% over the course of the year. During H2 2022, transactions started to decline, leading to some residential segments having only about a tenth of the previous year's deal numbers. Due to the drop in transactions and increase in interest rates, prices also began to fall, a trend that is likely to continue in 2023.

Industrial and logistics sector remained active

Industrial and logistics properties were the most transacted segment last year, with most transactions taking place in H1 2022. In H2, manufacturers faced increased costs and supply chain problems, leading many to restructure, lay off employees, or halt operations temporarily. This trend, along with lower consumption expected in 2023, will eventually affect logistics and alleviate pressure on a shortage of proper warehouses.

Domestic investors dominated the market

In recent years, the Estonian investment market has been dominated by domestic investors and 2022 was no exception. One of the most notable foreign investments was the acquisition of the Wendre production facility for over 30 million EUR, one of the largest transactions of the year.

New sporting goods retailer enters the market

Decathlon is set to open its first store in Estonia at the Kurna retail park, near the IKEA store. The 20,000 sqm park, under construction and set to be finished in August 2023, will include 20 stores and is being developed by VPH Group for over 30 million EUR.

End of the low-interest-rate era

The era of historically low interest rates ended in 2022, as policymakers were alarmed by high inflation across the Eurozone, which prompted the ECB to raise interest rates to control inflationary pressures. The ECB's target inflation rate is 2%, and further interest rate increases can be expected in 2023, though not as sharp as in 2022.

Higher interest rates should reduce property prices and increase yields. This may force some investors to sell their properties as higher capital costs make investment unprofitable.

The Lithuanian property market

The year 2022 was unexpectedly a roller coaster for Lithuania and the region. Despite facing a potent combination of challenges not seen in recent history, the country's economy still managed to grow, with a 1.9% rise in GDP. With high prices, one of the highest inflation rates in Europe (18.9% annual average HICP rise), low unemployment (below 6.0%), constrained consumption, and rising interest rates, a new period has begun.

One of the economy's key pillars, manufacturing, is slowing down, as are exports. Future growth prospects will heavily depend on foreign demand. In fact, foreign investors already doing business in the country continue to make long-term plans and

Russia will all play a role. Domestic consumption also factors in. The economy is expected to remain stable with up to 1% GDP growth and inflation controlled at 8-9%, but this will require effort. The government's budget includes programs to promote exports, investments, and aid to help residents and businesses manage rising energy costs.

Real estate investment transactions decreased in 2022 due to the market's phenomenal performance in 2021 and increased uncertainty. Local investors remained active, but seller and buyer return expectations diverged.

Projections for 2023 are varied. The extent of the economy's potential recession, the speed of price growth, and Ukraine's support in its conflict with

In the Baltic region as a whole, real estate investments totaled over EUR 840 million last year, with about EUR 365 million in Lithuania. The retail segment in Lithuania attracted the most interest, with total investments of about 220 million, a rare occurrence for a single segment. Even in the high-demand Lithuanian office segment, this amount was surpassed only once before.

After a long period of uncertainty, yields moved upwards. Both prime and secondary segments were affected by the change in expectations. The evolution of the high-interest-rate environment will determine the duration and extent of yield increases, but the “new normal” may arrive sooner than expected.

Contact:

Kristina Živatkauskaite˙

k.zivatkauskaite@newsec.lt

2022 was a year of slowing down before moving forward. Are we back to the “new normal”?

“ Future growth prospects will heavily depend on foreign demand”

Interesting trends on the Lithuanian property market

Future possibilities and Lithuania's breakthrough in manufacturing

Lithuania has become more attractive to foreign investment in the manufacturing sector. The country boasts a strong industrial base, and the government has encouraged foreign investment through incentives and grants. Access to skilled labour and innovative technology also makes Lithuania a desirable location for foreign investors. This has led to a surge in manufacturing investment in recent years, with nearly EUR 1 billion earmarked for projects involving the construction and expansion of 600,000 sqm of factory premises from 2022–2023. Both domestic and international companies see opportunities to grow and develop high-value-add industries in Lithuania.

Industrial and logistics market is set for significant warehouse projects

Speculative development in the industrial and logistics segment has been substantial. In the present geopolitical and macroeconomic environment, only large developers have the equity to assume the risk of speculative projects. Small and medium-sized developers have plans but are wary of starting them. The warehouse market offers two paths for development: large projects for in-house use and speculative projects for those taking a broader outlook. Both options

will result in a significantly increased quality of assets, often certified, ensuring long-term prospects for growth and strong market positions.

Office projects will boost business efficiency

The new supply of small-to-medium office projects serves businesses of various sizes, offering new quality, consolidation opportunities, and easily accessible, high-visibility locations. Developers are confident in planning and building these projects due to the growing demand they foresee. Adjustments to vacancy levels and rental rates are expected in 2023. Smaller-scale projects are better equipped to quickly adapt delivery schedules and follow market trends.

Population growth creates new demand for property

The rising population of the country has brought changes to many real estate segments, with Vilnius approaching a population of 600,000 due to internal and external migration. The residential rental market has had to keep pace with this growth, while changes in office market demand have been absorbed by companies relocating rather than investing and growing in the country, stimulating market activity and higher rental prices.

Project planning is hot in the Vilnius CBD

Demand for office space is high and competition for prime locations is fierce, with office demand in Vilnius having noticeably increased over the past four years. Developers, faced with a long-term low vacancy rate, now have a pipeline of new office and mixed-use projects planned for delivery in 2024–2025 and beyond. Class A offices in the CBD will remain in high demand as the growth in demand for office space is expected to continue.

The Latvian property market Investors were active

In 2022, there were over 20 real estate transactions in Latvia amounting to a total of EUR 250 million. Despite a slower second half of the year, the largest deal of the year was made in this period, with East Capital acquiring the Place Eleven office center from Lithuanian developer Hanner for EUR 53 million. The investment market is expected to pick up in the latter half of 2023, indicating sustained interest in the Latvian property market.

Indicators for inflation and unemployment were 17.2% and 6.9%, respectively. The Bank of Latvia predicts average CPI inflation of 10.9% in 2023 and 4.4% in 2024, which is higher than the EU average.

2022

Despite this, GDP is estimated to have grown 2.1% in 2022 and is projected to decline 0.3% in 2023, with a recovery of 4.4% in 2024.

Riga's office market saw limited new deliveries in 2022, with only one project, the class A Verde project with 15,000 sqm GLA, reaching the market in Q3. The high cost of construction and supply chain disruptions have delayed planned office projects. However, in 2023, a significant amount of new, high-quality, energy-efficient office space, both class A and class B, is expected to be delivered.

In 2022, construction costs caused significant increases in the prices of under-development and already commissioned new apartments. The first three quarters of 2022 were active in terms of residential transactions for both old and new properties, but the pace slowed in Q4 as the market prepared for the new heating season. The industrial market continues to develop, mainly with experienced developers, who are likely to pre-lease a lot of the industrial space during development and construction.

Overall, the property market is performing well despite the challenging economic and political situation. The pandemic has shown to have increased resilience among individuals and businesses.

Contact:

amid the challenges of

“ The investment market is expected to pick up in the latter half of 2023”

Interesting trends on the Latvian property market

New office developments excitedly awaited in 2023

There has been a lot of discussion about the significant amount of high-quality office space under development in Latvia for future delivery. Although the timeline has been delayed, the “future” is getting closer, with delivery planned for 2023 of nearly 100,000 sqm of new office space built to meet the latest standards and energy requirements. Over 70,000 sqm of Class A space will become available in the Skanste area, with 3 outstanding office projects: the second stage of Verde, Elemental Skanste, and New Hanza. The center of Riga will also be enhanced with the Novira Plaza, located in the busiest part of the city close to the Origo One office project completed in 2020. Each project is unique and inspiring. Meanwhile, the Class B market will see an increase of 28,000 sqm of quality office space, including the fully pre-leased Gustavs Business Center, and 3 other medium-sized offices: Valdemāra Biroji, Zeiss Biroji on Mūkusalas Street, and an office building extension of the existing Barons Kvartāls. These Class B projects are in many ways equivalent to Class A ones.

No clear indexation strategy yet

The season with increased heating needs for properties has started, and new utility bills have been received. While most

lease agreements include negotiated indexation, such as inflation caps, this time the situation is difficult. With rising additional costs, like utilities, property owners are unsure if they should raise the rent and to what extent. Decisions will vary segment by segment and on a case-by-case basis, depending on the leased space, agreement length, and other factors. It seems clear that as energy prices and ESG requirements increase, more attention will be paid to energy consumption, alternative energy options, and optimization through automation.

Experienced developers are encouraging industrial market growth

Currently, nearly 140,000 sqm of new high-quality industrial space is under development and scheduled for delivery in 2023. Most of this space is being developed by 3 experienced developers: VGP, Sirin Development, and Piche. In a few years, Sirin Development also plans to build another 200,000 sqm of high-quality modern industrial space near the Riga airport. With rising energy prices, smart energy consumption will be particularly important in the logistics industry, where the difference in rental rates among property classes may be less than the difference in utility costs. Thus, the market will embrace advanced, flexible, energy-efficient industrial developments.

Green rush

Recently, every business has been trying to implement energy-saving measures, from simple ones like lighting adjustments and energy equipment upgrades to hiring experts to review energy consumption and recommend optimization. Many property owners have turned to alternative energy sources, such as solar energy through solar panels.

Previously, tenants paid little attention to a property's “greenness,” but now that has become much more important. Real evidence is often demanded, such as utility costs, to enable comparisons with other similar properties. Before, end-user energy saving among consumers and organizations was often seen as an outdated habit, but now most such measures are viewed as normal or even smart, as every household and business has been affected by the rise in energy prices. Experience seems to have taught this lesson faster and more effectively than listening to the theoretical advantages.

European Markets Overview

One of the biggest falls in investment volume since the Global Financial Crisis (GFC)

The prolonged period of near-zero interest rates, a ten-year global norm, ended far more abruptly than many anticipated in 2022. In the space of six months, the world’s central banks normalized monetary policy back to the period before the GFC, delivering a cold hard shock to Europe’s real estate investment markets.

Total investment in Europe was €248.3bn for 2022, down 14% on 2021. This was a year of two halves, with the second half characterized by a deterioration in activity, resulting in a 76% decrease in transaction volumes in Q4 compared to the same period in 2021, which was far larger and quicker than that which occurred in the GFC period in 2008.

In terms of sectors, offices (€90bn) and logistics (€54bn) bore the brunt of the slowdown in 2022, each falling by 21% compared to 2021. The alternative sector declined by 14% to €27bn. Retail, the most battered sector of the pandemic, remained relatively stable at €34 billion, down 2% compared to 2021, largely due to strong growth in H1. The UK posted the largest investment volume at €64bn but also the biggest annual decline at -19%. It is followed by Germany at €54.1bn (-16%) and France at €27.9bn, with an increase of 1%. Many other countries also posted annual increases, including Belgium (€8.6bn, 177%), Spain (€12.9bn, 29%), and Italy (€10.9bn, 25%), largely due to the strong H1.

The UK posted the largest investment volume at €64bn through also the biggest annual decline at -19%. It is followed by Germany at €54.1bn (-16%) and France €27.9, with an increase of 1%. Due to the strong H1 many other countries also posted annual

increases despite the Q4 collapse. These included Belgium at €8.6bn (177%), Spain at €12.9bn (29%) and Italy at €10.9bn (25%).

H2. The European composite yield for retail stood at 3.6%, only 20 bps having witnessed the most increase during the pandemic. Logistics composite yields (16 markets) suffered the most, expanding by 70bps to 4.2%, the sharpest price correction of all sectors.

The new macro-financial backdrop for European real estate that emerged over 2022 is likely to give way to a year of greater stability as interest rate rises slow to a stop. The market is emerging from a period of pricing discovery led by the prime end of real estate. Much of the repricing for the best quality property has now taken place, though for secondary assets considerable uncertainty may exist over 2023.

Very active very selective office demand

Yields poised to take new positions in 2023

A large factor in the collapse of transactional volumes in Q4 lies with pricing mismatch. Against such a rapidly shifting backdrop of interest rate rises and bond yield escalation, fewer investors were willing to test the waters on acceptable pricing. This prompted one of the biggest yield decompressions in some markets. At the aggregate, the composite office yield for Europe stood at 3.8% for the 16 top markets at the end of 2022, which expanded by 60 basis points since the start of 2022, with sharp increases over

It was a good year for take-up, with around 9.17 million sqm of letting transactions in Europe’s 17 main markets, in line with the long-term average for take-up, which was 12% higher than 2021. The good lettings activity meant the occupational market diverged from the performance in the investment side of real estate over H2 2022. Dublin (63%), Warsaw (48%), and London (45%) witnessed good take-up over 2022. Cities where volumes exceeded 10-year averages included Milan (+38%), Cologne (+11%), Hamburg (+9%), and Warsaw (+7%).

Newsec's research partnership with BNP Paribas Real Estate enables both companies to provide full coverage across all European markets.

“ The market is emerging from a period of pricing discovery led by the prime end of real estate”

The European occupational market may be quieter in 2023 than in 2022 due to companies focusing on cost control amidst the economic outlook and persistent inflation. Hybrid working is also gaining momentum in Europe, which could reduce demand for office space in 2023.

Lettings in 2022 focused on securing modern, adaptable spaces with high environmental standards, favoring them over second-hand spaces. Pursuing the 'less but better' ethos associated with new working practices comes at the expense of second-hand ('grey,' especially) spaces put on the market. Consequently, the European vacancy rate remains static at 7.1%, unchanged from 2021. At the city level, the picture is more variable, reflecting the balance of modern-to-old stock and pipeline. German cities remain the ones with the lowest vacancy rate overall, led by Berlin at 3.2% (-20bps over 2022).

The demand for top-quality space has drained an already tight market, albeit one with an active pipeline. This leaves European markets cleaved between scarce good space and an abundance of lower quality offices (the units abandoned in 2022). This dynamic resulted in further widening between prime and average rents across Europe in 2022. Modern CBD-centered units, the segment with the best energy standards and lowest availability, drove prime rents in 2022. All cities witnessed growth. The strongest increases were seen in London (+19%), Warsaw (+13%), Milan (+11%), and Dublin (+9%).

The performance of secondary rents is now trailing that of prime rents. Older buildings are highly exposed to energy regulations that make units more expensive and far less attractive to occupiers. The European Commission proposes upgrading Energy Performance Certificates to at least Grade F by 2027.

The UK is further ahead, and in 2023, legislation will forbid letting of units below Grade C. Some properties not at this standard may start leaving the stock as energy-obsolescent buildings, a new market feature likely to become increasingly common from 2023 onwards.

Retail held up better than expected

Investment in retail survived the crash better than other sectors due to particularly healthy H1 sales, and ended the year only 2% down. The greatest challenge has been in the occupational sector where inflation and the cost of living crisis present immense operational challenges. Many brands have struggled to absorb the cost increases without cutting into their margins and, therefore, had to increase the prices of their products. Mass-market brands such as Zara, Uniqlo, and Mango increased the prices of their products by 8% on average in Europe. Luxury brands took the same direction. Nonetheless, retail sales were healthy in Europe in 2022. Many retailers reported solid turnover (Zara, Fast Retailing, SMCP, LVMH, Kering, Prada, and Hermès). The level was driven by a strong recovery in international tourism, and footfall in places of mass consumption sustained the occupier base.

There is bifurcation in rents between different retailing segments, though. Recovery in footfall and spend is insufficient in mass-market areas to support rental growth. Over 2022, declines occurred in the high street segment of some cities. London witnessed a drop of 26%, with Amsterdam (-7%) and Paris (-6%) also declining. Berlin was flat. In contrast, rents for units in luxury streets increased. London by 2%, Berlin by 10%, and Paris by 14%. This highlights the role that inflation plays in where consumption goes, having differing effects. As inflation is likely to continue over 2023, it implies

that food discounters and other value retailers will see continued trade as consumers struggle with the cost of living. At the other end, the luxury market will probably continue to expand with new units, particularly as high-end travel picks up.

The slowdown continues to be selective, with the most severe in Poland (-22%), the UK (-18%), and France (-13%). In contrast, the Netherlands (3%) and Spain (8%) both saw increases by the end of the year. The problems of securing suitable space have not gone away even with a slower economy. Consequently, vacancy in the logistics sector continues to operate at historic lows with the European average still below 4%. There are few speculative developments in any country.

Scarcity continues to shape the outlook for logistics

Although the volume of European investment declined by 21% in 2022 to €54bn, nearly €15bn, investment remains greater than the average annual amount recorded between 2017 and 2020. The market continues to attract buyers even with severe yield decompression largely because of the rental growth prospects.

The total letting volume for the six leading markets reached 26.9 million sq m in 2022, down 10% in the six leading European markets. This compares well with the exceptional volumes recorded in 2021. The lettings market volume in Europe remains above its 5-year average, and the market looks likely to hold up well despite economic slowdown.

The scarcity issues drive the rental prospects that attract investors. After a decade of flat growth, rents started to increase meaningfully across Europe in 2022. The average European growth was 12% over the year for 48 markets. Very large rental increases occurred in the UK, especially the Birmingham market (38%), London (19%), Warsaw (33%), and Prague (31%). Massive increases in construction costs led to significant rental growth in Hamburg, Munich, and Cologne during 2022. Persistent inflation, rising construction and labour costs, as well as the shortage of land, may continue to push rental increases over 2023.

Samuel Duah, PhD, Head of Real Estate Economics at BNP Paribas Real Estate

“

Hybrid working is also gaining momentum in Europe, which could reduce demand for office space in 2023”

Macroeconomic Data

Norway

Macroeconomic Data

GDP Growth

Property Data Property Data

Retail

Property Data

Retail yields

Logistics rents

Logistics Rents | Nordic Region

Logistics

Newsec

Gothenburg Malmö Oslo Helsinki Copenhagen

Average Annual Rental Growth 2018–2022 (left axis)

Forecast Average Annual Rental Growth 2023E–2025E (left axis)

Rent Level 2023E (right axis)

Prime Logistics Rents | Baltic Region

Newsec

Tallinn Riga Vilnius

Average Annual Rental Growth 2018–2022 (left axis)

Forecast Average Annual Rental Growth 2023E–2025E (left axis)

Rent Level 2023E (right axis)

Vilnius

Residential Rents | Nordic Region

Public properties

Prime Public Properties Rents | Nordic Region Source: Newsec

Annual transaction volumes

Gothenburg Malmö Helsinki Copenhagen

Average Annual Rental Growth 2018–2022 (left axis) Forecast Average Annual Rental Growth 2023E–2025E (left axis)

Rent Level 2023E (right axis)

Gothenburg Malmö

Average Annual Rental Growth 2018–2022 (left axis) Forecast Average Annual Rental Growth 2023E–2025E (left axis)

Rent Level 2023E (right axis)

Property Data

Office stock

Definitions

General

• All rents, yields and vacancies are end-of-year values.

• All forecasts are referring to nominal values.

• The rental levels are the most probable prime rent when signing a new lease agreement.

• All yield levels are referring to net initial yield.

Offices

• The forecast is referring to new/refurbished modern and flexible office premises with normal area effectiveness.

• The rents are referring to premises of at least 500 sqm.

• The rent is excluding heating and excluding property tax.

Retail

• The rents are referring to modern retail premises of 70–250 sqm.

• The rent is excluding heating and excluding property tax.

• The rents refer to prime areas with definitions by each country.

Residential

• The forecast is referring to attractive locations with an area of around 80 sqm.

• Definitions generally, as well as of new and old housing depend on the country.

Logistics

• The forecast is referring to warehouses and logistics premises.

• The rents are referring to premises of 5,000–10,000 sqm with a 10 year lease agreement.

• The rent is excluding heating and property tax.

• The rent refers to modern, newly built premises with a solid lease contract and tenant A properties.

Public Properties

• A public property is defined as a property used predominantly for tax-financed operations and specifically adapted for community service. In this document, public properties are limited to schools (pre-schools and primary schools), hospitals, and elderly care homes.

• The market data refers to public property premises of normal to modern standard with normal space efficiency.

• The market rent refers to the rent excluding supplements.

Exchange rates

All rents and transaction volumes are calculated using the average exchange rates in 2022.

The Newsec Property Outlook Team

Denmark

Finland

Baltics

Morten Jensen Head of Newsec Advisory Denmark morten.jensen@newsec.dk

Robin Rich Head of Research robin.rich @newsec.dk

Valtteri Vuorio Head of Research valtteri.vuorio@newsec.fi

Mindaugas Kulbokas Head of Research & Analysis m.kulbokas@newsec.lt

Kristina Živatkauskaitė Senior Analyst k.zivatkauskaite@newsec.lt

Inita Nitiša Real Estate Economist i.nitisa@newsec.lv

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