Vacancy rates are high but the market has bottomed out and rents should rise again in 2006
An outsider could be forgiven for thinking that nothing much has changed in the Swedish property market in the past year. The talk is still of a recovery, yet vacancy levels remain virtually unchanged; on Jones Lang LaSalle’s “property clock”, a measure of what stage markets stand at in the economic cycle, Sweden seems to be stuck at six o’ clock –the point where the market has bottomed out and is on the verge of accelerating rental growth.
But a closer look at the market shows that things are changing, albeit slowly. There is more activity in the market than a year ago. Swedish companies are considering renting more space when looking at new leases. In time, this is expected to have an impact on vacancy rates, but now may be the time for investors to position themselves in preparation for an upturn. But a lack of property on the market has resulted in fierce competition, leading to lower yields.
“We hit the bottom last year,” says David Dahlgren, head of investment strategy at Aberdeen Property Investors in Sweden. “The market is pending, but more improving than deteriorating. Letting activity is improving, but from very low levels.”
Economic improvement
The Swedish economy further improved last year, with gross domestic product (GDP) growing 3.5% compared with 1.6% in 2003, thanks to a rise in investment and net exports. Low interest rates and increasing house prices have led to higher household debt and increased consumer spending.
Like most other countries, the fortunes of Sweden’s economy largely depend on what is happening in the US, which is struggling with both deficits in the federal budget and the current account. There are worries in Sweden that a slowdown caused by the knock-on effects of US economic problems could cause a fall in house prices, which in turn will affect consumer spending.
Even though Sweden’s GDP growth is expected to drop below 3% in the coming years, companies have become slightly more optimistic about the economic prospects and are considering hiring more employees.
Claes Kjellander, European director of Jones Lang LaSalle in Stockholm, believes unemployment may no longer be increasing. “With the new leases being taken, you can see companies anticipating hiring more employees,” he says. “They are already taking more space.”
Phone manufacturer Ericsson reported a 12% rise in first-quarter sales compared to the same period last year and net profits rose 76%. Ericsson, while not Sweden’s largest company, is seen as a bellwether for the country’s IT industry because so many subcontractors depend on its fortunes.
So far, better company results have not lead to a significant increase in take-up, let alone a drop in the vacancy rate. Greater Stockholm still has a vacancy rate of 15%, according to Kjellander. In Kista, Sweden’s equivalent of Silicon Valley, the vacancy level has fallen from around 30% to 20%, but some observers point out that much of this drop can be attributed to a handful of lettings, including the Defense Research Institute (FOA) taking up 21,800m².
The central business district (CBD) vacancy rate is around 12%, according to Aberdeen Property Investors. Office take-up is still largely driven by companies wanting better accommodation or a better location. Any improvement in the market is largely limited to small, specific areas, says Aberdeen’s Dahlgren. Within the CBD, he sees companies moving from Stureplan and Kungsgatan to the area around the station.
There could be further shifts in occupancy patterns if the city introduces a congestion charge, which is now being considered.
Location really counts
Lennart Sten, managing director of GE Commercial Finance Real Estate, believes companies are more interested in location than in modern office buildings featuring the latest air-conditioning systems. After a short stint at Fabege, Sten returned to GE, where he was head of the group’s Nordic commercial property operation from 2001 to 2004, to take over from Lennart Weinz, who disappeared in Thailand when the Tsunami struck.
Sten believes Stockholm’s CBD and Kista will be the first to benefit from a recovery, but is more cautious about an upturn than most people in the market. “If we don’t have a strong disturbance, we will see rental growth in the second half of 2006,” says Sten. This may seem far away, but Sten believes now is the right time for GE to start looking for offices in Kista and the inner city with the aim of redeveloping them.
GE is not the only investor taking a renewed interest in an already crowded market. Companies such as Sweden’s Wihlborgs, which merged with Fabege last year, have been busy buying secondhand offices and refurbishing or redeveloping them in order to sell them on.
Swedish pension funds are also making a comeback. Rising stock markets have led to changes in the weighting of their investments, resulting in property becoming under represented.
The Swedish investment market produced a record Skr100bn (€11bn) turnover in 2004, according to Aberdeen Property Investors, a figure that is expected to be matched this year. Swedish investors accounted for 61% of acquisitions, whereas in 2003, around three quarters of all acquisitions were completed by foreign investors.
However, Swedish investors remained net sellers last year, disposing of SKr20bn more than they bought, according to Aberdeen Property Investors. Wihlborgs took fourth place in the tables for both last year’s biggest sellers and biggest buyers. Among Wihlborgs’ more recent deals was the SKr1.950bn sale of Fatburen 5, in the south of Stockholm, to Danish investor Keops. Wihlborgs had transformed the former sausage factory into a modern office building occupied on a long lease by Sweden’s tax office.
Together with Norway’s Acta, Keops has been buying aggressively over the past year. Keops buys properties at auction, financing its acquisitions with up to 80% of senior debt. The rest of the purchase price, including brokerage fees, is covered by mezzanine debt, financed by bonds issued to the public through the Copenhagen stock exchange.
Many Swedish market observers are worried about the long-term consequences of such aggressive deals, as they are taking place in markets that are not very liquid, which may not offer buyers an easy way to exit from their investments. Fatburen 5, for example, is located in a mainly residential area and its viability as an investment will depend on the tax office remaining there.
The strong demand for property has pushed yields ever lower. Swedish investors are still surprised by two recent office deals that reflected yields below 6%. German insurer Allianz bought the Jericho 34 office building from Swedish property company Diligentia for SKr1.165bn, reflecting a 5.75% yield, while Germany’s Oppenheim bought Elefanten 17 from Fabege for the same yield.
The downward shift in yields is making the market less interesting for opportunistic buyers. “There has been a yield compression of between 75 and 150 basis points in the past year,” says Leif Andersson, managing director of Andersson REIM and a local partner for Blackstone Group. “The competition is much harder. To carry out a deal you need to take on more risk and be more active as an asset manager.”
Opportunities in the regions
Opportunistic investors may still find potential purchases in the regions, where the markets are less liquid, or in Stockholm’s secondhand office market, according to Andersson. However, regional markets such as Gothenburg and Malmö are less liquid than greater Stockholm.
It took the Blackstone Group over two years to add another suitable investment to its first Swedish portfolio, which it bought in 2003; it finally bought four office buildings for Skr1.1bn from developer Skanska last month. Andersson declines to give the initial yield for the deal, but market sources believe it to be around 8%.
After this deal, Blackstone bought a 50,000m² office in Gothenburg for SKr540m. Two months ago, it sold three buildings, with total floor space of 70,000m², to Acta for a sum between SKr1.5bn and SKr2bn. The shortage of property on the market is underscored by the fact that most buildings in Blackstone’s transactions came from developer Skanska.
