In little more than two years the Finnish real estate investment market has virtually exploded in an astonishingly rapid development from a dormant domestic market to one of the most dynamic real estate markets in northern Europe. While this has inevitably led to a certain rise in prices and a corresponding fall in yield levels, Finland continues to be an interesting market for foreign leveraged investors. In a recent market commentary, Finnish investment advisors have estimated that the number of foreign investors active in the Finnish real estate market had between 2004 and 2005 gone up from 17 to 80. The rising prices have also had the effect of bringing new sellers to the market.
Another clear trend is the increasing role of leverage and, with that, external financing. More and more companies and properties are being purchased by highly leveraged professional investors. In real estate transactions, leverage is often expressed in terms of LTV (Loan to Value) ratio. The higher the LTV, the greater the upside for the investors in the form of potentially higher returns on their investment. Conversely, a high LTV-ratio means more risk for the lenders. With increasing competition, both among investors and among lenders, LTV-ratios have in certain cases been pushed as high as 80%, and in some cases 90%. There are also specialized structures in the market, where the combined external financing matches or even exceeds the purchase price for the property. In these structures however, the investors generally grant security, albeit very limited.
Based on the above, it may seem that real estate financing is no business for the fainthearted. However, the risk is in practice reduced by hedging 100% of the interest exposure and by annual (albeit small) amortizations. By hedging the interest exposure for the full term of the investment, an investor with a solid ten year lease can attempt to eliminate other risk than that related to a fall in property values over the investment period or the insolvency of the lessee. Seen in a ten year perspective, even modest annual amortizations will absorb a significant amount of property value related to risk.
It is obvious that the rapid development, the risk profile and the fact that most investors are foreign professional investors, have favored specialized foreign lenders with a clear view of the market and a willingness to make quick decisions. In particular Eurohypo’s market share is impressive. It seems obvious that one of the keys to success in this area is a strong international reputation combined with a market oriented and investor friendly local presence.
Most transactions are done under local law and with documentation that is clearly designed and negotiated with a view to being capable of being syndicated but at the same time very condensed, cost efficient and user friendly. Borrowers are generally Finnish special purpose companies held through Luxembourg. Often the target real estate company is, following closing, merged with and into the acquirer.
One new element that has emerged fairly recently is international banks teaming up with professional investors and taking a stake in the equity as well as providing the senior financing for the transaction.
Another clear development is new lenders without a local presence entering the market with a view to securitizing the financing once a suitable real estate portfolio and dressed up for the rating agencies. The requirements of the rating agencies could create a trend towards more complex and defensive loan and security documents. It will also be interesting to see what approach rating agencies will take to security over shares in Finnish mutual real estate companies.
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