Recent developments in the Finnish and Baltic real estate market

Author: Kaj Swanljung, Roschier, Helsinki

The Finnish and Baltic real estate markets maintained their rapid rate of growth through 2006. This growth has triggered a notable increase in the number of new international real estate investors entering the Finnish and Baltic markets. Relatively low interest rates and competitive yield levels, in comparison with other European markets, are fostering this influx of foreign investment.

One of the most interesting phenomena has been investors' gradually growing interest in residential premises, a segment previously dominated mainly by municipalities and pension insurance companies. The volume of residential property deals has historically been moderate as there has been a limited number of suitable residential property (portfolios) on the market. Therefore, the recent establishment of property funds specializing in residential properties has been well received, providing some indication of increasing liquidity and where the markets may be heading. While the prime source of residential properties has so far been from pension institutions, there are signs that some municipalities are becoming more active and considering divestments of their residential property holdings.

Another significant feature of Finland's property market is foreign and domestic investors' growing interest in energy sector property. This property sector, previously shared by industrial users, has this year seen some interesting acquisitions led by financial investors.

Other important developments observed recently in the Finnish real estate market were related to the introduction of new structures – Real Estate Investment Trusts (Reits) and limited partnerships (LPs) in the real estate investment business. However, despite high expectations, the launch of new legislative reforms that aimed to revive Reits was a disappointment to the market, which is the reason why Reits are generally not being used in Finland. In the meantime, LP structures commonly used in private equity transactions have been introduced in the real estate investment business, providing an attractive alternative to Reits. One of the most significant players in the LP property fund market is Capman, a Nordic private equity house that launched its first LP fund in June 2005 with a focus on commercial properties.

As both Reit and LP-structured investments are directed to institutional investors, it may be worth asking why there continue to be limited opportunities for private individuals to make indirect property investments. Considering the bull market in the property sector and long-term traditions in direct property investments, one may assume that indirect investment opportunities would be well received.

An additional trend, caused by the increasing flow of foreign investment, is the alignment of domestic market practices to those in use internationally. The vast majority of all significant real estate sales processes are now conducted through a controlled auction process. A noteworthy new development is reliance-based (legal, financial, environmental and technical) vendor due diligence (VDD) reports becoming an increasingly common feature in connection with structured sales processes. From a purchaser's perspective, the availability of a VDD report means savings in transaction costs and time and an incentive to participate in further sales processes. A vendor, on the other hand, benefits from a VDD report in two ways. Firstly, through improved control of the information flow, eliminating potential undesired surprises raised by a purchaser during the sales process that could have an impact on the purchase price. Secondly, the possibility of including several motivated potential purchasers until the final stage of a sales process enables competition among the potential purchasers until the end of the process. Naturally, this allows the seller to get the most out of the process in terms of purchase price and conditions.

The situation is similar in the Baltic States. However, some differences are apparent. For example, investments in commercial premises remain in the shadow of the residential premises boom. This is due to the fact that domestic investors, which still form a significant part of the real estate market, are focusing on short-term profit, and investments in the residential premises sector are expected to be more profitable than in the commercial segment. Also, residential premises are suitable and affordable targets for smaller domestic investors. However, foreign investors have also become increasingly more active during the past year and are mainly interested in large commercial premises located in major cities. Smaller foreign investors have also invested in residential premises. The number of foreign investors entering the Estonian, Latvian and Lithuanian market is expected to increase in the near future.

VDD reports are not a common feature of real estate transactions in the Baltics and are mainly used in situations where the seller or the potential buyer are foreign subjects and the seller is willing to save time on negotiation of the acquisition documentation.