Property Market Review Q1-Q3/2018

Predictability changed into uncertainty
Ten years have passed since the collapse of Lehman Brothers - the historical bankruptcy leading to the global credit-crunch, yet we feel the aftermath. Despite the good shape of the Finnish financial sector, Finland, as an open, export driven economy, was one of the most hit countries. In 2009, the GDP was reduced by a total of 8.3 per cent. As a result of the crisis, Finland was among the worst performing economies in Europe lagging behind our Nordic neighbours. The subdued economic situation was reflected in the real estate sector as stagnation in the occupational market, decrease in property investments, and investments focusing on prime product in the Helsinki Metropolitan Area (HMA).
Today, Finland is on the radar of international property investors harvesting opportunities both in traditional and in alternative property sectors. The Finnish economy has recovered and exports have supported GDP growth to 2.5%. Politically stable environment, easy to do business, an effective rule of law, and high quality infrastructure are some of the benefits Finland offers to foreign property investors. In the wake of economic growth the occupational market has been recovering, however, the recovery is mainly confined to attractive locations with tenants seeking the best lease terms, quality upgrades or strategic relocations. Highly urbanized metropolitan area and other major growth centers with universities and transport hubs attract both tenants and investors. Winning locations will be people-led. The importance of user preferences shows constant increase.
We have seen a decade of economic upswing without any shock in spite of many geopolitical clouds in the sky along the way. After years of steady growth and low interest rates, many observers anticipate a correction. For three years time a turn of the cycle has been expected but still, the property investment boom continues. Urban Land Institute in its annual Emerging Trends report expects an overall economic slowdown next year and sums up that the only certainty for 2019 is uncertainty. A few signals of increasing threaths are recent Brexit proceedings, political winds in Italy, in Germany, and generally in the EU. The whole world is more complex with different multilayer trends, the effects of which are unpredictable.
Technology tackles the real estate as the rise of industry-specific technology and artificial intelligence are gaining ground. Retail and office market transformation challenge real estate market players. Newcomers in real estate business, such as WeWork and Amazon, have recognized great potential in analyzing user behavior and preferences in order to offer best user experience. The rise of omni-channel retail and the shrinking retail space place new requirements on designers and investors to develop efficient and convenient uses of space from small shops to big box stores and shopping centers. The experience economy with versatile services bring new types of tenants and leases to the shopping centers.
Sustainability issues play a crucial role in real estate business. A recent report on the future of climate change even painted a gloomier picture than expected. Green practices are a core part of real estate business. Most major property investors and real estate companies have their own sustainability policy. Sustainability is more often one of the most important terms in tenants’ choice of working environment.  
All these facts mentioned above makes it very difficult to navigate in the business environment and to forecast how real estate manage to cope with the challenges ahead.

Property market sentiment remains positive                  

The volume of pending deals suggests increasing investment volume in Q4

Favorable economic landscape and persistent low interest rates have led to a continued attractive real estate investment market. Finland offers solid property market fundamentals, stable political climate and operating environment, and still attractive yields. Foreign investors appreciate transparent market and good availability of market information. Besides, the Finnish leasing practice is safe and one of most liberal offering equal benefits to local and foreign investors. Investment demand outweighs supply. Cross border investments accounted for approx. 66% of the total investment volume of 7.3 bn euros for a year-to-date. Office was the most traded property type in Finland thanks to the rental growth and leasing activity. Source: KTI

Pending deals and a strong start for the 4th quarter suggest the investment volume to surpass clearly the total volume of 2016 but to fall slightly below last year's record. A major transaction, completion in Q4, is the sale of the listed property company Technopolis Group’s shares to Kildare Partners. The market value of the properties owned by Technopolis in Finland amounts to more than 900 million euros. Another mega deal in Q4 is the sale of the shopping center Itis for about 516 million euros to the property fund managed by Morgan Stanley RE. The investment activity does not seem to slow down, even though the boom has been going on for several years, and heavy competition for prime properties has driven yields historically low.
Prime yields have stabilized largely in Europe towards the end of 2018 and they are expected to remain stable in the next few months. In certain alternative segments yields may compress further but the shift will be minimum. In Finland, experts still see an opportunity for further yield compress in the near future, based on the readiness of foreign investors to pay higher prices for good quality properties. The majority of RAKLI-KTI Barometer respondents, however, predicted a slight increase in yields over the next twelve months. Source: RAKLI-KTI Barometer
Office occupational market perform well - changes in working environment drive demand for office space
Current market conditions support rental growth at the quality end of the market. Customized new or renovated premises are preferred by users. Changes in working environment drive demand for office space. Preference of multifunctional shared spaces and a choice of additional services grow steadily.
Demand for serviced office space, coworking and other flexible space solutions included, have rapidly gained foothold. Both start-ups and established corporations are interested in coworking and multi-site working. Varied rental periods and flexible lease agreements are becoming more common. Still, there is need for traditional offices and for long leases as well.
We have seen rents continue to gently rise throughout the year. Prime rents have risen rapidly but at a slightly slowing pace recently. The rental growth will continue in early 2019. Rents for modern or redeveloped premises with good location have been showing the strongest performance. The monthly prime median rent for new leases currently exceeds €30 per sqm, representing a highest quotation registered, ever. The KTI rent index showed an annual growth of 6% in fall 2018 in Helsinki CBD, while in fall 2017 the growth was 3.5% and in 2016 only 1.1% respectively. The upper quartile is approaching €36 already and the top prime rent levels exceed €40 per sqm. Letting demand is increasing especially in central and inner city areas. Source: KTI
Activity in office construction has increased in the wake of the largest development projects in the Helsinki Metropolitan Area (HMA), ever. Well over 200,000 sqm of new office space and 113,000 sqm redevelopments were under construction at the end of September 2018, most in the city of Helsinki area. Office space supply will increase on the one hand by new building and on the other hand by the enhanced use of space and new ways of working. Occupiers’ interest in sustainable, functionally efficient and flexible space is a driving force for active office development. Source: KTI, RPT
The number of conversions of office buildings into alternative type of properties is growing. Over the last 5 years, more than 430,000 sqm of office space has been converted into other use or demolished in the HMA. However, this is not enough to absorb new supply entering the market even if the net take-up volumes have been positive for the third consecutive year. Rapid office development and demand focused on high quality and efficient premises keeps vacancies high, even if the vacancy rate declined by almost two percentage points during the last six months. Source: KTI
Retail is balancing between physical and online store
The retail sector is changing, driven by consumer needs. Changes in consumer behavior and restructuring of trade challenge both property investors and retailers. The marked growth of online business causes tough competition between different types of shopping. In an increasingly difficult environment, retailers are evolving their business models in order to be able to cope with in the world of omni-channel. It is difficult to find the right balance between physical and online shopping. Online stores might challenge turnover based lease agreements in physical stores.
Restructuring and consumer preferences are reflecting to the tenant mix and to the churn rate in the shopping centers. It is not enough to be a good shopping center with an ordinary tenant mix, more important is the entity: destination itself with good restaurants, cafes and services not to forget the environment and experiences it offers. Growth will be in experience and convenience.
The rent spread of new retail leases has decreased in the Helsinki city center area in 2018. The upper quartile fell, while the lower quartile rose. Monthly median rents in the KTI’s rental data base stood at €73 per sqm, which was down from the fall 2017, but at an average level compared to a few biannual periods before.

Shopping centers in the HMA have performed better than elsewhere in Finland supported by the net migration gain and stronger purchasing power. In prime shopping centers rental levels are anticipated to increase slightly, while in several submarkets the rents are expected to remain stable or even to decrease in minor shopping centers in secondary locations. The outlook for the performance of shopping centers outside the metropolitan area has turned negative. Source: RAKLI-KTI Barometer

So far, retail occupancy rates have remained resilient in the turbulence of restructuring. In KTI’s rental data base the retail occupancy rate was 94.2% in the HMA in September 2018, slightly less than in spring 2018. The nationwide occupancy rate of 91.6% was slightly up from the level of a year ago. Source: KTI

According to the RAKLI-KTI barometer the balance figure of the retail vacancy forecast in the HMA showed zero, meaning that half of the respondents expect the amount of vacant space to decrease and half to increase. In the rest of Finland, the balance figure showed negative trend, meaning increase in vacancy.

The volume of new retail construction has been strong in the Helsinki Metropolitan Area in recent years, and dynamic development will continue in the years ahead although the peak is over. In September 2018, there was some 240,000 sqm of new retail space or redevelopments under construction in the HMA. Within ten years more than 540,000 sqm of new and some 310,000 sqm of redeveloped retail space has been completed in the HMA, largely in the city of Helsinki and Espoo areas. Source: KTI, RPT
The population of the Helsinki Metropolitan Area is expected to grow from the current 1.1 million to 1.2 million by 2025. As a result of strong retail construction, the retail space per person grows as the population grows slower than the volume of new retail space production.
In other major cities (6 mentioned beneath) the rentable area of retail space under construction in September 2018 was just slightly more than 60,000 sqm in total. However, within ten years one million square meters of new retail space in total has been completed in Tampere, Turku, Oulu, Jyväskylä, Lahti, and Kuopio. Construction has been strongest in Tampere, where nearly 320,000 sqm of new retail space has entered the market. Source: KTI, RPT
Further information: Irma Jokinen, research manager