More challenging operating environment reflected in the valuation of the Nordic real estate sector

Analyst Comment

The share price development of Nordic listed real estate investment companies has been gloomy this year as the sector has declined by around 37% from the level at year end. The key factors behind the heavy share price drop are the market rates that made a clear upturn in early 2022, the credit risk margins that have flared out on the corporate lending market, and fears about a possible stagflation and a turn in the real estate investment market cycle.

Measured by share price development, the weakest performers in early 2022 have been real estate investment companies focusing on housing (median YTD -45 %) and the share price drop partly reflects the clear downturn in housing prices seen during summer in our western neighbor. Companies with both residential and business premises (‘Mixed’ in the graph) have also performed poorly in early 2022 in terms of share price development (median YTD -41%). Similarly, the real estate types that have fared best in early 2022 are commercial properties and real estate investment companies that focus on offices who were already priced at a clear NAV discount.

In H1, the Nordic real estate investment market still reached the trading volume of the comparison period and listed companies as a whole reported good results and positive value changes. Fair values have for some companies been supported by rent increases due to indexation and required returns that still decreased in certain real estate types in early 2022. However, pricing on the stock market is forward looking and future expectations are reflected in current valuation levels. A slight recovery has been seen in the share prices of the Nordic real estate sector in recent weeks and currently the sector’s median company is priced some 24% below the NAV at the end of Q2’22 (Q4’21: 26% NAV premium).

We believe that the current operating environment is rather difficult for real estate investment companies as the business drivers are pointing in the wrong direction. Higher interest rates and credit risk margins will increase companies’ financing costs and cause upward pressure on required returns for properties, which may result in a drop in the fair value of real estate. We also believe that companies in the Nordic real estate sector are more interest-sensitive than other European countries, partly due to higher indebtedness, financing having shorter maturities and more limited interest rate hedging. The current inflationary environment would in principle be favorable for real estate investment companies, but the deteriorating economic situation and the already high rental offering in certain sub-markets (e.g. the housing market in the greater Helsinki region) may in practice prevent rent increases. We expect companies whose gearing is relatively low and who focus on real estate with higher return levels will perform best in the current operating environment.

Despite declining share prices, we are currently cautious about the sector and find the valuation levels of the companies we monitor as neutral at best with current share prices. The Q2 company updates (in Finnish) for the companies we monitor can be read here: Cibus, Investors House, Ovaro Kiinteistösijoitus and Toivo Group