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EfTEN’s beginning years

Ten years ago we founded EfTEN Capital – an investment company focusing on investments in commercial real estate. The idea was born in late 2007. At that time, you could feel very distinctly that the rapid economic growth in the Baltic states, driven by the meteoric rate of borrowing, was bound to face a serious downturn and a collapse of property prices unavoidably brought along by it. Ten years ago we assumed that the fall in prices would remain within a range of 15%–25% of the price level in 2007. In retrospect, what happened was of course a much worse scenario – overall the prices lost roughly half of their peak value. At the time of our prediction, the Lehman Brothers’ bankruptcy was seven months in the making.

This investment argument of ours a decade ago was based on elementary logic – major foreign investors wanted to withdraw from the Baltic region (or at least would not engage in new transactions), liquidity would shrink and therefore the prices of property would decline. In theory, it was a right point of purchase, i.e., the classic contra-trend investment logic. Before the Lehman Brothers went belly up we had acquired two properties – the then recently opened K-Rauta’s store in Võru and the central logistics warehouse of Premia Tallinna Külmhoone in Tallinn. As we had predicted, these two leases stood firm against even the darkest days of the crisis. In this period, we knowingly staked only on long-term lease contracts of top companies in different business sectors.

The consternation that followed the events on the Wall street in September 2008 shocked all market participants. We were no exception. I remember how one of our founders, Mr. Olari Taal, said at one meeting that it would serve the investors’ interests to send the management of the fund on a holiday for a year so that they could not engage in new transactions. This jokingly uttered thought actually had a lot of truth to it. We did not conclude a transaction until a year later when we acquired from Riigi Kinnisvara AS an office building at Lõkke 4 in Tallinn. We bought the building for 2.4 million euros, leased then for governmental authority, National State Information Systems Centre. We sold it four years later for 4 million euros, having meanwhile earned a hefty income from the lease. It was a classical “blood on the streets” purchase transaction and the subsequent sale earned our investors a 44% annual return on equity.

However, everything is simple only in theory. At the time we had lots of doubts – the psychological environment surrounding us was very anti-investment –, company after company was going bankrupt, the GDP fall was nearly 15%, unemployment was on the rapid rise, newspapers were writing about the pending devaluation of the Estonian kroon, etc. At a moment where the motto is “Cash is the king”, it is an act of bravery to invest the free money on bank accounts. Continuation of the economic apocalypse simply seemed much more realistic than considering the situation to be the bottom of the market when all cash needed to be exchanged for property. In 2009, there was just one bank willing to risk to finance the Lõkke 4 transaction, others were busy with cleaning up their real estate portfolios of bad loans and would not grant new loans. The fact speaks for itself.

Just as impossible as spotting the bottom of the market is figuring out the peak of the market – the whole truth will unveil sometimes later, in hindsight. We too were very often lacking in self-confidence. In 2010, we were approached by one of the largest commercial property fund managers in Scandinavia who proposed to acquire a majority shareholding in EfTEN Capital. It did not go beyond talks, albeit detailed and thorough talks. I still remember the sentence uttered by the majority shareholder and founder of the Nordic investment giant: “You will regret every single transaction you do not enter into today because of your fears.” The year was 2010. What he said was based on his personal experience in the Scandinavian real estate crisis in the early 1990s. He later regretted many transactions that never materialized. At the time, the sentence stuck in the mind but was not completely believable – there were just so many risks in the surrounding economy. Today, eight years later, I can say that he was absolutely right. From time to time, when driving past certain buildings in the Baltic capitals I have this bitter blast from the past, remembering how we had been afraid of acquiring a building for one or another reason, considering the transaction too risky or too pricy, or rather both.

The most peculiar example from this genre in the brief history of EfTEN to date is the tale of Narva Prisma. In 2009, the developer of Narva Prisma, Oma Ehitaja, offered us an investment opportunity – acquisition of a land plot for a Prisma store in Narva and commissioning of its building from them. The total investment was in the range of 10–11 million euros which, in the context of the recession, seemed a huge investment. At the time, we were already developing, along the same lines, the common building of Rakvere police and rescue board with Oma Ehitaja. We were not too keen on increasing our development property position; rather we were just interested in completed buildings with already existing cash flows. The problem with development projects is that in the beginning, during construction, you invest in the owners’ equity and cash flow comes only after the building has been completed. Three years passed and we had become bold enough to acquire the same Narva Prisma, then completed and commissioned, from the Finnish company Vicus for 14.7 million euros. In turn, last summer we sold Prisma to the French asset management company for 16.7 million euros, thus earning investors a 25% annual return on equity. It should be noted that in 2014, there was another institutional foreign investor that wished to purchase Narva Prisma from us but the East-Ukrainian military crisis put a stop to that plan. Just a few more weeks and we would have been ready to have the deal notarized. Both the seller and the purchaser had made all preparations when the Putinist force majeure intervened.

One and the same commercial property objects being sold between different investors resemble the classic game of musical chairs where timing is of the essence and not the golden rule of property investments – the location. For instance, while British private investors purchased the Radisson Sky Hotel in Tallinn in 2007 for 73 million euros, eight years later we acquired the same building for 46 million euros. One of the largest shopping centres in Riga was sold for 150 million in 2007. EfTEN Kinnisvarafond II acquired the same building in 2016 for 74.5 million euros. The locations were the same, just the times were (very) different. To sum up – timing beats location. Of course, this is not an absolute truth. There are undoubtedly many exceptions that prove the rule but I still maintain that timing beats location.

Textbooks claim that a classical real estate cycle lasts ten years. This is the same numerical mini-anniversary that EfTEN Capital is celebrating. History has taught that no new crisis is comparable to the previous one – the sources and course of a crisis are always unexpected for economic analysts and every crisis differs from the previous cycle. For instance, after the 1990s great Nordic depression, the Swedish real estate market has been going upwards for more than 20 years. Hence, you cannot expect an automatic downturn when ten years elapse from the previous peak. But you need to be on your guard. Especially in regions with a downward demographic spiral, which the Baltic states unfortunately are. But I believe that in terms of population drain, the worst may be over.

Today we are more conservative than ever before. While in 2015, our new investments accounted for over 110 million euros and a year later for 140 million euros, in 2017 we acquired new objects for just 25 million euros. At first, the buyers’ market just turned into a balanced buyer-seller market. Today we are in a situation where terms of sale are driven by the optimistic price expectations of sellers.

They say that the justification of the asset management business lies in the fact that a part of the input needed for business is always missing – either there is not enough owners’ equity desiring to be invested or there are no suitable projects to acquire. Today we are in a situation where there is more capital desiring to be invested than ever before. On the other hand, there is a scarcity of affordable commercial property. In such a situation, it is important to maintain self-discipline and refrain from going along with the ever-increasing price rally. Nevertheless, good investment objects can be found today too – you simply need to look more thoroughly and longer than before.

Viljar Arakas

12 February 2018

We will be posting more in this blog about our past and current activities as well as plans for the future in this year of the tenth anniversary of EfTEN.