Blog
Raising capital in real estate market before the dawn
To make new investments EfTEN Real Estate Fund is raising yet again new equity in November, the darkest and gloomiest month of the year. The existing property portfolio does not need any additional capital. I have been asked why are we making a share issue right now when real estate is not an overly popular asset class? In our business there is a golden rule where one of two things is always missing – either capital or projects. During my more than 20 years of experience in the real estate market, I have also met fund managers who permanently lack both. On a more serious note, today we are in a situation where there is no shortage of good projects, but we lack the equity capital to benefit from them. Therefore, although from a helicopter view the market sentiment seems unfavorable, there is no better time to raise capital than today. I present our arguments below.
Interest rates. When the European Central Bank started raising interest rates in July 2022, most market players considered it as with little relevance. The 6-month Euribor was comfortably in a negative territory at the time, and no one could predict the worst. To tell the truth, I could not have foreseen such a rapid and merciless rise in interest rates as well. The close to zero cost of debt capital in the last decade had lulled us all back then. When by the end of 2022 the central bank had already raised the interest rate to 2%, it started to have an effect. The real impact came to the Baltic real estate market only a year after the first increase in interest rates. This was expressed in a sharply reduced demand for new apartments and in the freezing of the commercial real estate transaction market. Today, we are in the opposite situation – interest rates are falling at a faster pace than forecast before the summer. Once again, nothing will change overnight, but the real estate market is clearly becoming more active, the trendline has changed. As a surfer, you must catch the wave before the wave reaches its peak. This means that today is a better time to buy in the real estate market than it has been in the last five years.
A buyer’s market. When the interest levels started to increase and property yield expectations went up as well, the sellers understandably went on defensive mode – no one wants to sell their property too cheaply, because the dream of a record low yield, and a high sale price, lives on in the souls of developers and owners. By now, the sellers have also gotten used to the new price levels. No property is half as cheap today as it was in 2022, but there is much more to choose from – you can get more and better goods for the same money. In addition, our main competitors in the Baltic market are empty of dry powder to invest. In the older funds, the capital has been invested and new funds have not been raised due to the unfavorable market situation. This is also partly the case in EfTEN’s funds focusing on institutional investors.
Investors. There are two major types of investors: (i) institutional investors, like pension funds, life insurance companies, family offices, etc. and (ii) retail investors. Broadly speaking, Baltic institutional investors have a wait-and-see attitude regarding real estate. Their average allocation to the asset class is already historically high, and the inflow of new pension assets is questionable. In Estonia, the “Pension Reform” was carried out under the leadership of the party Pro Patria, which has restricted today’s pension funds from investing in the local illiquid market. Similar winds of populism are blowing in Lithuania as well. The partial release of pension assets is one of the topics at this weekend’s general elections. This has understandably put the Lithuanian pension funds on the back foot in terms of new investments. The elections have not taken place yet, the coalition has not been formed, and the corresponding domestic debates are still ahead in Lithuania, both something similar to what happened in Estonia is also in the air in Lithuania. Thus, the institutional investor is risk averse today, which creates a better opportunity for the retail investor than ever before. As a rule, institutional investors often make their own moves in changing market environment before the retail investors, but today it is possible to do otherwise. If you ask where the long-awaited foreign real estate investors are, I can answer this way – they are abroad and will stay there. All real estate investors have some sort of problems in their home market. The Baltic countries are not under their radar at the moment.
Banks. In short, the hunger of commercial banks for new business is currently beyond the expectations in the Baltics. The liquidity of the banking sector is good, the current projects are working smoothly, and the overdue loans are at a very low level. Who would have expected this after 9 quarters of economic recession in Estonia… but luckily it is so. At the same time, the banks have a concern – there are not enough new projects to increase business volumes, because the existing loan portfolio is amortizing. Using the example of EfTEN, we can confirm that banks have positively surprised us on several occasions during the last six months, where the loan terms offered have been better than we had originally asked for. There is really strong competition between banks, and every new loan project is fought for. Therefore, this important growth assumption of the real estate market is also in the right position.
Potential investments. There are many investment opportunities in the buyer’s market. It cannot be said that everything is very cheap, but today there is certainly a much better opportunity to make long-term good and lower-risk investments than it has been in the last five years. Charile Munger’s quote that he doesn’t want to buy a fair company at a wonderful price, but a wonderful company at a fair price, also applies in real estate. We are in the long-term business of commercial real estate investment. We do not engage in short-term speculation. Our latest examples of completed transactions prove that brand new buildings with good leases can be obtained today on significantly better terms than some years ago.
Scandinavian real estate market. The Nordic real estate market has turned the corner, and the decline has been left to the past for now. As compared to the Baltics, the Scandinavian real estate market is a “proper market”, where a transaction volume is 30-40 billion euros per year. While in the Baltic countries, it has reached just over one billion euros in good years. Looking back, the Nordic commercial real estate market bottomed out in the fourth quarter of last year. Since then, both shares and bonds of real estate companies in the listed market have seen a clear upward trend. The old truth that financial markets move 6-9 months ahead of the real economy is being confirmed again. Probably also knowing that the worst is over in the home market gives courage to Swedish owned banks to look more optimistically into the future also in Baltic property market. Sweden’s central bank was the first central bank in continental Europe to forcefully cut the base interest rate starting in May, followed by ECB in July. All of this is water to the real estate water mill.
The demand for commercial real estate. It has been frequently said that the decrease in demand for commercial premises caused by the COVID crisis will create a new crisis. Indeed, when a person is living in their own home, working in their own home, ordering takeout food and watching Netflix at home, a crisis is coming for sure – a mental health crisis. Of course, the increasing habit of working from home is also having an impact on the demand for commercial premises, but to a much smaller extent than expected. In the raw capitalist USA, employees are already ordered to work 5 days a week again, for example in the case of Amazon. In social democratic Europe, so-called hybrid work is here to stay. Living at the 59th degree of latitude, you don’t have to worry too much about the future of shopping centers either. In smaller towns, a modern shopping center replaces a cultural center and sometimes even a church. In larger cities, there is clear competition between shopping centers, but none of them are empty of people – where do people go to spend time with the family when it’s constantly dark outside? No one is particularly worried about the logistics sector. There is really no reason for that.
EfTEN Real Estate Fund. As a fund, we have excellently managed through the cluster of most recent crises. The fund with 35 properties provides a good diversification of assets, where no property and no tenant is too large or, to put it more delicately – systemically important. Indeed, on the transaction market we have been inactive for the past four years and have primarily worked with the existing portfolio. We are happy to say that everything is very good with the portfolio – the vacancy rate is 3%. Customer payment behavior is solid and our main cost line, the financial cost of bank loans, is falling rapidly. Yes, our share price has only moved sideways in the last year, but this is a decent result considering the environment – we have in the meantime also paid a dividend of 1 euro per share. Looking at the longer period, since 2017, our fund share price has increased by approx. 160%, which is essentially the same as the growth of the aggregate index of the Baltic stock market. On the other hand, in comparison with the pan-European Stoxx 600 Real Estate index, which has fallen by approx. 15% since the beginning of 2017, our share price development has been quite good.
One of the key success factor of EfTEN so far has been our team’s ability to be a few steps ahead of the competition. I believe we are about to prove the same this time again. It is always the darkest before dawn, and it’s time to take your own steps. It is up to you to make the decision whether to you join us. You are welcome!
Viljar Arakas
11. October, 2024