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EfTEN Capital investment outlook – 10 topics to follow in economy and Baltic property market in 2023

Business Climate

Inflation: in 2022 inflation surprised on the upside in almost every country in the world. Looking from the hindsight, 2022 can be described as a perfect storm from the inflation perspective: (i) energy prices that started to rise in the second half of 2021 got further boost after Russian invasion of Ukraine; (ii) Covid induced production lockdowns and frictions in international trade resulted in a lack of supply of many consumer and industrial products; (iii) unprecedented financial stimulus by central banks that lasted for years “finally” created excess demand-side inflation pressures.

Looking into 2023, peak in consumer price inflation is already behind us and y-o-y inflation rate will be falling relatively fast in all major economies, as well as in the Baltics. By mid-2023 we are likely to see single-digit inflation rates. It will however take much longer (well into 2024, if not longer) for the inflation to reach sub 2% level.

Central banks: stickier and higher than expected inflation was much of a surprise also for all major central banks. Until spring 2022 they considered that inflation pressure is transitory and likely to subside towards the year end. As a result, central banks fell far behind the curve in raising rates and started to hike with unprecedented pace only in late spring/summer. The late hiking cycle has been one of the steepest for decades. In some cases, it even seems that central banks are acting according to the 10-year-old statement of Mario Draghi: “whatever it takes…”. Instead of “…to save the euro”, it is now “…to bring down the inflation”.

For the Baltic (and other euro area) economies it is the decisions of the ECB that have the biggest influence. The markets are pricing that the Euribor rate will reach a peak of 3,5% in June 2023 (from ca 2,5% today). As the inflation rate is unlikely to fall below the ECB’s target of 2%, the Euribor rates at around 3% are likely to become the “new normal”. With current mortgage margins this means that 4,5%…5% mortgage interest rates will be the “new normal” in the Baltics.

Credit markets: the turn-around of central banks’ monetary policy in the middle of 2022 was very sudden and took most of the markets by surprise. First corners to react on financial markets was the liquid part of debt markets. Credit spreads widened at the fastest pace since 2008. Asset intensive sectors, like real estate, were hit particularly hard – average interest rate of European real estate sector bonds increased by almost 500bp to 5,3% during 2022.

Force sale of property assets: many property investors had become accustomed to zero interest rate outlook. As a result, property deals in Europe over the past few years were done with 3-4% rental yields, i.e below the current borrowing cost (above 5%). Going into 2023 such properties are likely to face difficulties upon refinancing. Listed stocks and funds of real estate companies who own such properties trade already on average at 40% discount to their book value in Europe. Significant reduction in dividends and forced sale of real estate assets is expected in 2023. In a worst-case scenario, there could be a run on open-end property funds, which will force them to close for redemptions and potentially push for even larger forced sale of assets.


Baltic Property Market

Refinancing of debt: bond financing is not widely used in Baltic real estate sector. As a result, a potential closure of bond financing is unlikely to have a systematic negative impact on property market. Still, some real estate related bonds which mature in coming years will be very difficult to refinance or at least the refinancing terms will become a lot more unfavourable (double digit interest rates can be expected).

From the Baltic property market perspective, the behaviour of Scandi owned banks is most important going into 2023. They have dominant market shares and their loan margins have historically been the lowest. At the same time property market is already in a steep fall in their home market Sweden. Should these banks in the light of Sweden’s property market downturn cut financing to Baltic real estate sector, it will have a significant negative impact to both commercial and residential property markets.

Behaviour of tenants: despite skyrocketing utility bills payment behaviour of tenants remained surprisingly strong in 2022. Consumers kept up their spending and turnover of retail tenants, especially outside capital centres, often posted records. So far hardest hit have been industrial tenants where energy prices make up a substantial part of total costs. Should consumers cut back their spending in 2023 troubles will spill over also to retail tenants.

New investors: due to successful exits of IT (but also “old economy”) companies we ended 2021 with increased number of so-called local family offices in the Baltics. Some of them hired in-house property managers and invested directly to local commercial real estate market. In 2022 there were no comparable exits in Baltic corporate market and as a result little new money is expected to real estate sector from such investors.

Many real estate investors in Europe are busy in finding solutions to their refinancing needs and increased interest expenses. This is likely to hold them back from expanding towards frontier markets like the Baltics. In addition, although small in size, the Baltic corporate bond market with 7-10% interest rates offers again a meaningful alternative for real estate investments for Baltic institutional investors (e.g pension funds and insurance companies).

All in all, we are unlikely to see new long-term capital entering the Baltic property market in 2023.

Transaction activity in real estate market: transaction activity in residential and commercial property market decreased significantly towards the end of 2022, but prices have been much slower to adjust. In residential sector higher Euribor rates and increased utility bills decreased consumer confidence in all Baltic countries to the lowest level in many years. This had a negative impact on consumers’ willingness to make property transactions. For example, in Tallinn the transaction activity with new developments during the last months of 2022 was only 10% of the one seen at the start of the year. Similar trend was also seen in the Baltic commercial property sector, where almost no meaningful deals were made during the 2nd half of 2022. Most likely decreasing transaction activity will be followed by some decrease in residential prices over 2023.

Rents and property yields: in commercial property sector investors often use “risk-free” rate (generally proxied by government bond yield) as an input to value assets. In 2022 Baltic government bond yields increased by ca 300bp to close to 4% level. As a result, transactions at 5-6% yield expectation are now a history in the Baltics and commercial property prices are likely to fall in 2023.

With increased utility bills and business cycle slow-down, we do not see that there is much room to pass on higher rents in 2023. At least not by a comparable level to increase in EURIBOR. As a result, most leveraged property owners will face a free cash-flow decrease.

Construction costs: construction costs started to increase in the Baltics already in 2nd half of 2021. Trade sanctions with Russia and Belarus cut the supply of certain construction materials and added further to construction prices in spring 2022. During 9 months of 2022 construction costs were up by 7,4% in Latvia, 12,5% in Estonia and 16,3% in Lithuania. However, towards the end of 2022 price increase stopped. New supply cannels for construction materials were found and demand for construction services decreased. Going into 2023 construction costs could easily fall back somewhat as there will be less private and public construction projects. As a result, 2023 could be a good year to sign new construction agreements. Even if construction prices will remain unchanged this will result in a relative fall versus overall increase in price level and wages.



Going into 2023 Baltic property sector faces strong headwinds from both international and domestic environment. No new capital is expected to Baltic property market. In addition, a potential spill-over from Swedish housing market downturn could significantly impact financing conditions from Scandi owned banks. As a result, we see that property prices (both, residential and commercial) will go through a correction in 2023:

  • in commercial property sector the exit values of the past few years are mispriced today. We expect to see higher exit yields and lower transaction prices across all commercial real estate segments;
  • In residential sector decreased transaction activity, decreased housing affordability due to increased borrowing costs over will result in lower prices.



EfTEN Capital investment team

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