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Quantitative Easing and Estonian Real Estate Market

Investing to equities, fixed income or property markets is always associated with certain risks. Over time various risks are differently priced – there are periods when equity markets look more appealing as compared to fixed income and vice versa.  As a result, investors frequently analyse the expected risk-return trade-off while allocating to different asset classes.

Effects of Quantitative Easing

Previous decade saw an unprecedented monetary easing by central banks through a modern history. One side effect of quantitative easing has been an ever-increasing valuation of various investment opportunities. By historical standards all major asset classes look either expensive or very expensive. This is best highlighted in fixed income markets where governments and even some corporates can issue debt with negative interest rates. I.e. over the lifetime of these instruments issuers have to pay back less than they initially borrowed.

Quantitative monetary easing has also affected valuation of different property markets – in most developed countries commercial property prices have grown ahead of rents. Rental yields in major advanced economies have over the past 8 years decreased for 6% to 4% according to CBRE. Somewhat surprisingly, this has had little impact on property yield premium. Commercial property rental yields are still 2-4%points above the expected return on risk-free assets (government bond yields) – a level persisting also during the early years of monetary easing. As a result, one can argue that quantitative easing has had little impact on expected relative return of commercial property as compared to fixed income markets.

Situation in Estonia (and other Baltics)

In the Baltics the effect of quantitative easing on various assets depends on their tradability. Pricing of assets which are more attractive to international investors has had a considerably larger impact from quantitative easing as compared to assets where local investors dominate.

One of the most frequently traded Estonia’s financial instrument is the 10y government bond issued in summer 2020. Its comparatively large size (1,5bio EUR), high liquidity and standardised terms have made it popular among various institutional investors. As a result, this bond is trading in parallel with most other euro area governments (at comparable levels to e.g. France and Ireland) and quantitative easing has pushed its yield level to negative territory. The situation is similar also in Latvian and Lithuanian government bond markets.

On the other extreme from international tradability perspective are different real assets of Baltic countries (e.g. property). Their traded volumes are tiny from international perspective and transaction as well as safekeeping terms are often not standardised. Thus, there are numerous “natural” barriers for international investors to invest in these assets.

Today, prime commercial property yields are around 7% in Baltics. Risk premiums often north of 7%points over government bonds have been very rear in history. It is somewhat harder to find reliable data for residential property yields. Those figures tend to fluctuate significantly between locations, property types and size, etc. As a result, it is easier to try to evaluate whether the increase in residential property prices has over the past years been in line with other economic indicators. In Estonia residential nominal property prices have increased by 55% over the past 7 years, which is exactly in line with nominal income growth. This is in sharp contrast with many other OECD countries where property prices have increased ahead of income and housing affordability has been significantly reduced.

Thus, one can argue that quantitative easing has had somewhat different effects in asset markets of Baltic countries as compared to major advanced economies. Tradable instruments have fully felt the impact of easing policies whereas the pass-through to less liquid instruments (e.g. property) has been much weaker.

Small and bank dominated financial market

There are numerous reasons for uneven impact of quantitative easing across different asset classes in Baltic countries. One can argue that bank dominated financial sector together with small and shallow investment opportunities are the main culprits.

There are only a handful of companies in Estonia and other Baltics who can issue debt on international fixed income markets. The overwhelming majority is borrowing from local commercial banks. As a result, banking sector serves as one of the main channels through which monetary easing is passed through to Baltic economies. During the recent years this channel has not functioned overly effectively in transmitting the changes in global interest rates. In 2020 corporate lending rates and mortgage lending rates where approximately at the same level as in 2013 in Estonia. Whereas corporate investment grade and high yield bond yields have significantly decreased in euro are over the same period.

Financial market in Baltics will remain dominated by banks also in the foreseeable future. As a result, quantitative easing will continue to have a limited pass-through to local property market. On one hand, this means that property yield premium is likely to remain elevated. On the other hand, housing affordability should not decrease at fast pace.

Effects of COVID-19

Just barely a year after the outbreak of pandemic major global equity markets are trading at life-highs and credit spreads are near all time lows (sic!). Seems like virus has had almost no effect to global financial markets. It is certainly too early to draw final conclusions on pandemic’s long-term effects to property sector. However, first effects are already well visible in Baltics as well as global property markets.

EfTEN has one of the largest office portfolios in the Baltics. Despite extensive “working from home” habits, somewhat surprisingly no major office tenant has asked for reduced office spaces in our portfolios. In metropoles (e.g. London) some companies have started to shift their offices from central districts closer to residential areas. This is aimed at reducing commuting needs of their employees and curbing the spread of virus.

Retail malls have been under a pressure from online shopping already for some years. Virus outbreak has accelerated this trend. Major shopping centres are looking to convert towards different entertainment services, like restaurants, cinemas, children play areas, etc. As a new trend, different medical services are slowly finding their way into shopping malls.



Kristjan Tamla
Head of Retail

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