Why do Nordic property companies take the high road on LTVs?

Before the global financial crisis, Nordic property businesses used to operate with high loan-to-value (LTV) ratios. While leverage has decreased from what was then often normal levels of some 70%, Nordic real estate businesses still operate with comparably high LTVs on the international stage. But how and why does it work?

“As an investor in the stock market, you get higher returns on leverage, so I like it, because it means that I can get a better performance,” says Jonas Andersson, lead portfolio manager of Alfred Berg’s Fastighetsfond Norden – a fund investing in Nordic property stocks. “If it’s a stable company I can live with high leverage but I want loan-to-value levels to be well in line with what the banks are comfortable with.”

In Sweden, banks are broadly looking for about 55% – any higher and it costs more, adds Mr Andersson. In the Norwegian market, average LTV levels for commercial real estate companies are about 60%, but can rise to about 65% depending on special factors, according to Dag Fjeldstad, client manager of real estate and construction in Norwegian financial services group DNB's large corporates segment.

How much is too much?

SBB Norden, a Swedish business with a focus on lower risk rental properties, had a slightly higher than average LTV of 60% at the end of 2017, according to chief executive Ilja Batljan. However, this figure has come down from more than 70% at the end of 2016.

“Ninety percent of our income comes either from government or from regulated residential real estate, which means that our exposure actually is to the Swedish and other Nordic states,” says Mr Batljan. “From that point of view we should be able to have an even higher LTV ratio.”

From a bank perspective, this would not be a problem, Mr Batljan notes, as “they are often open to have LTVs for regulated residentials of 70%”.

“Banks are much more aware when it comes to segmenting the sector, to look at you differently depending on if your properties are retail, office, prime office or regulated public properties,” he says. “Our LTV at 60% really is comparable with an LTV at 50% for commercial real estate.”

A risk for bond investors?

As Nordic property companies are increasingly turning to the local and international bond market, could these LTVs turn into a problem for bond investors?

“We believe that a rise in interest rates, even if gradual, could put pressure on the financial risk profile of these companies given their capital-intensive nature,” says Marie-Aude Vialle, director at S&P Global Ratings. “Higher interest rates could not only lead to weaker interest coverage ratios, which could be an issue particularly in low-yielding markets such as residential in Sweden, but also negatively affect asset valuations, pushing leverage ratios up, and closer to covenant levels for some issuers.”

Yet recently, the trend has been more towards a contraction in LTVs. According to Swedbank’s Nordic Real Estate Sector 2017 recap and 2018 outlook published in March, only seven out of 35 businesses increased leverage in 2017, while Humlegården’s LTV was the lowest at below 40%.

SBB Norden is also looking to further lower its LTV ratio, as Mr Batljan aims to improve the company’s BB rating to investment grade. He intends to achieve this, like many of his peers, through an increase in valuations. Some companies also raise equity to grow and lower their leverage, such as Citycon, which gradually brought its LTV down from 58% to 46% over a seven-year horizon, according to chief executive Marcel Kokkeel, giving it a BBB rating.

“Leverage levels are getting a bit more prudent and are going down to below 50% among core companies,” says Helena Olin, head of real asset investments at the Second Swedish Pension Fund AP2. “This might still be a bit higher compared with some of Europe, where levels are below 40%, but values in Paris or London are more volatile historically, so you might say it is fair to have slightly higher leverage levels [in Sweden].”