AMWatch

Nordic investors turning to real estate debt to boost fixed-income yields

Institutional investors in the Nordic region are increasingly adding lower-risk real estate debt to their fixed-income portfolios as a way of increasing their overall returns while at the same time keeping their capital requirements as low as possible.

Real estate is increasingly used by Nordic institutional investors as an alternative to bonds. | Photo: PR

Sweden’s Folksam pensions and insurance group and Kommunal Landspensjonskasse (KLP)— the Norwegian municipal pensions provider — have each invested significant amounts in Brunswick Real Estate’s second real estate debt fund in the Nordics, BREC II, which is currently raising funds.

So far the fund has taken in SEK 2.8 billion (EUR 288 million) in commitments and is composed of senior secured debt on real estate, where loans have a loan-to-value (LTV) ratio of around 60 percent.

Jan Willers, consultant at Kirstein in Copenhagen, confirms interest from institutional investors in the Nordics in different types of debt instruments involving more risk is intensifying.

"And that will have a positive spillover into infrastructure and real estate debt instruments," he says.

"Some managers have been promoting this asset class, and there will almost certainly be interest in it from seasoned investors," he says.

But how much has actually been invested overall in real estate debt as a result, he says, is another question.

Mainly Danish and Finnish interest in risky debt

Within the Nordic region, institutional interest in more risky debt instruments is mostly happening within Denmark and Finland and to some extent Sweden, Willers observes.

Louise Richnau, partner at Brunswick Real Estate in Stockholm, predicts the trend among Nordic investors to invest in real estate debt will continue.

"The reason for that is that they are seeking low volatility stable returns and that real estate debt is particularly well-treated under Solvency II, and on top of that, the interest in alternative investment is increasing very strongly — especially in the low interest rate environment we are seeing right now," she says.

Under Solvency II, senior secured real estate debt is treated in line with investment-grade bonds, making it very capital efficient, Brunswick Real Estate says.

The firm sees more demand for non-bank financing from real estate owners in the next few years not least because the banks will lack the capacity to continue providing such loans.

"The four big Nordic banks have balance sheets equivalent to four times Swedish GDP, and our analysis is that they cannot keep growing at the pace of the market," Richnau says.

Trend due to new financial regulation

The trend has mainly grown out of the two major sets of financial regulation put in place in the EU in the last few years in a bid to prevent any repeat of some of the most serious effects of the 2007/8 global financial crisis.

These are the Basel III international banking regulations and new regulations for life insurance companies arising from the EU directive Solvency II.

While Basel made it harder for banks to carry on lending to the extent they had before the financial crisis, the capital requirements Solvency II placed on life insurers and pension funds incorporated as such has forced these institutional investors to hold higher proportions of assets in low-risk investments such as government bonds.

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