A massive slump in long-term interest rates when the Covid-19 pandemic broke out helped the risk premium for Oslo’s best office properties to reach a record level. Interest rate trends have eradicated an already low alternative return after the 10-year rate fell below one per cent.

Prospects for the office letting market have admittedly weakened substantially, but the compensation is nevertheless sufficient to attract many investors. We observe that these are willing to go to considerable lengths to acquire attractive properties, and have lowered our prime yield estimate from 3.6 to 3.4 per cent.

Source: UNION and DNB Markets

Falling interest rates have contributed to a substantial decline in financing costs. Bank margins admittedly remain higher than in February, but interest rates have dropped much further than margins have risen. Depending on the buyer group, and on whether interest rates are floating or fixed, borrowing costs have typically declined by one to 1.5 percentage points.

Entra, which has the best terms in the market, currently has a credit spread of roughly 80 bps for five-year money.¹ And the spread for a one-year loan is only 36 bps, which means a total interest expense of 0.64 per cent with a floating rate.

Access to cheap credit means that many players can achieve highly competitive returns on equity at today’s yield levels. When much capital also needs to be put to work, yields come under pressure. Several capital-intensive family companies, such as Ferd and Canica, have both said and demonstrated in action that they have a lot of money to place. We also see that capital is flowing again into funds and club deals.

A majority of the big global investors want to increase their allocation to alternative investment classes over the next 12 months.² Property ranks admittedly as the only class where an increased allocation is not being sought, but that must be seen in relation to the hard blows suffered by this sector in many countries. The downturn in the real economy seems to be much worse in a lot of other nations, in part because of different industry compositions.

Although the market is currently being driven by Norwegian investors, international buyers are still showing interest. This applies both to players who already own property in Norway and to ones who have no such holdings at the moment but are actively seeking to make their first investment here.

Dark clouds can naturally also be seen. The economy is weak, and this will probably last a long time, at the same time as a number of newbuilds are being completed. We therefore expect office vacancy in Oslo to rise to more than eight per cent in 2021 and average rents in the city to decline by five to 10 per cent from top to bottom. This will contribute to yields probably developing more weakly for less attractive properties, while spreads between the best and the second-rate increase.

Source: UNION
* At september