A lot happened in the first half of 2022. First and foremost, capital costs shot up. Not only was there a considerable rise in interest rates, but credit spreads also widened a lot. The overall cost of loan financing for a player like Entra is now around 5.30 per cent, assuming a new five-year loan with full interest hedging. That is about 2.6 percentage points higher than last November. All Nordic property companies must take account, to a greater or lesser extent, of the same reality.

According to UNION’s bank survey, the overall loan financing rate was 5.14 per cent in the second quarter - the highest level since the autumn of 2013. The five-year interest rate has moreover risen by a further 35 basis points since the survey was conducted. Looking at credit market developments, moreover, the bank margin is relatively likely to move upwards in coming months.

How much will yields rise?
Developments in the risk premium (the difference between office yield and the 10-year swap rate) or in expected equity yield after loan financing costs indicate that yield must rise by around 125 bps if the market is to provide a return in line with the equilibrium seen in recent years. 

However, two factors pull in the opposite direction.

• A strong rental market helps to increase expected cash flow in the time to come. Viewed in isolation, that would make it possible to live with a lower yield at the acquisition point.

• The yield is a real rate of return, which helps to compensate for that part of the interest-rate increase which does not produce a rise in real rates.

Viewed overall, our main scenario therefore is that yields will increase less than indicated above, and that a new equilibrium can be established with yields 50 to 100 bps higher than at 1 January. The size of the yield increase in each case will naturally vary from property to property, but the following points can be made on a general basis.

• The more your property resembles a bond, the more the yield will probably increase. Properties with long leases and a non-central location, without prospects for growth in market rents, are particularly vulnerable.

• On the other hand, properties with a high standard and short leases in areas of high economic activity and limited supply, where rents are on the way up, will probably experience the lowest relative rise in yield.

Yields already on the way up
At the moment, few reference points are available which document with absolute clarity that yields have risen. Nevertheless, we see clear signs that the market is in motion.

• We know of many examples where the original accepted bid has been renegotiated to a lower price as a consequence of interest rate developments during the sales process. Such cases have normally involved a yield increase of 10-25 bps. But examples close to 50 bps can also be found.

• Where a number of bid acceptances are concerned, the buyer has thrown in their cards. Club deal arrangers have been on the buyer side in several such cases. Raising equity presents a challenge, which is a clear indication that investors expect higher returns.

• Property on the stock exchange is being repriced. The size of such repricing varies from company to company. With Entra’s portfolio, for example, the implicit yield has risen by about 75 bps (based on the developments of the share price).

At the same time as yields are seen to be moving, many buyers have climbed onto the fence. Sellers are also taking a “wait and see” approach. Many examples are available of players who have initiated a process to prepare a property for sale and then put the process on ice before taking it to the market.

However, it is not certain that the timing will be better a few quarters from now. The peak we saw at the New Year is likely to have passed, and players will in most cases probably have to accept that asset values are declining somewhat.

At the same time, it is worth noting that examples can still be found of transactions where properties with short leases and development potential are sharply priced.

How assured are our forecasts?
The most challenging exercise is not to calculate how much yields should rise given today’s interest rates, but to estimate what tomorrow’s rate level will be. Rates have shown big fluctuations in recent months. The credit market is nervous, and sensitive to data points which indicate one thing or another with regard to future inflation and growth trends.

If inflation becomes entrenched and the economic trend continues, interest rates are likely to increase further. If Norway is heading for recession, on the other hand, rates will probably decline somewhat. In any event, we believe real interest rates are likely to become higher than in the past two years, and that yields must be adjusted accordingly.

Substantial uncertainty persist about where a new market equilibrium will be established, but we believe it will be with yields on a substantially higher level than at 1 January.