Vacuum in the transaction market
Liquidity in the transaction market has declined substantially since 1 January. Rapidly rising interest rates, reduced availability of loans and an uncertain macro picture make it difficult to navigate.
Interest rates with a tenor of five years or beyond have more than doubled over the past 12 months. Credit spreads have also widened a great deal. In other words, external capital has become substantially more expensive. At the same time, returns elsewhere have become much better and “there is no alternative” (Tina) has been put on ice for now. Yields are continuing their upward journey.
Poorer macro prospects, where a soft landing looks increasingly unlikely, and a record increase in financing interest rates have greatly reduced liquidity in the transaction market. The downturn is with us, and it will take time to establish a new market balance. As a result, the brakes have been stamped on in the transaction market and many processes there are put on ice.
Cash-flow properties with long contracts reacted first. Such assets have had the wind in their sails at a time when low interest rates led to great yield compression. Prime yield for logistics properties in Greater Oslo, for example, fell from 4.75 per cent pre-pandemic to a record low of 3.90 per cent at 31 December 2021. Yesterday’s yields will be virtually impossible with today’s cost of capital. We estimate that yield for the best logistics properties has climbed by 90 basis points since the low point, but uncertainty is great. Few or no references are to be found.
Interest-rate developments have had a big impact on the buyer groups which have been the strongest drivers of liquidity in recent years. In 2021, Swedish property companies and club-deal players were responsible for about half the purchase volume in the Norwegian transaction market. These investor groups probably rank among the most interest-sensitive players, and are also meeting the greatest resistance in the loan market at the moment.
The Swedish companies are struggling with a difficult bond market. They have based their business largely on cheap borrowing with low interest rates and narrow credit spreads. Both rates and spreads have now shot up, and many are in the risk zone for being downgraded by the rating agencies. Swedbank calculated earlier this autumn that the listed property sector must sell off about SEK 100 billion to saving its rating.
Club-deal players are also under pressure from high borrowing costs. Debt has admittedly become more expensive for everyone, but single-purpose-vehicle (SPV) financing is particularly difficult in today’s climate. It has also become harder to attract equity.
However, activity has not ceased completely. There are still processes under way, but great uncertainty over prices means that it often takes a long time to complete transactions. As the market looks now, a risk exists that processes get put on ice because of discrepancies between the seller’s expectations and the buyer’s willingness to pay.
Today’s market is therefore completely different from the one we’ve seen over the past two years. The record activity during 2021 continued into 2022, with the transaction volume for the first quarter amounting to just over NOK 40 billion. This level is the highest, by a good margin, we have ever measured in the first three months of a year. Activity in the second quarter was also surprisingly high, even though some of this had carried over from January-March. The big about-turn occurred during the summer.
It will probably take time before activity in the transaction market returns to a normal level. The market probably needs more predictability in the outlook for interest rates and inflation to get moving again. In addition, we need reference transactions which allow us to determine a new market equilibrium.
A scenario many are perhaps hoping for is that interest rates begin to decline more quickly than expected. We believe the interest-rate pressure will ease next year as the Norwegian economy enters a downturn. Given the outlook right now, however, it seems unlikely that rates will return to the low level we started from. Moreover, a big fall in rates would coincide with other bad news – such as a deeper economic downturn, for example – which means that prospects for the rental market worsen correspondingly.
In any event, we believe the market must face up to a broad-based repricing.