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catella market view january 2016 Macro tailwind will turn in 2016 – but property remains attractive Properties worth SEK 130 billion changed hands in Sweden during 2015. This is not quite as much as in record-breaking 2014, but it is well in line with the years before the financial crisis. In total, properties worth around SEK 17 billion were sold in December, compared with SEK 33 billion in the same month 2014. Arvid Lindqvist, Head of Research [email protected] The December volume reinforces the falling trend in the rolling twelve-month volume that we have seen since the summer, and is set against the highs in July and August of almost SEK 160 billion respectively. The drop in volume has been evident in the office, residential and public property segments, while retail and logistics have continued their strong growth. Institutional investors increased their market share significantly during December, and accounted for almost half the volume during the month. The institutions therefore overtook real estate funds for the full year and, together with private and listed property companies, these now dominate the market. Foreign investors kept a relatively low profile towards the end of the year, and accounted for just over 20 per cent of the market for the full year. Although the market share of foreign investors has increased for three consecutive years, it is still only slightly above the range of 10–20 per cent that has been the case since 2009. However, there is intense international interest in Sweden and we will probably see some more major foreign investments during the first half of 2016. How will the property market evolve in 2016 and beyond? Yields and yield spreads between A, B and C locations are both at historically low levels. Yields in 2015 were considerably compressed by strong economic growth in Sweden, coupled with increasingly expansionary monetary policy. Since the start of the year, however, the slowdown in the world economy has become ever more pronounced. The global economy is being hampered by high debt and weakening growth in emerging countries, the stock market has had a difficult start to the year and the VIX index (volatility index for US S&P 500) indicates declining risk willingness on the financial markets. Credit spreads between US corporate bonds with high credit ratings and those with lower credit ratings continue to widen, and interest rates have surged on the US high-yield market. This was also apparent in the latest Catella Real Estate Debt Indicator (CREDI), which measures debt market sentiment in the property market. The indicator switched in December from expansion to contraction. However, the trend in the world economy is not directly downward. We are seeing broad economic recovery in the euro area, and US household consumption may be strong in 2016. The turmoil in financial markets could also lead the Federal Reserve to pause rate hikes during the spring, which might cause the equity markets to temporarily bounce back. Similarly, Swedish inflation is stubbornly low and the Riksbank has threatened to intervene in the currency market, which would further stimulate the economy. In the somewhat longer term, however, the direction is unequivocal – we are heading towards a global downturn that is likely to have a negative impact on the Swedish economy from the second half of 2016. This at a time when fiscal policy is already highly expansionary and the scope for further monetary stimulus is limited, to say the least. The average yield in the transaction market is highly correlated with GDP growth, and a weaker economy will lead to higher average yields on the property market. A significant portion of this increase, however, will take place through the standard deviation, i.e. yield spreads between A, B and C locations, rising while transaction volumes contract in secondary locations in the major cities and in smaller municipalities. However, continued zero real interest rates and turbulence in the stock market will make high-quality properties in prime locations very attractive. The strong growth in Sweden compared Property will remain an attractive investment because it can provide strong and stable real yields in an uncertain environment. with other countries may also mean that we will see more major investments by international parties. Property will remain an attractive investment because it can provide strong and stable real yields in an uncertain environment. However, investors in secondary locations in major cities, and in smaller towns, must remain vigilant as the macroeconomic tailwind of recent years could rapidly turn into a headwind. catella market view january 2016 Yields on finalized office and retail transactions** STDAV in yields (%-points) Yield (%) Total transaction volume BSEK Swedish GDP growth and the stock market GDP growth (%) / Total return, FTSE Sweden (%) Office and retail yield spread and the VIX CBOE Volatility index STDAV in yields (%-points) Yields on office and retail transactions and GDP growth* Yield (%) GDP growth (inverted scale, y/y, %) The average yields on historical office and retail transactions have fallen significantly since the end of 2012. There is a correlation between standard deviation of yields on the Swedish property market and volatility on the US equity market (measured as the CBOE Volatility Index) – where the VIX seems to be a leading indicator for the property market with a 6–9 months’ time-lag. Volatility increased significantly on the equity marked since the summer 2015. If this development resumes, the result may be lower liquidity and higher standard deviation on the Swedish property market from mid–2016 and onwards. * Calculated index based on the standard deviation of yields from historical transactions, in combination with measures of the over-all market liquidity. ** Yields are based on historical transactions in Sweden. Yields are either verified or estimated by Catella. Source: FactSet and Catella.