Investors in Danish real estate are making a highly cautious entry into 2018, preparing for the expected decline in returns, according to quarterly market statistics from the Danish Property Federation. Total returns for 2017 are expected to peak at 5.8 percent, the federation's analysis of data from 44 market players reveals. After 2017, total returns  ­ which measure profit from investment properties compared to the investment’s size ­ are expected to fall to 5.5 percent.

“It’s surprising that we are aware that we have had a few good years, but that the coming years can’t reach the same heights. This kind of statistics doesn’t usually have that kind of decline; usually we expect things to go forward steadily. In 2006 and 2007, some probably believed that these were new times and prosperity was here to stay. Now the industry – luckily – seems to be aware that good times don’t last forever,” says Morten Marott Larsen, senior economist at the Danish Property Federation, to EjendomsWatch, an AMWatch sister site.

Foreign investors will withdraw

The generally cautious assessment from the industry is spoken despite the currently favorable state of the Danish economy. However, this development is exactly what might be signaling the beginning  of the end for later years’ prosperity in real estate.

“In terms of demand – Danish economy in general – the years ahead seem promising, which creates a demand for office premises. Yet still, investors are cautious and preparing for an effect such as rising interest rates to affect how valuations develop. This might bring bonds back into vogue, which in turn would pull money out of the real estate market, and that would result in slower increases in property prices compared to recent years,” he explains.

How exactly can you tell when the market turns?

“Demands for owning property will seem to have reached a peak. If bonds again start yielding more than 0 percent in returns, some of the funds will go there. A shift in allocation will affect prices, although we are seeing very positive trends in terms of demand.”

Expectations are following roughly the same pattern that commercial property agent Sadolin & Albæk has mapped out in its latest quarterly report.

“Within the next 12, 24, or 36 months, the market will turn, and real estate prices will come under pressure.  The reason may be an increase in interest rates after an even more prosperous economic period and inflationary trends. It may be a decline in growth and employment. It may be because the pension sector internationally needs to bring down its real estate exposure – and international investors then withdraw from investments in more marginal markets such as the Danish,” says Sadolin & Albæk CEO Peter Winther.

Focus on core business

Interest rate increases and subsequent increased allocations for bonds are, according to Morten Marott Larsen from the Danish Property Federation, the most realistic scenario for capital flight from the real estate market. It will, however, be a much less catastrophic collapse than the financial crisis was.

“If money leaves the market in favor of bonds, the market development will be much more natural and balanced than it was in 2006 and 2007. For this reason, it’s important to focus on running properties in a good and professional manner, and that core business has good returns,” says Morten Marott Larsen.

What will a market that promises dwindling returns mean for the amount of international investors in Denmark?

“The interest towards allocation seems to come in waves, and there has been a lot of available capital globally which has deemed the Danish market a good place to invest. If interest rates increase, the international investors will most likely withdraw to some extent. It might happen over the course of a few years like their entry into Denmark, proportionately with the development of real estate value. Others might find that their investment has been very good and let parts of their capital stay in real estate so it’s ready when the market turns again.”

What are the biggest influencing factors that may cause the market to develop differently than expected?

“The Danish market is kept under surveillance for comparison with other markets. Currently, Denmark is still considered relatively attractive for secure investments with good returns in bigger cities. This may be more difficult now, so people have begun looking for secondary locations. So it’s necessary to factor long-term demand for the property into one’s considerations.”

Much needed trængsel in commercial properties

Growth in Danish economy also plays into the demand for office premises. The commercial property sector is doing well with extraordinarily high expectations towards property value, and occupancy rates in commercial properties are also expected to rise. Office properties are expected to rise most in property value, occupancy rates, and market rent compared to current levels.

“The industrial sector has seen relatively much financial stagnation. The improved situation comes from a basic level that has a lot to offer. The office market has been better despite stagnation, but there are still spaces to fill out in all types of commercial property, which has put a damper on new construction. Stores in particular are feeling the improved economy that benefits commercial property in general and sends commercial property to a new level,” says Morten Marott Larsen.

The real estate investors that partook in the Danish Property Federation’s market statistics expect higher real estate value in commercial properties, and the expectations have grown higher since the last quarterly market statistics. It is the highest quarterly increase in this survey, which means that expectations for real estate value is now level with expectations for the office- and residence sectors. Return on income and return on invested capital are factored into the total returns.  Total returns are the period’s running net operating income divided by the investment’s size at the beginning of the period. Return on invested capital is the added value of the period divided by the investment’s size at the beginning of the period. Total returns are before financial expenses and inflation.

English Edit: Marie Honoré