Newsletter Q3 2017 UK

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NEWS LETTER Q3 2017

Commercial property market commentary

Market update by Sadolin & Albæk 2 Property market indicators 4 Property investors’ appetite for risk is mounting 5 Are central banks pursuing sound monetary policy? 7 Digitalisation changes the rules for office letting 12 Speculation in the cooperative housing market 17 The sharing economy – now also moving into the office 20

Newsletter Q3 2017

MARKET UPDATE Q3 2017

The Danish investment property market – propelled by the perfect storm

By Peter Winther, Partner and CEO, Sadolin & Albæk

In today’s Danish property market, it is fair winds and plain sailing all-round. Economic and employment growth momentum is fairly strong. As a result, commercial vacancy rates are downtrending, and rental prices slightly uptrending. In the housing market, rental prices are seeing a fair increase, too. In addition, interest rate levels remain historically low. Central bank initiatives have vastly increased the amount of liquidity in the global markets, and all of this cash is now looking for investment opportunities that retain their value and maybe even produce certain returns. It is hard to imagine better framework conditions for property investments; It is the perfect storm, only turned upside down, and the fact that the financial sector has not yet pulled all stops when granting credit is actually the only factor that prevents

”Perfect storm” is a concept commonly used to describe an incident where a rare combination of circumstances seriously exacerbate a situation.

property prices from skyrocketing completely off the scale.

Without a banking crisis, no property crisis This being said, we believe that the fair winds will slacken at some point or another. Within the next 12, 24 or 36 months, the market will turn and property prices will come under pressure. The trigger may be an inexpedient rate hike to a level, which is not sufficiently supported by underlying economic

2 Published by Sadolin & Albæk. Reproduction or citation only with acknowledgement of source. Contact: Mette Lundorf, Head of Communication & HR +45 22 13 42 80 mlu@sadolin-albaek.dk

Newsletter Q3 2017

Sadolin & Albæk has mediated and offered advisory services on very sizeable transactions in recent years, and not once have we seen any instance of imprudent credit granting in the banking or mortgage banking sector. However, investors should not let themselves be carried away. If a property owner only wants to sell at a price that cannot be supported by rational investment analyses, there is no reason why you as investor should waste any time on such an offering. Property agents and pessimists Pessimists have always existed – also in the investment markets. Such “doomsayers” constantly foretell the collapse of the market. Now and again, typically 7 to 10 years apart, they are right and are hailed as geniuses. Like other investment advisers, property agents are not pessimists. If anything, they tend to get carried away by good vibrations. When prices continue to climb, it hardly matters that you agree to sell a property on commission at too high a price – the market is bound to catch up. risks are showing renewed interest in property investments. Both rambling development projects and less attractive built-to-suit properties at relatively secondary locations are today offered for sale as syndicated investments targeting private investors, with a return to risk ratio that would make any professional investor run away screaming.

growth and inflationary trends. It may be caused by a slowdown in the economy and employment. It may be because the pension fund sector on international level needs to reduce its property exposure – and international investors therefore discard investments in more peripheral markets such as the Danish. Or the root cause may be something we have been unable to predict. However, we believe that such a setback will not cause the market to collapse. A profound and severe property crisis will not set in without a banking crisis, where the banks suffer substantial property losses and were finance possibilities dry up. We do not envisage such a crisis in the foreseeable future. Sadolin & Albæk has mediated and offered advisory services on very sizeable transactions in recent years, and not once have we seen any instance of imprudent credit granting in the banking or mortgage banking sector. Undeniably, the scenario is different than in 2006 and 2007, when a great many property transactions were financed with a display of risk tolerance resembling a cocktail of over-optimism, speed blindness and utter death defiance. Significantly higher risk of misinvestments From an investor perspective, it has been difficult to put a foot truly wrong in recent years. If you paid a high price, the market would quickly catch up the additional price, and before long even the most aggressive investments would suddenly appear highly attractive. The margin of error is now substantially lower. Given the pricing seen in today’s market, the risk of misinvestment has increased substantially. Nevertheless, it is important to note that today’s market is dominated by highly professional investors, who make in-depth analyses of investment risk profiles, facing the risks head on. Recent months’ developments give rise to some concern. The latest property crisis seems to have faded into oblivion, and now private investors without in-depth knowledge of property-related

Newsletter Q3 2017

PROPERTY MARKET INDICATORS 2016 2017

Rent levels

DKK/sqm/year excluding operating costs and taxes Copenhagen Prime

1,800

1,800 1,200 1,400

1,850 1,200 1,400

Secondary

1,150

1,175

Aarhus

Prime

1,350

1,400

Secondary

775

800

Triangle Region

Prime

1,000

1,050

Secondary

550

Net initial yields % Copenhagen

Prime

4.00 6.25 4.75 6.25 5.50

4.00 6.25 4.50 6.25 5.50

4.00 6.00 4.50 6.25 5.25

4.00 5.75 4.50 6.00 5.25 7.00

4.00 5.75 4.50 6.00 5.00 6.75

Secondary

Aarhus Office Retail Industrial** Rent levels Aarhus Triangle Region Net initial yields % Copenhagen Aarhus Triangle Region Vacancy rates % Greater Copenhagen Aarhus Triangle Region Rent levels Aarhus Triangle Region Net initial yields* % Copenhagen Aarhus Triangle Region Vacancy rates % Greater Copenhagen Aarhus Triangle Region Triangle Region Vacancy rates % Greater Copenhagen Aarhus Triangle Region

Prime

Secondary

Prime

Secondary

7.25

9.40 8.90 8.90

9.60 8.50 8.80

9.30

8.60 7.60 8.70

8.20 7.50 8.60

7.60 7.80 9.30

9.10

8.90

2016

2017

DKK/sqm/year excluding operating costs and taxes Copenhagen Top

23,500 17,500 8,500 6,000 3,000 3,000

24,000 17,500 9,000 6,300 3,000 3,000

24,000 17,500 9,000 6,500 3,000 3,000

High

Average

Top

Average

Top

Average

1,250

Prime

3.50 6.00 4.00 6.25 5.25 7.50

3.50 6.00 4.00 6.25 5.25 7.50 3.70 6.00 9.40 575 325 425 275 425 275 6.25 8.75 6.50 8.75 6.50 10.00

3.25 5.75 4.00 6.25 5.00 7.50 3.90 5.60 9.00 575 325 425 275 425 275 6.25 8.50 6.50 8.50 6.50 9.75 2.70 4.00 2.90

3.25 5.75 4.00 6.25 5.00 7.50 3.80 5.50 9.40 575 325 450 275 425 275 6.00 8.50 6.25 8.50 6.25 9.75

3.25 5.50 4.00 6.00 5.00

3.00 5.25 4.00 6.00 5.,00

Secondary

Prime

Secondary

Prime

Secondary

7.25

4.00 5.50

3.80 5.50

4.40 5.30 8.40

9.10

8.10

2016

2017

DKK/sqm/year excluding operating costs and taxes Copenhagen Prime

575 325 400

575 325 450 275 425 275 6.00 8.25 6.25 8.50 6.25 9.50

575 350 450 275 425 275 6.00 8.25 6.25 8.50 6.25 9.50

Secondary

Prime

Secondary

275

Prime

400

Secondary

275

Long Short Long Short Long Short

6.25 9.00 6.50 9.00 6.75 10.00

3.40 4.00 2.90

3.10

2.70 3.90 2.90

2.30 3.60 2.80

2.40 3.40 2.30

3.90 2.60

*Long and Short denotes the lease term **Industrial includes production, storage and logistics facilities

Newsletter Q3 2017

PROPERTY INVESTORS’ APPETITE FOR RISK IS MOUNTING Strong transaction activity and a predominance of international investments: Transaction activity in the Danish investment property market continues to be brisk. Sadolin & Albæk therefore expects 2017 to see a record-high volume of traded commercial and investment properties to the tune of DKK 80bn relative to DKK 64bn in 2016.

By Peter Winther, Partner and CEO and Kristian A. Nielsen, Senior Consultant, Sadolin & Albæk

Mounting risk tolerance In this context, it is interesting to note that investors today demand investment opportunities associated with higher risk. In 2016, 72% of the transaction volume involved core properties, i.e. typically fully let investment property associated with low risk and high cash-flow security. In the first half of 2017, the share dropped to 47% - while the share of value-add investments, i.e. investments associated with weaker and more uncertain cash flows and a potential for operational improvements subject to proactive management, rose from 13% in 2016 to 49% in the first half of 2017.

The market is greatly affected by the fact that international investors have particular appetite for large-volume single properties and property portfolios. Whereas international investors accounted for almost 45% of aggregate property investments in 2016, they accounted for as much as 67% in the first half of 2017. The predominance of international investors has become even more pronounced in the segment involving assets with a volume in excess of DKK 500m. In the first half of 2017, they in fact accounted for all of 85% of transactions in this segment, up from 55% in 2016. In terms of the very largest transactions, with a volume in excess of DKK 1bn, domestic investors accounted for 10% in the first half of 2017 – a historically low share.

At the same time, however, so-called opportunistic investments associated with very high risk continue

International investors account for most high-volume transactions

2016

2017

32%

68%

59%

41%

37%

63%

<500m

500 - 1,000m

<500m

500 - 1,000m

51%

49%

>1,000m

International investors Domestic investors

Sour ce: Sadolin & Albæk

Newsletter Q3 2017

Breakdown of property investments by segment

4% 2%

12%

2016

H1 2017

13%

72%

47%

49%

Core User Source: Sadolin & Albæk. Based on aggregate transaction volume of commercial and investment property, Denmark Value-add Opportunistic

The commercial letting market is strong, the vacancy risk is diminishing, and rental prices are uptrending.

to account for a negligible share of the aggregate investment volume.

Due to the favourable development investors are ready to assume higher risk.

The stronger risk tolerance is seen in the domestic institutional sector too: An increasing number of pension funds are investing heavily in the value-add segment. To a certain extent, the appetite for risk is driven by the decline in returns on investments in the core segment as recent years have seen downtrending net initial yield requirements in this segment. Investors in pursuit of higher returns may therefore be tempted to accept higher risk. Stronger growth momentum and letting market recovery support higher risk tolerance Nevertheless, it is important to emphasise that the fundamental drivers of the property market are fairly strong. Economic momentum is strong, inflation is edging up, and the commercial letting market is recovering. Measured in terms of sqm space, office vacancies have been reduced at a steady pace in recent years, and in the Copenhagen CBD (Central Business District), the office vacancy rate is at an 8-year low.

Consequently, the appetite for risk is not driven by an unthinking pursuit of high returns in a low interest rate environment, but by fundamental analyses of the risk profile of property investments in an improved market.

O ce vacancy rates

16.00%

14.00%

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%

0.00%

03 04 05 06 07 08 09 10 11

12 13 14 15 16 17

Greater Copenhagen, ex CBD

CBD

Greater Copenhagen

Source: Ejendomstorvet.dk

Newsletter Q3 2017

ARE CENTRAL BANKS PURSUING SOUND MONETARY POLICY?

Current and planned monetary measures by central banks may give rise to concerns about investments in real estate. In this article, we provide our take on how upcoming monetary policy changes may impact the market.

By Christopher Elgaard Jensen, Manager, Sadolin & Albæk

not always clear-cut. The figure lists selected factors that are, in theory, affected over time by monetary regulation. Are rate hikes imminent? In the USA, the Federal Reserve is gradually raising interest rates after a seemingly persistent economic recovery with growth in consumer spending and downtrending unemployment rates. Several of the most recent key US economic indicators, however, suggest that the impact on US wage growth has been limited, with inflation staying below the target. For the same reason, the Federal Reserve has proclaimed that it will exercise restraint in terms of the originally scheduled rate hikes if inflationary expectations are not supported by solid key indicators. Indeed, the latest Federal Reserve policy meeting (FOMC) did not prompt further rate hikes, but instead raised expectations of an upcoming sale of the vast bond

Opposing views on the course of monetary policy

One of the most topical issues currently debated by economists in the world’s leading economies is whether central banks are pursuing a sound monetary policy. Monetary policy, which e.g. controls the key policy rate, may be used to influence several key macroeconomic indicators of a country’s economy. Central banks directly control short-term interest rates, whereas they can buy or sell government bonds (quantitative easing or tightening) to influence long-term interest rates directly, in addition to the implicit adjustment that follows from market expectations, also affected by short-term rates. The below figure illustrates how monetary policy may impact the economy. Please note that the figure shows the theoretical effect. In practice, the effect is

Contractionary monetary policy

Expansionary monetary policy

Short-term interest rate is raised Possible quantitative tightening Investments down

Short-term interest rate is lowered Possible quantitative easing Investments up

Spending down Demand down Production down Employment down Inflation down

Spending up Demand up Production up Employment up Inflation up

Several EU economies continue to struggle to maintain a stable growth momentum and lower unemployment.

partly because financing is cheap. Recent increases in house prices are also largely attributable to low interest rates, allowing for more favourable terms on new mortgage loans. There is hardly any definite answer to the question of whether the central banks are pursuing the right monetary policy. Instead, as is often the case with economic issues, it is possible to list advantages and disadvantages. The disadvantage of rate hikes is that they inflict higher loan costs on businesses and homeowners, who may be in dire straits if their budgets do not allow for a higher cost level. Rate hikes may cause corrections in the financial markets and in the property market. At the same time, rate hikes may depress favourable housing market trends as the financing of home purchases becomes costlier. In the past, we have seen that rate hikes as a response to rising inflation have resulted both in dramatic corrections in the pricing of investment assets and economic recession. But then again, rate hikes may limit possible bubbles in the financial and housing markets and give central banks greater leeway to cut rates when the next recession sets in. The advantage of keeping interest rates low is that money remains inexpensive, which may potentially have a substantial effect on the personal finances of Danish homeowners. Limited effect? In brief, the pursuit of expansionary monetary policy has given banks more money at their disposal so that they have sufficient capital to grant the loans required. At the same time, banks are faced with

portfolio of some USD 4,500bn, purchased by the Fed by means of quantitative easing measures in the aftermath of the financial crisis. In Europe, the situation is different. Several EU economies continue to struggle to maintain a stable growth momentum and lower unemployment. In addition, the full implications of Great Britain’s Brexit have probably yet to materialise. We therefore expect European interest rates to remain low, although the European Central Bank, the ECB, has hinted at upcoming monetary policy contractions, provided European economies show clearer signs of recovery. Signs of recovery are already seen in the economies of northern Europe, whereas the economies of southern and eastern Europe find it difficult to kick-start growth. The ECB is currently buying government bonds at a monthly rate of EUR 60bn. US rate hikes have been one of the factors causing long-term eurozone rates to edge up slightly, but strong demand for Danish government bonds, thanks to Denmark’s ”safe haven” status, has helped to keep Danish interest rates low. The present historically low interest rates date back to the aftermath of the financial crisis and the credit crunch, when central banks carried out substantial rate cuts and started to buy bonds to provide liquidity to banks and other businesses as an economic stimulus to accelerate growth. However, the effect on economic growth has been limited in many European countries. Low interest rates, on the other hand, have boosted the pricing of investment assets, including investment property and stocks, partly because the yield on government bonds is less attractive in a low interest rate setting, and

Newsletter Q3 2017

stricter demands in terms of liquidity reserves and lending, e.g. via the Basel regulations, which is putting a dampener on banks’ lending activities. In fact, the lending volumes of domestic banks have been shrinking since the financial crisis, whereas mortgage lending volumes have been growing. In particular the combination of increased mortgage lending and record-low interest rates has driven the surge in demand for real property. The fact that the expansionary monetary policy has had limited effect on real-economic growth in practice is probably due to a combination of factors. One essential factor is that domestic households have greatly increased their savings and bank deposits instead of raising their debt. This may be due to stricter financial regulation and uncertainty about the economic outlook. Low interest rates have served to provide many homeowners with higher disposable incomes and increasing equity, seemingly affecting savings more than spending, at least until 2015. In terms of economic growth, the effect has been limited. In addition, higher savings ratios serve to increase the placement requirements of institutional investors. Similarly, the effect of monetary policy is limited when demographics

indicate fewer young consumers and more senior citizens with a preference for saving. This is especially the case when the latter demographic group stands to benefit from expansionary monetary policy, as this policy to a certain degree is expected to have increased the equity of established homeowners. This matters in a country like Denmark, where an increasing proportion of the population is aged 50+. The business sector has only on a moderate scale increased its debt in order to invest in their own operations. The increase in commercial lending is apparently driven by mortgage loans, mainly via direct bond issues. This suggests that investments are placed in fixed assets and not in core business operations (except for property companies). However, since 2015, banks have seen a slight but upward trend in commercial lending activities. Moreover, because of the low interest rates, the yield on government bonds in particular has plummeted to an unprecedented low. This has made investors zoom in on asset classes other than bonds, as clearly reflected in the overall deposit statistics of domestic investment funds.

Money is invested in bricks and mortar: Private mortgage credit loans head the field (DKKbn)

1,000 1,200 1,400 1,600 1,800 2,000

0 200 400 600 800

2006

2009

2008

2005

2007

2010

2014

2016

2013

2015

2012

2017

2011

Private lending, banks Private lending, mortgage banks

Commercial lending, banks Private lending, mortgage banks

Source: Danmarks Nationalbank

Newsletter Q3 2017

Secure bonds discarded as risk tolerance grows (investment fund deposits and transaction volume in terms of investment property, DKKbn)

100 150 200 250 300 350 400 450

0 50

2010

2011

2012

2013

2014

2015

2016

Deposits in equity funds Deposits in hedge funds

Deposits in bond funds

Deposits in mixed funds

Transaction volume, property

Sources: Danmarks Nationalbank and Sadolin & Albæk

It is becoming obvious that low bond returns have sent investors in pursuit of higher returns. Investors have therefore turned to stocks and real property instead. Properties with great cash-flow security may act as an alternative to bonds, offering a similar low-risk profile. Among other things, this has caused a surge in investment property transaction volumes since 2011. In this context, it deserves mention that prime (first-class) properties offering great cash- flow security account for the majority of traded properties. The strong demand for such properties has driven down yield requirements, in the process driving up the pricing of this type of property, in theory equivalent to the price increases in the bond markets when interest rates are downtrending.

to fear that the favourable trend in pricing and transaction activity will not continue in the prime property segment. Although the low interest rate levels in Denmark and the rest of Europe are expected to be maintained for some time yet, it is extremely difficult to predict when Danmarks Nationalbank is expected to start hiking rates, and not least at what pace. Of course, much will depend on the ECB’s monetary policy as well as the future key indicators of economic momentum in Denmark and the rest of Europe. Provided interest rate levels remain low, we expect investors to continue to allocate an increasing share of their capital to assets other than bonds. The spread between the yield on a 10-year government bond and the net initial yield on prime residential rental properties, assets with a history of comparable risk profiles, is currently just in excess of 300 bps. Adjusted for inflation, the bond return becomes more directly comparable to the net initial yield on prime residential property. The fact that the net initial yield on prime property exceeds the inflation- adjusted bond return makes good sense as the

Will the pricing of investment property be affected?

In light of the fact that transaction volume and property pricing are gradually nearing pre-crisis levels or perhaps even higher levels, many investors may well be concerned that the market has in fact already peaked or is about to. Bearing in mind the effect of the low interest rate level, it is only natural

Newsletter Q3 2017

terms of risk-adjusted returns – also when factoring in the illiquid nature of property assets. Although we do not expect the yield requirements on prime property to continue downtrending at the same rapid pace as we have seen in the past three years, we still maintain that there is room for further – albeit marginal – reductions in yield requirements, provided the low interest rate level is maintained, in light of the historically wide inflation-adjusted yield spread vis-à-vis bonds. In addition, we do not consider a gradual and moderate escalation of interest rates a major short- term threat to the prevailing pricing mechanism in the investment property market. The greatest threat in this market is no doubt a renewed financial crisis in tandem with economic recession, which could limit monetary policy manoeuvrability as well as impact the occupational market. All other things being equal, however, that is the (probably greatest) fear of any investor, no matter which asset class the investor is exposed to.

spread denotes the illiquidity premium achievable when investing in real property.

In the years preceding the onset of the financial crisis, the spread between the inflation-adjusted bond yield and the net initial yield on residential property fluctuated between 0.91% and 2.30%. In 2002-2007, the spread averaged 1.68%. Today, the spread is as wide as 4.08%. The wider spread is mainly due to higher capital and liquidity requirements imposed on banks. Even if rate hikes will make it possible to achieve higher bond returns, making this asset class more attractive in relative terms, such rate hikes may well coincide with rising inflation. As a result, the above- mentioned spread is not likely to change much. Theoretically, we believe that the current spread between the yield on bonds vs. properties with a comparable risk profile is still sufficiently wide for the current property returns to tolerate an increase of 125 bps in 10-year bond rates before the net initial yield on prime property is driven up.

For this precise reason, investment property is still to be considered a highly attractive asset class in

Prime residential property yields greatly exceed government bond returns

+300 bps

-1%

00 01

02 03 04 05 06 07 08 09 10 11

12 13 14 15 16 YTD17

Prime net initial yield, residential

10-year government bond return Inflation-adjusted bond return

Sources: Danmarks Nationalbank and Sadolin & Albæk

DIGITALISATION CHANGES THE RULES FOR OFFICE LETTING

When tenants are searching for commercial lease premises, a telephone call to the local estate agent or browsing the ads in the local weeklies are about to become a thing of the past. New research by Sadolin & Albæk shows that completely different channels have come into play.

By Andreas Brandt, Senior Consultant, Sadolin & Albæk

As digitalisation is penetrating Danish society, consumer buying patterns undergo dramatic changes. The new buying behaviour not only affects retail sales but also traditionally static markets like the office letting market, where new parameters, or value drivers, influence tenants’ choice of lease premises.

Digitalisation has caused important change in the way advertisements are run. According to the latest edition of ‘Global Trust in Advertising’ by analytical consultants Nielsen, consumers believe online ratings to be the most reliable, outranked only by recommendations from personal networks and various products’ own online channels. The growing influence of online ratings on the B2C (business-to-

Newsletter Q3 2017

Denmark tops the list of Europe’s most digitalised countries (DESI scores, Denmark 2014-2017)

Evolution over time

Connectivity

2014: 0.65 2017: 0.71

2014: 0.66 2017: 0.76

Integration of digital technology

Use of internet

2014: 0.57 2017: 0.72

2014: 0.43 2017: 0.62

Source: European Commission

Note: Highest score is 1.0

consumer) market ties in with the explosive growth of businesses such as TripAdvisor, Expedia and Trustpilot. For instance, TripAdvisor alone features more than half a billion approved ratings, and online ratings are increasingly used to support decisions. Digitalisation therefore plays a vital role in the consumer buying process. Change in consumer behaviour feeds through to the office letting market In a historical context, the office letting market has been a static marketplace, predominated by traditional sources of information. Among other things, advertisements in the printed media and estate agent contacts have been the preferred channels of information for the mediation of lease premises. In recent years, however, digitalisation has fed through to the office letting market too, and in this field the range of options available has seen a sharp increase for tenants and landlords alike. Sadolin & Albæk has conducted a tenant survey of the office letting market to map the value drivers of tenants and their decision-making patterns when selecting new lease premises. The survey is based on interviews with 400 private businesses across

According to the EU’s ’Digital Economy and Society Index’, Denmark is the most digitalised country in Europe. Denmark tops the list in categories such as ‘Use of Internet’ and ‘Integration of digital technology’. In addition, a growing number of Danish businesses have become more frequent users of various digital services, including the social media, as part of day-to-day business operations. The increasing availability and growing penetration of online apps greatly affect consumer patterns in society. Typically, it only requires one single click on a link for consumers to be redirected to a site where they can obtain more information about a product or buy it. This dramatically speeds up the consumer buying process.

Newsletter Q3 2017

Personal networks and online searches preferred by tenants looking for new o ce premises

Network recommendations Search via Google or other search engines Through estate agents Reached out to landlord in person Search via commercial lease portals Had seen ads on the Internet

14%

19%

11%

16%

Was contacted by the landlord/commercial estate agent Had seen ads posted around town (signs on buildings, etc.) Had seen ads in newspaper Search via social media (e.g. LinkedIn or Facebook) Other No recollection

15%

14%

Source: Sadolin & Albæk

11%

All interviews were conducted as telephone interviews by Megafon A/S on behalf of Sadolin & Albæk and It’s A Fact ApS. Note: The results do not add up to 100% as the respondents were given multiple reply choices. Base = 400 surveyed. 178 respondents.

large scale too when looking for new lease premises. The survey indicates that small and medium-sized businesses integrate the digital tools in the search process but have no predefined search strategy. It took the interviewed businesses 26 weeks on average to find new lease premises, but for more than 60% of the small businesses it took less than 12 weeks. The same applied to more than 40% of the medium-sized businesses. Conversely, businesses with more than 100 employees take much longer to search the market. Confidence in landlord a key value driver As the office letting market is becoming more dynamic, tenant parameters in connection with the selection of new lease premises have changed substantially as well. In the past, tenant demand was characterised by great focus on price, location and size, but today’s office tenant has a great number of additional value drivers that are key factors in the selection of new lease premises.

various industries and business size brackets in the Capital Region of Denmark, with special emphasis on Copenhagen. To get close to the decision- makers, the target group was individuals fully or partly in charge of selecting business premises. The tenant survey shows that the personal network is the most widely used channel when tenants are searching for new lease premises, ahead of online searches and estate agent contacts. It is worth noting that tenants only on a limited scale avail themselves of traditional advertising media when searching for new lease premises. Conversely, online searches have become much more commonplace and, broadly speaking, the tenant survey results confirm the notion that the office letting market has become increasingly digitalised and dynamic in recent years. In addition, the tenant survey shows a preference among small businesses (2-19 employees) for the network as the most favoured research method. In addition, small and medium-sized businesses (20- 49 employees) employ online search engines on a

Both indoor climate, accessibility and flexibility are high-priority concerns, and the tenants questioned

Newsletter Q3 2017

Indoor climate and confidence in landlord outrival price (top-10 value drivers)

65% 63% Indoor climate

58% 51% Price Good parking facilities

59% Good accessibility by car

Confidence in landlord

41% Quality and signal value of lease premises

41% Conditions on arrival

40% Adjustment options

40% Flexibility of lease agreement

35% Proximity to Metro or S-train

Source: Sadolin & Albæk Note: The results do not add up to 100% as the respondents were given multiple reply choices. Base = 400 surveyed. 178 respondents.

All interviews were conducted as telephone interviews by Megafon A/S on behalf of Sadolin & Albæk and It’s A Fact ApS.

in the Sadolin & Albæk tenant survey list more than seven parameters on average as key determinants of their preferred location. Somewhat surprisingly, confidence in the landlord ranks as the second-most important value driver among tenants. The emphasis on confidence in the landlord is manifesting itself in tenant buying behaviour, with recommendations from personal networks being the preferred starting point when looking for new lease premises. Via network ratings, tenants are indirectly reassured that they can trust a given landlord. This is supported by the findings of the Nielsen survey, where network ratings rank as the most reliable source of information. On the face of it, it therefore seems that general societal trends are mirrored in demand drivers among commercial tenants in search of new lease premises.

employing online search engines as part of their search strategy. Due to digitalisation, consumers are to a varying degree relying on online ratings in the B2C market, which is also confirmed by the Nielsen consumer survey. By employing online search engines, tenants are not only able to search the market for new premises, but may also make preliminary enquiries about a landlord. Although landlord ratings have yet to become a widespread phenomenon in the office letting market, they are common in segments of the residential rental markets, with tenants reporting and rating landlords on services such as Airbnb. Given the increasing digitalisation trend and prevalence of reporting services, it is not unlikely that this will become part of the office letting market and the commercial letting market in general. Sadolin & Albæk believes that this is a trend to monitor in future.

Confidence in the landlord as a value driver tallies with the relatively large proportion of businesses

Newsletter Q3 2017

Downtrend in o ce vacancy rates

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%

0.00%

2007 2008 2009 2010 2011

2012 2013 2014 2015 2016 2017

CBD

Greater Copenhagen, incl. CBD

Source: Ejendomstorvet.dk

Does behavioural change affect vacancy rates?

indications of this being attributable to a change in the buying behaviour of commercial tenants, the relatively short decision-making process and increased digitalisation. Market developments are largely supported by a sustained strong labour market, driving the demand for additional office workplaces, all other things being equal. In addition, conversions of office space for both residential and hotel purposes affect vacancy statistics, although the scale of these conversion schemes is difficult to gauge. However, Sadolin & Albæk believes that, due to the increased digitalisation and use of networks, it is possible to find a quicker match between a prospective tenant and landlord for their mutual benefit. All other things being equal, this makes for a more active office letting market, where trends are favourable.

The most recent vacancy figures from Danish online portal Ejendomstorvet.dk show a 6.1% decline in the Copenhagen CBD (Central Business District) office vacancy rate, marking the lowest level since mid-2009. In the span of the last 12 months alone, vacancy has seen a 1.8 bps decline, corresponding to a decline in office vacancies of almost 100,000 sqm. This trend is also confirmed by the latest market statistics released by the Danish Property Federation, measuring financial vacancy in the market (with financial vacancy defined as the sum total of current annual rent of all vacant leases divided by the sum total of current annual rent in both tenanted and vacant lease units). In the CBD, financial vacancy has dropped by 0.8 percentage point in the last 12 months, standing at 5.6% as at start-Q3 2017. In Greater Copenhagen, the pattern is the same: the vacancy rate has come down to 7.6%, but financial vacancy is calculated at 13.1%.

Irrespective of the highly favourable trend in office vacancy rates, however, there are no clear

Newsletter Q3 2017

SPECULATION IN THE COOPERATIVE HOUSING MARKET

Quite contrary to intention, antiquated lease legislation opens up for speculative capital gains when dissolving the housing society and selling the property.

By Peter Winther, Partner and CEO, and Ole Hjorth, Director, Sadolin & Albæk

media in connection with ailing societies, interest rate swaps, bankruptcies, under-the-table money and major uncertainty about valuations made by real estate appraisers. A lot of the problems are associated with cooperative housing societies established in the period up to the financial crisis when the combination of high prices of residential rental property and complex financial products resulted in unviable societies. However, it hardly evokes sympathy that the members of such cooperative housing societies have specifically targeted bankruptcy, inflicting substantial losses on the loan providers while enabling the members of the society to continue as tenants. Valuation uncertainty Ailing cooperative housing societies aside, the challenges presented by this form of ownership are mainly rooted in the problems inherent in the combination of a maximum price system and uncertainty surrounding the valuation of the society’s prime asset – the property.

In recent years, the Danish private cooperative housing sector has been the object of quite a bit of negative press coverage caused by the valuation problems inherent in this form of ownership. The combination of a maximum price system and complex rules produces major valuation uncertainty to the disadvantage of both residents and investors. Cooperative housing as a form of ownership has existed for more than a century and is an offshoot of the cooperative movement. The form of ownership has evolved markedly from the emergence of the very first housing societies at the end of the 19th century to the private cooperative housing societies of to-day. Like owner-occupied dwellings, private cooperative housing societies account for about 30% of the housing stock in Copenhagen and Frederiksberg, making them a key component of the overall housing supply.

However, cooperative housing has in recent years drawn quite a number of negative headlines in the

Newsletter Q3 2017

The maximum price system gives rise to problems when the price difference between a cooperative housing unit and a comparable owner-occupied dwelling exceeds a level explainable by differences in financing options and taxation.

The maximum price system is generally based on the provisions of the Danish Cooperative Housing Act governing the transfer of a unit in a cooperative housing society. The Act prescribes that the price of the unit cannot exceed a price reasonably justified by the value of the unit relative to the society’s assets, improvements made to the unit and the state of repair of the unit. The maximum price system gives rise to problems when the price difference between a cooperative housing unit and a comparable owner-occupied dwelling exceeds a level explainable by differences in financing options and taxation. A housing cooperative is free to use the purchase price, the cash market value as a rental property or the most recent official property valuation for a property valuation. If a housing cooperative opts for the approach providing the lowest value, the units become assets sold substantially below the actual market value. Such a situation would foster nepotism, with the friends and family of housing cooperative members having a first claim to units for sale, and may lead to demands for money under the table or demands on buyers to pay unreasonably high prices for furniture and equipment. The inherent imperfections of the maximum price system support the use of valuations made by real estate appraisers, as these would be more likely to ensure that current conditions in the investment and housing markets are factored into the valuation, but the valuation is subject to unacceptable uncertainty as a result of complex legislation. Valuations made by real estate appraisers must be based on the cash market value as a rental property. This means that the appraiser will need to take into consideration the legislation that the property would be comprised by had it been a rental property. Accordingly, the applicable legislation is determined by the year of construction of the property and whether it is situated in a regulated or unregulated municipality. These factors determine whether market rent can be charged or whether rent is to be Increased use of valuations made by real estate appraisers

determined in accordance with the utility value or cost-related rent.

If valued as a rental property subject to cost-related rent, the property will be valued substantially below the actual market value of the individual units combined. This is due to the fact that cost-related rent is generally much lower than the rent that a house- hunter would be ready to pay in a free market. However, the members of the cooperative housing society will have a direct financial interest in achieving the highest possible valuation price as it makes it possible for the unit owners to realise substantial tax-free gains. As a result, we often see an unhealthy scenario where the housing cooperative is incentivised to pick the real estate appraiser prepared to value the property at the highest amount – not the appraiser providing a correct value of the property as a rental property. Complex and antiquated legislation Most of the properties owned by private cooperative societies in Copenhagen, Frederiksberg and Aarhus were built before 31 December 1991 and comprise more than six units. As these three municipalities are regulated, most of the properties are to be valued on the basis of the provisions of the Danish Housing Regulation Act and in practice pursuant to extremely complex and antiquated legislation. Accordingly, a correct valuation of a property comprised by the provisions of the Housing Regulation Act on cost-related rent must comprise a determination of the rent that may lawfully be charged, improvements made to the property in

Newsletter Q3 2017

relation to section 5(1) of the Housing Regulation Act and the maintenance history of the property in relation to provisions under sections 18 and 18b of the Housing Regulation Act, etc. In a correct statement of the property’s current income and operating expenses, the valuation should also take into account any optimisation potential currently factored in by the market for traditional rental properties. In a joint effort, the Danish Ministry of Industry, Business and Financial Affairs, the Danish association of private cooperative housing, ABF, and Finance Denmark have listed 13 recommendations to safeguard responsible operations in the cooperative housing sector. The 13 recommendations pertain mainly to formation, financing and the transition from unit owners to tenants, whereas the valuation is only touched upon very lightly, because of concurrent efforts presently undertaken by the Danish Association of Chartered Estate Agents and the Danish Property Federation. These two organisations are in the process of updating the guidelines and norms for real estate appraisals, including ways of ensuring that the appraisers have the required qualifications. However, updated guidelines and norms alone are not enough to reduce the uncertainty associated with valuations made by real estate appraisers as the valuation basis remains an antiquated and complex body of laws. Serving as a current example of the consequences of the challenges posed by the maximum price system, several old and well-run cooperative housing societies are being liquidated, guaranteeing the unit owners a profit that substantially exceeds the value of the property had it been valued on the basis of continued operation of the cooperative housing society. As a result, it does not seem fair that tenants, who are often long-term residents at very low rent levels, pursuant to the mandatory pre-emption rights of tenants as set out in the Danish Rent Act may take over a rental property by forming a cooperative Speculative dissolving of housing cooperatives

The underlying philosophy of cooperative housing was to establish a type of housing that would offer reasonably priced dwellings free of any speculative element. housing society, subsequently realising substantial tax-free profits when dissolving the very same society and selling the property as an untenanted rental property and therefore with a significant immediate upside potential for a buyer. The underlying philosophy of cooperative housing was to establish a type of housing that would offer reasonably priced dwellings free of any speculative element. By dissolving a cooperative housing society and selling the property, however, the unit owners precisely do speculate in achieving tax-free capital gains. Valuation basis remains antiquated Like the maximum price system, cost-related rent was introduced in a statute passed as a temporary measure by the Danish Parliament, Folketinget, in 1937. The statute entails that the income basis of a rental property is artificially low as the rent is often much lower than the real value of the asset as warranted by the right of disposal of the unit. As a result, the correct valuation by a real estate appraiser of a cooperative housing property will often be substantially lower than the actual market value of all units combined. The Danish Parliament hardly intended for members of housing cooperatives to realise tax-free capital gains by dissolving cooperative housing societies. However, this option fundamentally continues to co-exist with the effective unhealthy maximum price system.

Newsletter Q3 2017

THE SHARING ECONOMY – NOW ALSO MOVING INTO THE OFFICE

In the wake of the business success of e.g. Airbnb and GoMore, several sharing-economy ideas and concepts are gaining ground in the office letting market.

By René Faaborg Greve, Consultant, Sadolin & Albæk

Airbnb has continued to draw headlines in recent weeks. Not long ago, the company released a report showing an almost 50% increase in Danish peer- to-peer home lets in only 18 months. In addition, the report shows that 31,000 Danes use the service to rent out their home or a room. One of the hot topics of debate is whether Danish politicians should intervene and limit the possibilities of landlords engaging in private hotel operations and how to report the rental income to the taxation authorities. Airbnb. According to Bloomberg, in the span of only nine years, Airbnb has managed to make more rooms available worldwide than the three largest hotel chains, Hilton, Marriott and InterContinental, combined. In 2014, Airbnb outperformed Hilton in terms of market value – not bad for a brand that does not actually own the rooms. One of the reasons why the sharing-economy concept is gaining ground is the explosive market entry by

Unlike ‘traditional’ economics, the starting point of the sharing economy is not scarce resources, but rather surplus resources, or surplus capacity. It is all about gaining access and right of use to more of the objects that we surround ourselves with rather than obtaining ownership to them. The sharing of private homes, cars, music, etc. has been greatly facilitated by the advance of digitalisation. This also applies to the sharing of offices and workplaces. Today, there are numerous websites where landlords offer office workplaces or entire office leases to let, whether on an hourly basis or on multi-year leases. Originally, the concept of shared workplaces targeted business start-ups, freelancers and small businesses. How-ever, major companies have also started to recognise the advantages of shared workplaces/offices.

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