SWEDEN: An Introduction to Real Estate

Considering the year 2021 as a climax, the Swedish real estate market has flourished over the past decade. Firstly, the policy rate (previously referred to as the repo rate) has remained unusually low ranging from -0.50% to 0.00% from October 2014 until May 2022.

The low policy rate combined with the Swedish central bank’s massive increase of its bondholding, which has had a significant effect on the accessibility of capital in the market, has led to decreasing requirements of yield. These factors combined have significantly boosted the property values over an extended period of time. As a result, many of the Swedish real estate companies have adopted a growth strategy. To finance the growth, many of the companies have issued unsecured bonds. The low policy rate, increased liquidity in the market, and subsequently lowered yield requirements, given unchanged loan-to-value ratios, have allowed for more loan capital to be allocated to properties, the issuance of unsecured bonds has further enabled increased loan-to-value ratios and the allocation of additional loan capital to properties.

Low yield requirements and high loan-to-value ratios has resulted in each euro in rental earnings having to cover the interest on relatively large loans. For instance, with a required yield of 5.00% and a loan-to-value ratio of 50.00%, each euro of rental income covers the interest on ten borrowed euros. If there is 10% inflation, each rental income euro increases by 10 cents. However, if the interest rate increases by more than one percentage point, the interest expense will increase with an amount larger than the increase in the rental income by the same amount. This effect has further intensified the lower yield requirements and the higher loan-to-value ratios.

The annual inflation rate in January 2023 was 11.70%, in comparison to the Swedish central bank’s target level of an annual inflation of 2.00%. To mitigate the inflation, the Swedish central bank has raised the policy rate substantially. During the past year, specifically since the spring of 2022, the policy rate has increased from what was previously a zero or negative rate to a the current rate of 3.00%. This has posed a challenge for Swedish real estate companies as they have adapted to remarkably low policy rates over the past decade. Furthermore, the Swedish central bank has completely ceased its purchase of bonds. The resulting increase in interest rates and reduced liquidity in the market has impacted yield requirements, but more importantly has intensified the ever-present uncertainty regarding the long-term yield requirements for properties.

The heightened level of uncertainty regarding the yield requirements for real estate has resulted in a significant decrease in real estate transactions. Sellers are uncertain as to whether the current higher interest rate-based yield requirements represent the new norm or what future requirements will entail. Naturally, the sellers are hopeful that the low-interest rate environment will return. Buyers are reluctant to purchase real estate based on yield requirements established during the low-interest rate environment, as there is a risk that the current relatively high interest rates will persist. Both buyers and sellers are therefore adopting a wait-and-see approach to determine whether the low-interest rate environment will return or whether the current high-interest rate scenario is a long-term trend.

In addition to the uncertainty about the future interest rate environment, the real estate sector is facing significant challenges in the short and medium term. Unsecured bonds for significant amounts, approximately SEK100 billion in 2023 and approximately SEK400 billion up to and including 2025, are due for payment. On top of this, significant amounts are denominated in Euro with foreign investors, which lead to further uncertainty in the possibility to refinance the bonds among Swedish banks and investors. This creates a shortage of capital in the short and medium term, which can impact the yield requirements and market values of properties.

In contrast to the somewhat grim description of the Swedish real estate market, it is worth mentioning the fact that rising inflation rates also reduce the effective value of loans. Thus, investors may consider the effective interest rate rather than the nominal interest rate to accurately evaluate the true cost of borrowing in their calculations. This was evident during the 1980’s, when investments in the Swedish real estate market were strongly encouraged despite rising inflation, periodically reaching double digits. The underlying cause of the encouragements can be attributed to the fact that the rising inflation coincidingly increased property values alongside rental incomes, while simultaneously diminishing the effective value of loans. The combined positive effect of these factors was recognised and pursued by investors, which maintained a robust real estate market in Sweden during a high-inflation and high-interest rate environment.

In conclusion, the Swedish real estate market has seen significant growth due to favorable economic conditions over the past decade, but the market is facing challenges due to increasing inflation and the following rising interest rates. However, investors may act upon the above-mentioned positive calculations, as they evidently have done during periods of rising inflation in the past. The market's future remains uncertain, and stakeholders must carefully consider the long-term yield requirements for real estate transactions.