What will be the impact of housing market anxiety?

Overproduction of expensive tenant-owned flats in the big cities is now evident in slow – or no – sales and lower prices. One reason for this is that the bulk of production is aimed at high-income buyers, while the surge in population growth has been fuelled mainly by immigration and most of this group lack the financial resources required to buy a flat.
Representatives of Catella and Catella Fonder made the case in a podcast with property market analysts Arvid Lindqvist and Martin Nilsson, who are also managers of Catella's hedge funds.

Arvid Lindqvist predicted overproduction and a consequent price drop, especially in the housing sector, fully a year ago in another Catella podcast. He also warned that the market could deteriorate for certain segments of commercial property and shopping centres in less than prime locations. We are now seeing downwards movement.

"We observed quite a while, more than 18 months, ago that the components don't really fit. A great deal of housing is in planning and the type of products being planned in the Stockholm area are, generally speaking, very expensive," says Lindqvist.

"And if you look at the demographic trend, there is actually zero growth in the high-income stratum. Population growth in the Stockholm region consists mainly of people of foreign background, most of whom are from outside the western world. They simply do not have the means to go out and buy these expensive homes," he continues.

There is also a lot of psychology involved in market behaviour, according to Arvid Lindqvist, referring to a major change that occurred at the end of the summer even though the underlying factors had not changed since the beginning of 2017. The building pipeline looks about the same, but sentiment has changed dramatically.

New production came more or less to a halt at the end of summer, which has to do with a turnaround in the psychology of homebuyers – a trend that is strongest in the Stockholm area.

"We can see there is a near-linear correlation between house prices in Stockholm and Swedish GDP growth, six months ahead of time. What we see over time is that annual growth of 7 percent in house prices is required for GDP growth of 2 percent. We are now moving below zero – a clear indicator that we are going to see a relatively sharp slowdown in growth. We expect a fairly steep drop in economic growth in the second half of 2018," says Arvid Lindqvist.

We usually talk about the strong link between GDP growth and the property market. But the latest figures on the global level are upwards revisions – shouldn't that also benefit Swedish companies?

"We are seeing an upwards revision for the global economy, and Europe and the US are booming. This is, of course, extremely good for the Swedish export industry, as evident in strong order inflows. But Sweden is out of step: we actually had no major slowdown in terms of household consumption and house prices during the financial crisis, unlike almost every other country in the western world. We kept biting and household indebtedness has been growing for 20 years. On average, we have injected 4 percent of GDP per year via increased credit growth," says Lindqvist.

According to the analyst, Sweden is lucky to have a strong business environment because that holds back the tide a bit. Even though the export sector is not hiring as much anymore, it is nevertheless an engine of growth. At the same time, it is apparent that the domestic factors are slowing down and are extremely dependent on house prices.
"What we have been seeing during the last few quarters is that housing investments have been an unmistakable growth driver and, roughly speaking, account for 1 percentage point of the annual growth rate right now. We are now seeing a sharp deceleration, meaning that housing investments in the second half of 2018 will probably be a clear factor that drags down growth by a percentage point instead of adding a percentage point," says Lindqvist.

"Economic growth is going to be considerably weaker in the second half of next year. Rather than 3 percent, we are going to see an annual rate of 0 to 1 percent," he continues.
But the normal annual rate of production in the Stockholm region has just about trebled. What happens now? New projects are being cancelled, we have seen that certain housing developers are struggling and that firms are probably going to consolidate. Do you believe the rate is going to plummet?

"I believe that if you look at the pipeline, there are nevertheless a relatively large share of stable companies that have cash flow. What we are seeing is that production costs are very high and demand is starting to stumble a little," says Lindqvist.

Do you believe we are going to see a conversion to a higher volume of rental properties?

"Yes indeed. It is getting harder to flog the tenant-owned flats and when this occurs developers try to convert projects to rental housing. But that is not always easy. Initial land prices are often very high in Stockholm, which means the numbers just do not support rental housing. Construction costs are also lagging behind production, and they are record-high."

Martin Nilsson notes that fund managers could already see last spring that all was not as it should be in the housing sector.
What might this mean purely in terms of investment? We have seen housing developers drop in the neighbourhood of 60 percent.

"Relatively early in the year, by April/May, we had already identified that sales of new construction were faltering. So, we took short positions in many of the builders, primarily the major ones because shares in the smaller ones cannot be borrowed. So, one reason for the strong performance of our hedge funds in the period of June to August was actually that we were short in much that was construction-related," says Nilsson.

He notes other factors as well: when we see a weakened economy that had been driven by low interest rates and consumption, there is a whole range of companies surrounding the builders that are also affected, which have delivered weak performance – and are going to continue doing so.

And if one looks at the Swedish stock market from a 100-year perspective, it has actually been the best in the world, along with Australia.

"But when foreigners read about a building bust in their papers, it is easy for them to sell. Where they have increased their positions over a period of five years is in Swedish banks and property companies, actually, which they are now selling off. Looking at the Swedish banking sector in recent months, the trend has been feeble. We recently saw Millennium, one of the biggest hedge funds in the world, double its short positions in the Swedish stock market," says Nilsson.

He describes the strategy going forward as the reverse of the 2015 strategy, when companies with large domestic exposure were on the long side, while steel, metals and cyclical were short. Now it is the opposite: short positions in more domestic companies with large exposure to the local market and long positions in companies that benefit from a weaker Swedish krona.

"The major concern is a global recession. We do not believe that is going to happen, but if it does, it will be a very dark scenario for Sweden," says Nilsson.

One year ago, Arvid Lindqvist also warned of a slowdown for commercial properties as well, at least in certain segments. He believes he has been proven right on that front.

"Exactly what we expected has happened: underperforming retail properties and the average yield requirement in the durable goods segment have illustrated a weaker market, along with a difference between class A, B, and C locations. What we are seeing now, after the summer, is a much more hesitant market. Transaction volumes are going down," says Lindqvist.

There is still very high demand for office properties in central Stockholm, for example, but the market is utterly different in below-prime locations in smaller cities. It is a quality difference, according to Arvid Lindqvist: "What we are waiting for now is for buyers and sellers to start coming together in the less attractive locations."

But with the trend towards increased e-commerce, Black Friday for example, are we going to need as much commercial space in the future?

"That is a structural transformation parameter. Growth in retail has actually trended downwards in the past twelve months. E-commerce is approaching critical mass where it is starting to have an impact," says Arvid Lindqvist.

Martin Nilsson agrees: "Take Amazon, for example, which we know has bought land for premises but will not be entering the Swedish market before the fourth quarter of 2018 at the earliest. Historically speaking, Amazon has typically taken a 25 percent share in its chosen segments within three years. This has impact on most segments and is disastrous for many, but good for some."