5 Reasons Why Expats Should Not Invest In Property In Finland
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Introduction
The risks in the real estate sector of Finland listed below are reasons why expats should not invest in property in Finland at this point in time.
Nordic real estate market risks are undeniable and has long been there.
The Nordic countries have significant vulnerabilities related to household debt and residential property prices, and Nordic banks lend a lot to the real estate industry.
Finland’s economy is also at risk from the risks to the financial stability of the Nordic countries. There is a link between tail risks in the Finnish economy, or the increased likelihood of sizable drops in total output, and the rise in household debt in other Nordic nations.
Using macroprudential tools, the risks in the real estate sector have been reduced, but the most recent assessment by the European Systemic Risk Board indicates that this hasn’t gone far enough.
5 Reasons Why Expats Should Not Invest in Property in Finland
1. Rising housing prices raise the risks associated with the housing market
The other Nordic nations have experienced an increase in residential property prices in recent years.
The COVID-19 pandemic has caused a particularly noticeable increase in prices: residential real estate costs in Sweden, Norway, and Denmark have increased by more than 20% in nominal terms since the year 2020. The corresponding increase in Finland has been around 7%.
The disparity in regional price trends between Finland and the other Nordic nations is partly to blame.
Finland is the only Nordic nation where residential property prices have been declining for some time, according to a recent Statistics Finland report. The overall price trend for the nation has been fairly level as a result of this.
The European Central Bank (ECB) found evidence of overvaluation in Sweden’s residential real estate prices. A number of valuation techniques have led to the conclusion that the sudden increase in prices in Sweden cannot be explained by the usual supply or demand factors.
At a European level, Sweden is significantly overvalued, and this overvaluation grew in the 2010s.
According to the ECB’s analysis, residential property prices in Finland and Denmark are in line with the overall economic trend, despite the fact that some indicators in Denmark have recently indicated an upward trend.
In the medium term, the increase in recently begun construction projects may lessen the upward pressure on Swedish residential real estate prices.
Economic crises have frequently been fueled by the housing market. For instance, the US housing market was where the 2008 global financial crisis started.
These crises are typically preceded by a time of sharply rising residential property values, during which time household debt increased as a result of housing purchases being financed using a lot of leverage.
A sharp decline in prices could occur if the rise in residential real estate prices turns out to be unsustainable. A decline in asset values could then result in a decline in consumer demand, particularly from households with high levels of debt, which could start or exacerbate an economic recession.
The risks in the Nordic housing markets have been brought to light by the European Systemic Risk Board (ESRB). Finland, Sweden, and Denmark have received alerts from the ESRB regarding security flaws as well as suggestions for specific actions to be taken.
The most recent report from the ESRB, released in 2022, evaluated the steps taken by these nations to reduce the risks associated with their housing markets and found that they were, in part, insufficient.
Norway has only previously received a warning; the actions it has taken are currently thought to be sufficient.
2. The debt-to-income ratios of Nordic households are high
Residential property prices have experienced an exceptional rise globally during the pandemic, making the economic crisis caused by it unique in this regard.
This has been attributed in part to investments made in housing as a result of an increase in the number of people working from home, with money that might have been spent on travel instead.
The ease of obtaining mortgage financing during a period of low-interest rates may have increased demand for residential real estate, which in turn raised property values.
The combination of housing investment and affordable mortgage rates has led to an increase in residential property values and a rise in household debt.
The majority of household assets are made up of owner-occupied homes, and for some families, housing debt is disproportionately high compared to available cash. High household debt levels pose a serious threat to the Nordic countries’ ability to maintain their financial stability.
The Nordic nations have some of the highest household debt levels in Europe when compared to annual disposable income. If interest rates rise, the high level of household debt could cause issues.
As a result, consumer demand would decline, slowing GDP growth. In the worst-case scenario, some households might struggle to pay back loan instalments if, for instance, unemployment were to rise or the number of temporary layoffs to rise.
3. Real estate sector debt held by Nordic banks is among the highest in Europe
Due to a large number of housing and commercial property loans that their banks hold on their books, the Nordic countries are, by international standards, particularly vulnerable to issues affecting the residential and commercial property markets.
By the end of 2021, nearly 70% of Denmark’s banks’ loan portfolios were related to the real estate market. The corresponding percentages for Sweden, Finland, and Norway were 66%, 57%, and 54%, respectively. The share is below one-third in many of the bigger euro area nations.
Nordic banks’ exposure to credit risk is significantly influenced by lending secured by real estate. In a downturn, the commercial real estate market can result in loan losses for banks due to its historical cyclical sensitivity.
The Nordic banks’ loan losses on mortgages, however, have typically been modest. Due in part to the various support measures, like payment holidays, loan losses have also remained low throughout the pandemic.
Even though the payment holidays have already mostly ended, the proportion of non-performing loans for residential and commercial real estate in the Nordic countries is still lower than the average for Europe.
Nordic banks issue covered bonds that are backed by residential mortgages to finance a sizeable portion of their operations.
For the banks to receive funding, the covered bond market must operate effectively, and the quality of the real estate loan stock has a significant impact on both the availability and cost of that funding.
With the exception of a brief period in spring 2020, the covered bond market has performed well throughout the pandemic. Since the start of Russia’s invasion of Ukraine, the market has also been unaffected.
4. The vulnerabilities of the Finnish economy are reflected in the debt of Nordic households
During economic downturns, macroprudential policy is used to make sure banks have enough equity and capacity to absorb losses.
Macroprudential regulation is used to foresee not only the most likely course that the economy will take but, more importantly, the more unlikely and particularly unfavorable scenarios.
The quantile regression method has proven to be an extremely helpful tool in analyzing these so-called tail risks for the economy.
The term “tail risk” describes a potential decline in the gross domestic product (GDP) that could be brought on by an unlikely financial crisis.
Although “improbable” has many different definitions, in this analysis it refers to a 5% chance that a downturn would occur.
It is possible to calculate how much GDP growth would slow down each time the tail risk materialized using the quantile regression method. The severity of the crisis varies with the state of the economy at any given time.
To lessen the size of the tail risk without changing the most likely favorable path of GDP growth, macroprudential policy is used.
It is known from earlier studies that a rapid rise in household debt portends the beginning of an economic crisis as well as a bank crisis, which would deepen and extend the already ongoing downturn.
Therefore, it is not surprising that there is a strong statistical correlation between the rate of debt accumulation and economic tail risks.
A sudden decline in the overvalued prices of residential real estate entails risks to the stability of the financial system as well.
The capital adequacy of banks would be directly impacted by a sharp decline in residential property assets, which would also lower private consumption. Investing and the purchase of durable consumer goods would then show signs of tightening financial conditions.
Economy-wide vulnerabilities typically worsen over time in a slow, steady manner. According to numerous studies, the best indicator of the start of a crisis a few years later is the rate at which household debt is accruing.
As a result, it is intriguing to try and predict how tail risks will evolve, say, three years in advance because over this kind of timescale, predictive variables will have the greatest explanatory power.
The other Nordic nations have a significant economic impact on Finland. This is clear from both the interconnectedness of the banking industry on the financial markets and the foreign trade statistics in the real economy. Finland is also at risk from the risks present in these neighboring nations.
Through a variety of channels, negative shocks can be transmitted across borders, and the easier this transmission is, the more interconnected the economies are.
Risks coming to pass and a decline in spending and investment in Finland’s Nordic neighbors will have a direct impact on the country’s export earnings.
Another pathway for the dissemination of these shocks is through the international operations of Nordic banks. As a result of credit losses coming from a single nation or the realization of market risk, banks’ capital adequacy may become less adequate.
Due to the fact that group-level measurements of solvency are taken, lending requirements would be raised across all of the nations where the bank conducts business.
Furthermore, as the GDP growth in the aforementioned countries slows, the credit risk associated with loans made by Finnish banks abroad may become realized, further tightening financial conditions.
5. The capital needs of Nordic banks are rising due to risks in the real estate market
To reduce the risks associated with mortgage loans and household debt, the Nordic countries have introduced macroprudential instruments.
Macroprudential tools related to the real estate market include countercyclical capital buffers for banks that are designed to reduce cyclical systemic risks, risk weight floors for loans that are specifically related to real estate, and tools that directly deal with lending for home purchases.
In particular, the countercyclical capital buffer is designed to reduce systemic risks brought on by the financial cycle overheating. A particularly quick increase in lending and residential property prices are regarded as indicators of overheating.
Before the pandemic, countercyclical capital buffers for banks had been established in Sweden, Norway, and Denmark. The buffer before the pandemic was 2.5% in Sweden and Norway and 1% in Denmark. Additionally, Denmark had declared pre-pandemic increases in the buffer to 2%.
The buffer was reduced in Sweden, Denmark, and Norway to 0% and 1%, respectively, after the pandemic’s outbreak. As they transition from the exceptional conditions of the pandemic to normal circumstances, all three countries have now once more announced increases in the buffer.
Sweden has modified its countercyclical capital buffer strategy in light of the lessons learned from the pandemic, adopting a 2% positive neutral level even in normal circumstances, when there aren’t necessarily any signs of an increase in risks. This enables better defense against unforeseen financial system shocks, even those that do not come from the banking industry.
For the purpose of incorporating risk weight floors into bank capital adequacy calculations, residential and commercial property loans have been introduced in Sweden and Norway. The risk weight floor can be used to lower the risk weight ceiling for specific loans.
The more equity a bank needs to have to cover the credit risk of a loan, the higher the loan’s risk weight. Housing loans have very low-risk weights because the historical credit losses associated with them have been minimal.
Macroprudential tools geared toward residential mortgage borrowers are used in all of the Nordic nations. The loan-to-value ratio at its maximum is one of these instruments (LTV ratio). In relation to the value of the property, a borrower’s ability to obtain a large enough mortgage depends on the LTV ratio.
Nevertheless, the other Nordic countries have a wider range of macroprudential tools than Finland does for home mortgage borrowers. Norway has a debt-to-income ceiling that is used to limit how much a household can owe overall in relation to its gross income.
A requirement for amortizing housing loans is also present in Sweden and Norway. The amortization requirement affects households in both nations whose mortgages are disproportionately large to the value of their homes.
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