The Post-COVID-19 Finnish Real Estate Market amidst European Energy Crisis and the War in Ukraine
The COVID-19 pandemic, the war in Ukraine and the following rise of energy prices have all affected economic activity and added uncertainty to real estate markets around the world. Despite that, there are noticeable reforms and developments leading the green transition in the Finnish real estate market. In many ways, the post-pandemic issues, such as rising interest rates and energy prices, have boosted sustainable projects and activities. High energy prices have affected industrial properties in particular. Many have resorted to sustainable measures to conserve energy. This has attracted investments in renewable energy, energy efficiency and smart functions in the real estate market and construction as the payback period of these investments has been reduced considerably.
Despite the rising interest rates and high inflation, real estate investments tend to perform well in the changing business environment. Currently, investors and buyers are seeking economic stability by investing in properties with high and steady returns and with relatively low risks. Real estate can overcome inflation-inflicted pressure while preserving and building value which can be seen as an advantage of investing in real estate.
Health and Social Services Reform and EU Taxonomy
At the beginning of 2023, the organisation of public healthcare, social welfare and rescue services were reformed in Finland. Consequently, the responsibility for organising these services was transferred from municipalities to wellbeing services counties. This reform has attracted investments on social infrastructure premises and service properties.
Social infrastructure premises and service properties have been a subject of interest for investors for a long time. However, the national reform has accelerated the trend. Social infrastructure and healthcare properties are in demand among investors, as they are seen as relatively safe investments regardless of the world situation. Long-term leases usually generate steady rental income at low risk. Finnish and international investors specialising in public healthcare, social welfare and rescue services have established new real estate funds for public services properties.
The changes in the social and health services reform have coincided with EU taxonomy and ESG-related factors. The Taxonomy Regulation (EU) 2020/852 is one of the measures taken by the European Union to meet its objective of Climate Neutrality by 2050. The regulation indirectly affects real estate operators seeking financing for their investments from the market. In addition, the regulation has implications for the construction industry regarding the construction of new buildings and the renovation of existing buildings. Taxonomy compatibility of target properties is of growing interest for investors. Accordingly, Taxonomy Due Diligence plays a significant role in current and future Due Diligence processes, a trend prominent especially in social infrastructure and health services investments.
Smart Readiness Indicator (SRI) – A Proposed Unified EU Framework for Evaluating the Smart Readiness of Buildings
The smart readiness indicator or SRI is a system developed under the European Commission to evaluate the readiness of new buildings for the implementation of smart features. The aim of the development of the SRI is to make the energy usage of buildings more flexible and demand-based, which can be achieved, for instance, by using automation to direct the usage of resources to places where they are needed, storing energy with smart storage systems and acquiring different kinds of data from the smart systems of the building and utilising such data to conduct maintenance and upkeep more efficiently. In practice, the smart readiness indicator consists of 54 individual smart ready services that are evaluated in accordance with functionality levels ranging from 0 to 4. The evaluated services are then summed with pre-set weights to arrive at an SRI score ranging from 0% to 100%.
The smart readiness indicator is a similar concept to the already implemented energy performance certificate (EPC) and it is intended that the two will form a combined system for the evaluation of the energy performance of buildings. The experts currently in charge of issuing EPCs are also most probably the ones that will be competent for issuing SRI certificates. The potential implementation of the SRI framework could be viewed as a burden for the parties partaking in the construction projects of new buildings, but as smart buildings and energy conservation seems to be a global megatrend, it might be worthwhile to take the initiative and start evaluating the smart readiness of new buildings even before there is any legal requirement to do so. Such evaluations could also potentially lead to new innovations and developments in the field of energy performance.
As of now, the SRI is in a testing phase wherein different EU membership countries are researching the applicability of the indicator to the local building regulations, methods and conditions and are also running tests of the practical usage of the SRI to evaluate existing buildings. Finland is one the countries that are carrying out testing of the SRI along with Austria, the Czech Republic, Denmark, France and Croatia. According to the proposal to be the new European Union directive on the energy performance of buildings (EPBD), the testing phase of the SRI shall be finished by the end of the year 2025, after which a requirement for conducting such assessment for new buildings of certain types may be implemented if the testing phase yields successful results.
Finnish Merger Control Thresholds and the Rise of Real Estate Transactions
By way of an amendment to the Finnish Competition Act, effective from 1 January 2023 onwards, Finnish merger control turnover thresholds have been lowered significantly. The new thresholds will relate exclusively to turnover achieved in Finland, and thus align the jurisdictional rules with those applied in Sweden and Norway respectively, where only national turnover is considered for establishing jurisdiction over an otherwise notifiable transaction.
Prior to the amendment, a transaction was notifiable if the parties’ combined, aggregate worldwide turnover exceeded EUR350 million, and the turnover achieved in Finland by each of at least two parties exceeded EUR20 million.
With the new thresholds in place, a transaction is notifiable where the parties’ combined, aggregate turnover generated in Finland exceeds EUR100 million, and the turnover achieved in Finland by each of at least two parties exceeds EUR10 million.
As previously, prior transactions completed within a timeframe of two years between the same parties will be assessed as a single transaction for the purposes of determining the notification obligation.
Practical Effects of the Amendment
According to the Finnish Competition and Consumer Authority (“FCCA”), the change in the thresholds will double the number of transactions caught by the national merger control rules. Prior to year 2023, between 20-40 transactions were notified annually to the FCCA. Following the amendment, the FCCA expects some 60-70 transactions to be notified annually. The FCCA has indicated a need for an addition of five officials to handle the increase in the authority’s merger control workload.
As regards Finnish real estate sector, a typical real estate transaction carried out in the Finnish real estate market is still likely to fall below the threshold figures. However, we do at times see real estate portfolio transactions in the Finnish market with purchase prices in the hundreds of millions of euros, meaning that the net operating income may also lie above the now applicable EUR10 million threshold.
The newly adopted notification figures may be especially relevant for professional real estate investment funds and other institutional real estate investors who make real estate investments on a regular basis. In particular, as consecutive transactions are being assessed as one, investors who frequently trade amongst each other will need to monitor the fulfilment of the notification criteria more carefully than in the past.
Whether the more frequently met filing obligation will have an actual impact on the Finnish real estate market remains an open question. Depending especially on the definition of the relevant geographical market, a transaction that meets the turnover thresholds may fall under further scrutiny (should it for example result in overlaps in the supply or demand side). Thus, it may be of even greater importance that competition filings are done professionally and carefully to maximise the likelihood of the desired outcome.
Upcoming Changes in Tax Legislation and the Taxation of Capital Gains
Currently Finland does not tax capital gains on Finnish properties if held via a real estate company or holding company structure and the shares in the holding companies are disposed in the exit. This applies to all foreign investors. The respective tax treaty is not relevant as the tax exemption is based in Finnish tax legislation and respective tax treaty cannot enlarge the scope of tax for Finnish purposes.
The Finnish government has initiated a change in law according to which the said tax exemption for foreign investors will be abolished. The tax treatment of capital gains is then dependent upon the applicable tax treaty. As a result, investors from, for example, Sweden and Germany would become liable to tax in Finland on capital gains. Certain tax treaties would still enable tax exemption. Such tax treaties include Luxemburg, which is a country of choice for the structuring of Finnish real estate properties.
The government has stated publicly that the proposed new legislation should not result in material tax revenue and the other Nordic countries would continue to grant tax exemption for foreign property investments. Taking into account the need to change a number of tax treaties, the new legislation should not be effective and impact the competitiveness of Finland going forward. The new tax legislation may come into force during 2023.
Acquisition Permit Process and Legislative Amendments
At the beginning of 2020, a set of legislation concerning real estate transactions took effect covering, to varying degrees, both asset and share deals. For instance, the new permit system, purporting to offer the Finnish state a means of protecting national security, contains a pre-emptive right and redemption which applies to asset deals executed with non-EU/EEA-domiciled purchasers only. As a part of this legislative package, real estate purchasers with a domicile outside the EU or the EEA, and those owned by at least 10% or factually influenced by such, need to apply for a permit to acquire Finnish real estate from the Ministry of Defence (this does not apply to share deals). However, the permit does not need to be applied individually per each transaction as it stays valid for as long as the ownership and the actual beneficiaries remain unchanged.
The functionality of the acquisition permit regulation has been evaluated and new legislative amendments entered into force on 1 January 2023. The new amendments have tightened the real estate acquisition permit process and increased the authorities’ discretion and the Ministry of Defence’s access to information. The aim of the amendments is to prevent real estate transactions if the transfer is deemed to endanger national security. In addition, the Ministry of Defence can reject the permit application if it is obvious that the property to be acquired would not be suitable for the stated purpose or if the property is acquired by a person who has been issued a deportation decision and is staying in the country illegally. The applicant also has the obligation to contribute to the investigation of the case under the threat of a negative decision. The Ministry of Defence has the right to find out the financing of the acquisition of the property and its origin.