Glacial lagoons of the purest blue, waterfalls the size of skyscrapers, desolate black sands and white geothermal springs. This is just a taste of what tourists experience in Iceland. But what about the investor experience?
After suffering a large decline in output following the great recession of 2008-09, Iceland delivered one of the world’s strongest economic recoveries among its peers in the Nordics, Baltics and G7. This recovery was led by tourism, and in 2017 US tourists were the largest nationality travelling to the country. The industry is now the biggest generator of hard currency and its revenue has more than doubled over the past decade.
Iceland’s tourism-led recovery contributed to the fall of most capital controls, a policy that restricted the flow of capital in and out of the economy. Now Iceland is back on the foreign investment stage.
Currently, supply of the country’s hotels, rental cars, and transport assets does not meet the inbound demand. As a result, in 2018, private market investors can fill these gaps.
The volcanic eruption
The eruption of the Eyjafjallajokull volcano in 2010 put Iceland in the global spotlight when the international media was plastered with awe-inspiring images of nature. The tourism industry collaborated with the authorities on the ‘Inspired by Iceland’ campaign to capitalise on this exposure, turning what could have been a death blow into a unique opportunity. This led to Iceland becoming the prime shooting location for high-profile films and television programmes, including Star Wars and Game of Thrones.
Renewed attention to nature, sustainability and safety attracted tourists, and airlines collaborated with tour operators to offer packaged deals. Iceland has successfully repositioned itself as a transit hub for passengers flying to and from North America and Europe. During peak times, there are 27 airlines utilising the main international airport, Keflavik, flying to more than 90 destinations. They include 56 weekly flights to New York and planned routes to China and Japan.
Since the volcanic eruption, the tourism sector accounts for the largest share of recent job creation, including 12,000 new jobs from 2010 to 2016. The industry’s expansion represents important diversification for a small economy reliant on fish and natural resource exports. Foreign investment will be essential for the national economy and will mitigate localised risks. In 2017, each month saw double-digit year-on-year tourism growth, while 2018’s projection is expected to approach more sustainable levels, according to the IMF. This is advantageous for foreign investors drawn to tourism’s growth, because it eases the risks of an overheated market.
Currently, there is a heightened demand for, but low supply of, Iceland’s tourism infrastructure. Critical infrastructure encompassing airports, roads, hotels and tourist site maintenance are all areas that remain underfunded. Correcting this imbalance will lead to sizeable opportunities for international investors seeking exposure to alternative credit, infrastructure, and real estate since capital controls have collapsed.
Greater inflows will produce another challenge – finding the right deals for new capital. Tourism has created interesting opportunities in direct equity and alternative credit deal pipelines. The hospitality sector and its subset of hotels and transport are capital-intensive industries in dire need of capital injections. However, loans and financing from commercial banks in this direction will be limited and this provides an entry for alternative funds or limited partnerships to fill the financing vacuum.
Other private equity funds can enter additional elements of the tourism market, such as the accommodation sector – the supply of hotel rooms does not match inbound occupancy demands. As a result, 30 percent of tourists are reportedly staying in privately owned apartments or houses over the past couple of years. To reverse this trend, there are plans to build 2,500 rooms before 2020, which will serve 190,000 to 215,000 visitors. Iceland’s hotel industry has four large chains with a combined market share of 54 percent, but there is a notable gap in the luxury segment, which presents another entry point for developers.
Iceland’s hotels recently attracted foreign investors – PT Capital Advisors and JL Properties reportedly acquired a 75 percent stake in KEA Hotels, a major hotel chain. Marriott is preparing a new property beside the famous Harpa Concert Hall.
Other mismatches are in the fragmented rental car sector. Every other car sold in Iceland since 2008 was bought by car rental companies and one out of 10 cars on the road belongs to these rental agencies. Foreign investment can not only present cash injections, but also catalyse consolidation opportunities between the country’s sizeable population of car rental firms.
Infrastructure funds will be required to promote the development and improvement of the nation’s toll roads, tunnels, rail lines, bridges and other forms of critical infrastructure which are worn down, dated and underfunded by the authorities.
The reduction in new investment in infrastructure has been substantial since 2008, standing at 3.8 percent of GDP in 2016 compared with around 6 percent in 2008. The airport’s renovation plan calls for new terminals, aircraft stands, and access infrastructure. This multi-year endeavour presents a total investment of between $1.2 billion and $1.5 billion for foreign managers. Airport growth has spawned other projects, including improving transit systems to and from the capital. A new airport express train is slated to cut travel times to 18 minutes and will be a $650 million to $950 million investment opportunity for foreign funds.
A reliable business environment
With the advent of foreign direct investment, the government should continue its efforts to preserve the highly rated business environment and maintain policy continuity. Iceland was named the world’s most peaceful country by the Global Peace Index and has very low political risk – critical for long-term investments. On building permits, Reykjavik’s municipality is increasing ease of access to the capital area, namely in zones surrounding the downtown neighbourhood.
Iceland is used to collaborating with large foreign investors and is a member of the European Economic Area, which makes market entry more efficient. Relying on local partners, via public-private-partnerships, means the process will not be unnecessarily complicated. The evolving role of public-private-partnerships is a growing topic among policymakers, and the government is increasingly seeing it as an important tool to address infrastructure issues.
The land of fire and ice is a top destination for holidaymakers, but it is also a top destination for foreign infrastructure investors. Iceland’s recovery, declining capital controls and massive supply-demand mismatches, should not be ignored.
Valdimar Armann is chief executive of GAMMA Capital Management, Iceland’s largest independent asset manager with $1.4 billion of assets under management