The strong recovery seen in Ireland’s commercial real estate market last year is expected to continue into 2014.

January 2014

Near-term risks to the outlook have declined significantly in recent years which makes this an especially opportune time to invest. But the opportunity may not last for long with pricing likely to turn quickly.

The cyclical case…

Economic recovery to gain traction:

Economic data released by the Central Statistics Office in Ireland is considered to be volatile. Last year there were unexpected downward revisions to both 2013 GDP numbers and historical data. GDP growth for 2012 was revised down from 0.9% to 0.2% while the 2013 consensus forecast GDP figure is expected to be -0.1%.

A sustained recovery is, however, expected from 2014 onwards as Ireland starts to benefit from its economic adjustment. The country exited its three-year international bailout in December of last year and economic indicators such as consumer confidence and employment are already heading in the right direction.

Capital values have turned the corner and are expected to continue rising:

Following five years of falling prices, commercial real estate saw positive capital growth during 2013.

According to data from real-estate research consultancy, Property Market Analysis (PMA), the prime office sector saw capital value growth of 22% in the first three quarters of 2013 and we forecast positive capital growth across all sectors over the medium term.

Irish real estate yields are still attractive compared with yields in most other European markets:

Although Dublin yields fell during the first nine months of last year, they remain higher than those of any other major European market. As at the end of September 2013, prime office yields in Dublin stood at 6.5%.

The sharp rise in transactions is likely to continue throughout 2014:

Liquidity has risen sharply in the Irish real estate market with transaction volumes continuing to strengthen throughout 2013. The volume of transactions in Ireland in 2013 reached €1.8 bn, the highest level since 2007. Overseas investors, including private equity groups, are behind this.

The successful launch of the Green REIT and Hibernia REIT in 2013 is also evidence of the increased investor interest in prime Irish real estate. The National Asset Management Agency (NAMA) intends to capitalise on this growing confidence with plans to bring €1 bn of Irish assets to the market this year.

Rental market to improve over the next five years:

The higher levels of demand and the shortage of supply (in the prime office space) are driving a stronger recovery in the Dublin occupier market than we expected.

The rebound in rents has been more robust than previously forecast with PMA data showing prime Dublin office rents increasing by 9.1% in the first three quarters of 2013. We now expect this momentum to be maintained for a sustained period.

During 2013, prime retail rents continued their adjustment downwards and have fallen back to early 2000 levels. We believe the necessary rental adjustment is now behind us and forecast an increasingly positive rental growth outlook over the next five years.

We have raised our medium-term total return forecasts from Q1 2013:

Because of the above, the increased confidence in the economic outlook and the sharper than anticipated turnaround in occupier and investment markets, our five-year forecasts have been revised upwards.

For the five-year period from the start of 2014, we project Irish prime commercial real estate returns of over 15% pa (gross).

These returns are higher than those forecast for UK and other European markets. The Irish real estate market also ranks amongst the most attractive markets in Europe on a risk-adjusted basis.

However, benefiting from this market opportunity requires careful asset selection. In particular, before buying into this market,  a careful assessment of the sustainability of rents and of lease terms is crucial.

The structural case

Diversification:

Studies show Irish commercial real estate to have a low correlation with returns from equities and government bonds. This suggests that real estate can make a positive contribution to the risk-return attributes of a balanced investment portfolio.

Robust performance:

The Irish property market has delivered robust returns over the long term. The IPD Ireland Index shows all-property total returns averaging an annualised 8.8% over the last 29 years.

Liquidity and transparency: we believe Ireland is one of the most transparent and best-established property investment markets in the world. According to property specialists Jones Lang LaSalle’s latest global real estate transparency index, Ireland ranks among the top 15 countries globally.

Tangibility and ability to add value:

Real estate is a tangible asset with intrinsic value. Although a physical structure might need replacing, the land on which real estate is built will always have a value.

Real estate is also an asset that can be improved by active management via refurbishments, use changes and lease renewals. This is unlike an investment into an equity or bond fund, where generally a fund manager has little or no scope to add value to individual holdings.

Stable income and low volatility:

Under normal market conditions, and over the long term, we would expect the majority of the return from commercial property to consist of income, with the remainder being made up of capital growth. This generally results in returns from the real estate market exhibiting lower volatility than returns from the equity market.

According to the IPD Ireland All-Property Index, income from Irish property has only once fallen below 4% pa over the 29-year history of the index.

Inflation hedge:

Some commercial real estate leases benefit from indexation, providing a highly effective inflation hedge. Furthermore, with the ability for rental growth to move with broader price trends, commercial real estate generally has the potential to be a good hedge against inflation. 

Summary

Investing in this market isn't without risks. There's ongoing economic uncertainty in the Eurozone and weakness in the banking system. Also, with large gains already seen at the prime end of the market, the window of opportunity to invest might be short lived 

Nonetheless, we believe there's a strong case for investors to participate in Irish commercial real estate. Prices are gaining momentum and we're forecasting a 15% pa return over the five years starting from 2014 – supported by robust income and capital growth. Also, Irish commercial real estate can play a positive role in a diversified investment portfolio.

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