When an individual investor or a fund invests in a property, returns are derived from a combination of capital value movements and rental income.
Over the past five years, since the global economy began its recovery, Irish commercial property has experienced exceptional double digit returns, mainly driven by capital growth. Historical evidence supports the fact that although there will be fluctuations in the short term, capital values should appreciate over the long term, in keeping with or ahead of inflation. I expect that, for the foreseeable future, commercial property returns (combining capital valuations and rental income) should be above cash deposits and inflation.
Following a period of exceptional capital growth, we are now witnessing a slowdown in market-driven capital appreciation (positive capital growth is continuing, but at a slower pace than in recent years). I expect that rental income will likely be the main impetus of returns going forward. For example, the Lisney Retail Index has shown that prime rents on Grafton Street increased by 5.5% on year on year, and JLL has predicted growth of up to 8% over the course of 2018 in prime retail rents. Other commercial sectors such as industrial and suburban office are also experiencing very strong rental growth at present. The Dublin city centre prime office sector is the only exception, as rental levels are already slightly above the previous peak, being driven upwards by a current shortage of supply (which is being addressed by new developments in the city). I expect that these rental levels will stabilise and may even come back in the near term, when the supply/demand imbalance is addressed.
- WALT (or WAULT)/ Duration/Lease Term– the weighted average (unexpired) lease term. On a portfolio basis this is the average number of years until the earlier of the next break option or the lease expiry across all of the leases on all of the properties.
- Net Initial Yield is the annualised current rent (often called passing rent) for a property portfolio as a percentage of the capital value of the properties (adjusted for notional standard purchaser’s costs).
- Quality of Tenant (Covenant): Covenant strength describes the strength or quality of a commercial tenant.
- Break Options: This is an agreement between the tenant and the landlord entitling one or other party to bring the lease to an end at an agreed date, before the ultimate expiry of the lease.
- Estimated Rental Value: ERV is the current market rent if a property was rented on the current open market.
- Rent Reviews: Leases typically have rent review clauses, stating that the rental levels can change at an agreed date in the future (often on a five year rolling basis).
- Rent Collection: Rental income is only as valuable to a fund as the rent that is physically collected.
Active property management involves balancing the above components of income in order to arrive at an acceptable, appropriate, overall portfolio income profile for the Fund.
Friends First Irish Commercial Property Fund
The Friends First Irish Commercial Property Fund places great importance on income as a significant contributor towards overall returns. Sourcing and retaining high quality tenants and pursuing ‘value add’ strategies in order to generate additional income from properties contribute to strong income statistics for the Fund, as I have highlighted in the three diagrams below.
As I have mentioned above, it is my expectation that total property returns are likely to be driven mainly by income going forward. Therefore, the strength and quality of a portfolio’s rental income is of critical importance when assessing a fund for a long term investment. The income statistics and the tenant profile of the Friends First Irish Commercial Property Fund (as outlined above) are particularly noteworthy, and the in-house property team will strive to maintain this calibre going forward.
For more detailed information on this topic download ‘Property Investing – The importance of Income.’
Analysis based on data available up to September 2018.
The views and opinions expressed in this article are those of the author, Suzie Nolan, Senior Property Manager, Friends First.