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As we approach the end of another very active and exciting year in the Irish property market, it is time to take stock and give some thought to what’s coming down the tracks in the year ahead. Investment volumes for 2017 are expected to come in somewhere between €2bn and €2.5bn (with an average investment size of only €7m). This is significantly below the 2016 level of €4.5bn (although ahead of the 10 year average of €1.8bn). The decline in volumes is due to the flow of investment grade stock coming to the market. 2016 was buoyed by some significant once-off transactions such as Blanchardstown Shopping Centre at €950m, Liffey Valley Shopping Centre at €630m and the PwC building at €250m, while the largest transaction for 2017 (to date) was the forward funding of the new Grant Thornton headquarters at City Quay, for €126.3m. The Square Shopping Centre, Tallaght is expected to transact close to year end at c.€250m, with US equity group Oaktree outbidding a number of foreign funds.
There is significant pent up demand from international investors waiting on the side-lines for larger ticket size properties to come to market. This demand is expected to spill over into 2018 and may continue to drive prices up (putting downward pressure on yields) particularly in the prime investment space. International investors are impressed with the quality of the prime office stock in particular, and are attracted to the longer leases achieved in Ireland relative to our European counterparts. We expect that there will be an increase in larger investment opportunities coming to market in 2018 for two key reasons: (i) the change to the CGT exemption holding period should serve as an impetus for some of the 2011-2014 investors to liquidate their holdings and realise their profits and (ii) the new developments under construction in the city are expected to start to change hands (from the development funds to long-term, “hold for income” investors) when close to completion and/or pre-let.
The performance of a property market is hugely dependent on economic fundamentals. The Irish economy continues to perform exceptionally well, with GDP growth expected to come in close to 4.8% for 2017, and is forecast at circa 4% for 2018, the fastest pace in Europe, as noted by Jim Power, Friends First Chief Economist, in his latest Economic Outlook. Unemployment is now 6%, down from 15.2% in 2012, and much lower than the European average of 8.9%. Expanding employment, wage growth, tax cuts (although relatively minor) and weak consumer price index (CPI) inflation are all boosting real income, which in turn, is driving the domestic economy.
These macro-economic indicators make Ireland a very attractive destination for international investors’ capital. However, the continuing housing crisis (both the serious shortage of accommodation coupled with the increasing cost base) is posing a major problem for companies looking to relocate staff to Ireland, and is negatively impacting our international competitiveness, particularly in the wake of Brexit. Proposed changes to planning guidelines for build-to-rent schemes may help address this issue in 2018 and beyond.
Investment returns are expected to be mainly driven by income going forward. We expect capital appreciation to continue but at a slower pace than recent years. There will be higher capital appreciation in certain sectors of the market, such as industrial, which is expected to outperform the national average in terms of capital appreciation in 2018. The graph below illustrates the capital value growth index up to September 2017, highlighting that all sectors remain significantly below the recent peak levels. We are not implying that the market will get back to those levels, just highlighting that while media speculation is that the market is getting back to “peak levels”, this is simply not the case.
Capital Value Growth Index to September 2017 – MSCI
Rent & Yields:
Rent levels are expected to remain relatively stable in the prime Dublin office sector (where rents are now close to peak levels – see graph below). Headline rents for prime offices in Dublin 2 are now c.€675per square meter (psm) (€63per square foot (psf)) and have remained relatively stable in recent months. There may be some further rental growth experienced (following 30% increase in office rents over the past three years according to Savills Ireland), due to the continued demand for prime office space. Our view is that if rental levels get much higher, they may become unsustainable for some businesses in the future, and investors may be exposed to defaults or indeed reducing income returns when the first upward/downward rent reviews take place. Suburban and provincial office rental levels are expected to increase in 2018 as occupiers seek alternative locations to the city, which is now both expensive and in short supply.
Prime retail rents may move up slightly, while secondary retail rents are expected to remain stable. However the food and beverage (F&B) sub-sector of the retail sector is seeing increased demand from occupiers (driven by the improving consumer sentiment and increase in disposable income) which in turn, is driving F&B rental levels upwards. This is also due to the shortage of suitable space in the city for F&B usage which requires specific planning permission, so there is a supply/demand imbalance at play.
Rental Value Growth Index to September 2017 – MSCI
Industrial (or logistics) rental levels are expected to rise throughout 2018 (currently circa €110psm or €10.20psf), following a prolonged period of low rents. These rising rental levels coupled with the increasing demand from occupiers for high quality, modern logistics space (mainly driven by the expansion of e-Commerce), is now making speculative industrial development viable.
In terms of prime (across all sectors) Ireland continues to look attractive relative to our European counterparts. There is still scope for further yield compression in the coming months. The graph below highlights the strength of the Dublin office market and the spread over government bond yields relative to other global cities.
The simple answer is that there is no “one size fits all” solution. Different real estate sectors suit different types of investors, depending on their risk profile. Long term investors, including some of the large, international players, are seeking a “safe haven” for their equity (income return and preservation of capital). This type of investor will most likely continue to pursue city centre offices, with long leases and high quality tenants. Investors chasing income will most likely focus on logistics / industrial assets, a sector that typically generates a higher yield and is expanding at present. Those chasing capital value growth (typically sit further up the risk curve) are exploring value-add opportunities, including Dublin suburban office refurbishments, properties with change-of-use potential, provincial locations where there are improving economic fundamentals etc. Right at the top of the risk/reward curve are investors willing to take development risk for potentially significant returns. We are seeing more and more forward fund deals taking place across the various sectors. These projects can be somewhat de-risked if a pre-lease is in place, but there are several other risks of development attaching to these projects.
Regarding the retail sector, it is important to understand the different sub-sectors. Of particular note at present is the F&B sub-sector. This is a real growth area at the moment, a trend that we expect to continue into 2018. In the right location, F&B rent can be up to 30% higher than “normal” retail rent. This obviously then drives up the capital value of the property also.
As noted above, industrial assets are becoming more popular in recent months due to their relatively higher yields and scope for rental growth. Industrial (or logistics) assets usually command longer leases (as the tenants incur very significant fit out costs, particularly when automation is involved). In addition, the tenants requiring large high-tech industrial space are typically good quality tenants, posing minimal credit risk. This sector is seeing significant expansion as a result of the continuing of online shopping, click-and-collect, and increasing consumer expectations, such as same day delivery.
There has been an increasing focus on the alternative real estate sector recently, which includes hotels, healthcare centres, data centres, student housing and the private rental sector “PRS” (or “build to rent” BTR schemes). For Irish investors, this is considered quite a shift away from “standard” real estate investment sectors, with some more cautious investors watching on from the side-lines until these asset classes become more mainstream (like they are in the US and more recently, in the UK) and demonstrable results are available. To date, the investors operating in this space in Ireland are predominantly international players, such as Hines, Kennedy Wilson, Oaktree etc.
In addition, the recent emergence of co-working, or flexible work space, and co-living sectors in Ireland are gathering momentum, and are likely to be on the “watch list” of many investors in 2018. “We Work” recently announced their first Dublin locations (of circa 110,000 square feet across two sites), and “Iconic Offices” continue to grow and already have 250,000 square feet of co-working space in Dublin.
The Friends First Irish Commercial Property Fund:
The outlook for the Friends First Irish Commercial Property Fund is very exciting. There are some key events commencing in Quarter 1 2018 which will drive the returns for the Fund, both in terms of income and capital, over the coming months and years. These value-add projects are being carried out in line with the overall fund strategy, which is highlighted in the strategy pyramid below:
The major redevelopment projects in Blackrock (Enterprise House and Blackrock Shopping Centre) and Royal Hibernian Way, Dublin 2 are due to commence in January. Both Enterprise House and Royal Hibernian Way have been largely de-risked through successfully signing Agreements for Lease with high quality tenants, at strong rental levels.
In addition, we are also focusing on office opportunities outside the city centre, either in suburban Dublin or select provincial locations. We believe that the yields attaching to the prime city centre offices are too tight to represent value for the Fund and we have concerns over the sustainability of the high rental levels being agreed at previous peak levels.
In the retail space, we continue to position the Fund’s retail exposure towards the growth retail areas. For example, the recent acquisition of the Merrion Collection, four properties on Merrion Row, Dublin 2, together with the existing Clarendon Collection, provide excellent value-add opportunities in the F&B space. In addition, the retail parks are experiencing strong performance and we expect this to continue into 2018 as retail parks thrive in a growing economy, especially as a result of new house builds, home improvements etc.
In late 2017 we further increased the Fund’s exposure to the industrial sector through the acquisition of a unit in Merrywell Industrial Estate, Ballymount, Dublin 12, through a sale and leaseback transaction with Valeo Foods. We will explore further opportunities in the industrial space in 2018, which is in line with the Fund’s strategy to maintain a very strong income profile (attractive yields, with long leases and quality tenants).
Finally, we are reviewing the so called “alternative sectors” including build-to-rent, student accommodation, healthcare, co-living and co-working. We hope to make our first investment into alternative real estate in 2018.
Analysis based on data available up to December 2017.
The funds referred to on this page may be linked to an insurance-based investment product and the Key Information Document (KID) for this product is available at www.friendsfirst.ie/kids. The Risk Ratings of the funds referred to in this document differ from the corresponding Summary Risk Indicators shown in the KID. An explanation of the differences between the Risk Rating and the Summary Risk Indicator is available at the location above.
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