13/11/15: Dublin: Overpriced Office Space is Back... Any Wonder?

A neat set of charts from Knight Frank report showing commercial real estate mapping of Dublin relative to other European cities

To start with: returns over 10 years to December 2014:

Here are some more charts

The key point from the above is that historical valuations for Dublin property have been distorted to the upside by the pre-2008 boom, whilst subsequent collapse has driven prices back to below their fundamentals-determined valuations. However, forward expectations by the markets participants are now pricing in a significant medium- to long-term rebound in commercial property rents and values that are implying fundamentals well ahead of anything consistent with the ‘normal’ 4.5-5 percent yields. In other words, we are heading toward 2-2.5 percent yields, assuming current trends persist, or into another correction downward.

Absent robust supply increases, the former is more likely than the latter. With rates normalisation still some time away, the former is also more likely than the latter. And the longer the former goes on, the bigger will be the latter, eventually.

These dynamics, in return, underpin also residential markets, where credit supply tightness in house purchasing sector is pushing rents up to stratospheric levels, with rents currently in excess of October 2008 levels.

Welcome to the economy where largest land-owner - Nama - thinks developers are only good to attend horse races.

14/12/2014: Irish Building & Construction Q3 2014: Another Quarter of Unconvincing Recovery

Indices for activity (volume and value) in Building & Construction sector in Ireland were published this week covering Q3 2014. Here are the details:

Across all Building & Construction sector:

• Value index for all Building & Construction sector rose to 108.6 in Q3 2014 - the highest reading since Q4 2009 and the second reading over 100.0 since Q4 2010. Year-on-year, index is up solid 11.38%, slightly slower than Q2 rise of 11.55%. The index, however, is still 70.88% below the peak.
• Excluding Civil Engineering, Building & Construction activity rose in value 103.4 in Q3 2014, he highest reading since Q4 2013 and up 9.77% y/y. This is the slowest rise in the index in 6 quarters. In Q2 2014, index rose 11.82% and in Q1 it was up 14.91%.
• In volume terms, all Building & Construction activity index reached 108.1 in Q3 2014, up 9.97% y/y, slightly below 10.37% growth in Q2 2014. Volume of activity in the sector is still 72.40% below the pre-crisis peak.
• Again, taking out Civil Engineering, the activity in the sector is growing at a slower pace in volume terms - up 8.43% y/y in Q3 2014 and down 80.03% on peak.

Chart to illustrate:

In basic terms, overall activity in the broad sector is running along a nearly flat trendline with some signs of very fragile recovery. And that is off the levels so abysmally low that one would require sustained 20%+ growth rates to achieve any meaningful gains.

Underlying the above trends, we have at least some life showing in the Residential Building segment. In Q3 2014, Residential Building activity index posted a 21.13% y/y rise in terms of value, reversing two consecutive quarters of decline. Still, value of activity in this sub-sector remains 90.5% lower than at the pre-crisis peak. In volume terms, the index rose 19.55% and is down 91% on pre-crisis peak. 

Two chart below show just how pathetic the recovery has been to-date in Residential Building & Construction sub-sector.

In summary, there is barely any life in the Building & Construction sector activity - measured against both volume and value of activity - across all sub-sectors, save Civil Engineering, where the falloff has been relatively shallower (down 26% on peak in Q3 2014 in terms of value and 28.5% in terms of volume). And, of course, the data is again contrary to the booming Construction Sector PMIs. What a surprise!

Interestingly, in non-Residential Building sector, activity is growing at the rates of just 2.33% y/y in terms of volume and 3.75% y/y in terms of value - despite the numerous 'good news' claims from Nama and the commercial real estate sector and despite the allegedly 'low' vacancy rates and rising rent rolls.

5/6/2014: Irish Commercial Property Values Forward...

Lost decade in Irish non-residential property? 

Based on IPD quarterly index, here is an exercise in basic forecasting (take it as just a stab in the dark - things can go all over the shop in a small economy, like Ireland) for capital values returns for 4 asset classes of Irish non-residential property.

The forecast is based on 'better case' scenario that assumes rates of growth from Q2 2014 on that reflect:

• Last 3 quarters growth rates in Retail, Office and All Property indices, which are respectively: Retail 1.9% q/q (4 quarters growth rate is less benign at 1.0%); Office 4.3% (4 quarters rate is 3.5%); All Property 3.1% (4 quarters rate is 2.3%); and
• Last 4 quarters growth rate of 2.3% for All Property taken as growth rate for Industrial class (own Industrial Class 3 quarters growth rate is 0% and own 4 quarters growth rate is negative - 0.2%).

And the 'lost decade' in capital values is:

• For Retail sector: 19 years
• For Office sector: 13 years
• For Industrial sector: 23 years
• For All Property sector: 16 years 

Some 'decade' that is… and the numbers are not out to the peak-to-peak levels, as peak valuations took place around Q3 2007 and the exercise is from Q4 2006, when all above asset classes capital valuations were below the peak by between 9.2 and 10.5 percent. The exercise does not cover explicit outlook for interest rates or credit flows associated with it. Nor does it account for the overhang of land held by Nama. The key point here is really to show three things:

1. It will take a long, very long time for the markets to come around; and
2. So far, turnaround was not miraculous or dramatic, as some agents would led you to believe...
3. Finally, in one segment - Offices - we do have some rays of hope - both uplift and dynamics of that uplift are supportive of the stronger case than what I expected back in the days of 2010, when Nama was unloading properties off the banks balancesheets.

13/10/2013: Yields, Prices and Damn Splits in Office Property Markets...

Few days back I highlighted the CBRE Q3 2013 research on Irish office and retail property markets. Here's food for thought in a related spectrum. Is Dublin office space still overpriced?

The above is taken from Q3 report on European markets from Cornerstone. Here's what they have to say on this: "On the supply side, local vacancy rates vary considerably – from around 5% in Paris CBD and central London to in excess of 20% in Dublin and Athens. Where vacancy levels are lowest, the recovery in average rents will tend to be faster. However, the lack of new development in recent years means that shortages of Grade A accommodation already exists in an increasing proportion of markets. The probability of rental growth, particularly on a net effective basis, at the top prime end is thus
growing."

Which suggests the markets in the likes of Dublin and Athens are bifurcating - demand for quality outstripping supply of quality and this means aggregate yields (inverse of prices) are not reflective of underlying market dynamics. Instead - new properties are finding buyers and seeing appreciation, older / existent properties are setting into stagnation before the onset of continued decline (as/when supply of new properties improves). It might be fine to think of the property prices as rising, unless you own the properties that are not fitting the rising demand for quality... God forbid, with leverage on top of ownership...

10/10/2013: CBRE Research Q3 2013: Dublin Offices Market & Irish Retail Market

Some good news from the Dublin Office Property markets and Irish Retail Property markets via CBRE Research Notes today. CBRE Research, as usual, provide very good insights and both notes, so quoting from the first note directly:

• 56 individual letting transactions signed during Q3 2013
• Almost 80% of Dublin office take-up in Q3 located in the city centre
• 68% of total lettings in the quarter smaller than 465m2 (5,000 sq. ft.)
• Prime rents expected to increase over coming months as the scarcity of prime office buildings in the city centre escalates
• Continued decline in vacancy rates in all districts
• Prime office yields have contracted by a full 150 basis points in the last 18 months
• Escalation in investment transactional activity over recent months
• Prime Dublin office yields contracted to 6% during Q3
• The city centre accounted for 79% of overall take-up in Dublin in Q3
• The Dublin 2/4 postcode accounted for almost 44% of letting activity in the city centre in the quarter
• The city centre vacancy rate was 15.7% at the end of the third quarter while the vacancy rate in Dublin 2/4 was 12.7%
• 8 office investment sales totalling € 73.65 million completed in Dublin during Q3
• Offices accounted for 30% of overall investment spend in the Irish market during the first nine months 2013

Some charts:

Less encouraging changes in the Retail Property sector. Again, via CBRE:

• An improvement in consumer trends in the first half of 2013 as the Irish economy shows some signs of improvement
• Some variation between the performance of different sectors of the retail market
• Considerable retail leasing and sales activity occurring in the property market
• Prime Zone A rents now showing signs of stabilisation following 60% fall from peak
• Little improvement in high street vacancy rates over the last six months with vacancy rates in provincial towns remaining stubbornly high
• €84 million invested in retail investment properties in the first half of 2013, accounting for 14% of investment activity in the period
• Prime retail yields have contracted since the beginning of the year in response to strong investor demand

And a couple of charts:

30/7/2013: It ain't recovery until prices start rising, folks...

You know the myth - the one spun by the realtors and the likes of the various business development bodies around the country - that goes something like: "Irish recovery is showing green shoots, as foreign investors are flocking to the Irish market, kicking tyres and snapping all commercial property they can get their hands on".

As usual, there's a basic logic flaw with much of the internal Irish commercial / business world. Normally, when someone is flocking with suitcases of cash to some destination to buy, demand goes up, and prices rise. In the short run, this logic might fail to hold if there is a supply rise of involuntary sales of properties in the market. In the long run, this demand-price relationship must hold, because both voluntary and involuntary supply of properties adjusts to move along with prices. In other words, even idiot bankers would begin to withhold property from the falling market when there are willing buyers kicking tyres in hope of gaining more on sale.

It has been years, that's right - years - since the reports of the alleged 'tyres-kicking' foreign investors first started to percolate. And yet... oh well... just look at prices:

Yes, per Central Bank chart (above), commercial property is still shrinking in terms of prices. The rate of shrinkage is moderating. But that is not the same as saying that prices are rising. They are falling, falling at a diminished rate, but still falling.

The 'recovery' is much more likely in the housing market, where cash-rich farmers (having made their dosh on pre-bust sales of land and still awash with CAP cash), cash-rich and property-secured senior professionals and retirees (having made their surplus money on pre-bust sales of homes in Donneybrook etc) and cash-rich Googlites and Namanoids (the sub-sects of the South Dublin younger professionals in cushioned jobs) are all chasing prime properties in the upper middle class segment of the market. Aside from that, things are not exactly hunky-dory, like...

Still, the housing market is telling a much better story of a 'recovery' (albeit it is still not a true recovery, yet), than the fabled foreign-investors-teaming commercial property markets... The old Widow Scallan's reincarnation as an ex-Spar 'prime retail' space is out for grabs... There's (allegedly) American investment funds-led bidding war going on across the country... so hurry up...

24/7/2013: CBRE Q2 2013 Irish Commercial Property Report

A very good quarterly report from CBRE on Irish Commercial Property markets in Q2 2013.

Some highlights:

In the above, I added the red line for referencing current yields to other urban locations across the EU. Pretty much suggests current valuations are in line with current macro fundamentals. Also, the chart above shows just how much more dramatic the swing has been from the cycle high to the cycle low in Dublin - wider than anywhere else.

Does this mean the market is now priced about right? Barring any dramatic improvement in the fortunes, I can't see much of an organic upside here. That said, external investment demand and longer-time investment horizons can (and probably will) push prices up. On the downside, there is the pressure of cost of long term funding news acquisitions.

On the shorter end, there are strong signs of market recovery. Per CBRE: "There was a significant improvement in transactional activity in the Irish investment market during the first half of 2013. In total, there were 34 investment transactions of more than €1 million in value completed in the six month period. In total, €603 million was invested in the first half of 2013, compared to a full year spend of €545 million in 35 transactions in the entire year last year."

More on the good news side: " Total returns in the Irish market in Q2 2013 increased by 2.3% while capital values were flat in the period according to the Investment Property Databank (IPD) Irish Index. Indeed, total returns in this index have been positive for seven consecutive quarters now." However, the chart shows continued negative capital returns:

The chart also shows that cumulated total returns over the positive 7 quarters are just about cover total losses cumulated from Q4 2009 -Q1 2010.

The headwinds remaining in the market, in my opinion are:

1. Risk to growth fundamentals in the economy: any further significant compression on current yields will have to be factoring stronger growth than recorded in 2010-2012,
2. Risk to the future long-term interest rates
3. Risk to supply/demand balance: current demand is driven largely by lack of other asset classes with comparable returns, plus surplus cash positions built up by some domestic investors. These are at risk of reversals on foreign demand side and exhaustion of domestic cash reserves. On supply side, there is a risk of NAMA eventually starting to dispose of domestic assets in earnest. 

For now, however, my feeling is that the yields are close to fundamentals-determined equilibrium.