IrishMarketThe commercial property market is going through one last binge before the detox has to start, warns Bill Nowlan
Would a normal person invest in a commodity that is going into oversupply, is overpriced and has little prospect of income increasing? The Irish answer is "yes".
The commercial property investment market is, in my view, going through one last binge before reality emerges and the detox has to start. This feeding frenzy is being driven by the perceived infallibility that Irish property values will always go up.
Commercial property values are currently rising due to yield compression arising from pressure of money - both borrowing and equity - with no focus on the long term realities of little or no rental growth.
The underlying fundamentals of the property market have been forgotten in this current feeding frenzy. That fundamental is, of course, customer demand for floor space and the price that those customers (tenants) will pay. When did you last hear an investor refer to a tenant as a customer?
The music will stop, either suddenly due to some unforeseen event, or the more likely scenario is that reality will gradually dawn on investors that current rental income will not remunerate the capital invested and that rents are not going to rise in the foreseeable future.
Rents will not rise because our vastly expanded and mainly professional property development industry has been, or is in the course of, providing more floor space than could possibly be required by existing or new tenants for business occupation.
Reality is that there is no shortage of business buildings in the Irish economy. No shortage is in sight even if our population grows as predicted. Reality is that there are more commercial buildings out there available for letting or in an advanced stage of planning than tenants need now or are likely to need for a very long time. Tenants are becoming very important people again!
The development industry is both the engine of, and the cause of, the problem.
We have an oversupply of offices, an oversupply of industrial space, with the possibility of an oversupply of retail being a little further away other than for retail warehousing which is fast reaching saturation point.
If you don't believe me look at the SCS/IPD figures for rental value growth over the past three years. See what they say in the SCS/IPD figures for rental value.
Rents for industrial and offices, which make up the bulk of the property investment industry, are static or falling, and in my view are likely to remain so, as market conditions allow tenants to pick and chose which developer or investor to favour with their business.
The figures for retail are somewhat better than those above, with an average rental growth over three years of a little over 8 per cent per annum, but the purchase yields currently being bid for the limited amount of such investment at circa 3 per cent are even more scary as the growth will go out of that market shortly.
Investment is supposed to be about making money not having a warm emotional feeling about your holding. Traditionally, property showed portfolio yields of 7-8 per cent and the capital appreciation came as a bonus. Such historic yield levels with traditional borrowing levels of 60-70 per cent loan to value, gave cash flows sufficient to pay a dividend to the investor and service debt including capital amortisation. There was even room for a wobble in the cash flow if there was a tenanting problem.
With office yields rapidly moving towards 4 per cent, the available cash flow from rents give little scope to pay a dividend, service debt and pay for repairs/renovation. God forbid a period of void!
Perhaps the time has come to look at the alternatives to property and heed the words of economists like Robbie Kelleher of Davys who points out that property price earnings ratios are way above those on blue chip shares.
The property circle is getting harder and harder to square. Indeed, if interest rates make any upward movement then it will be impossible to square and there will be some forced selling. This will inevitably have a knock-on effect on values and then the correction process may get underway.
I am not forecasting a collapse of the property development industry or of the investment business. What I am forecasting is a lot of very disappointed investors who may be servicing debt out of other resources than rental income and for a very long time.
A further rapid rise in property values or a rise in rents is not going to happen to save the day. Property, except in some special niche situation, is a commodity just like coffee beans, oil or lumber. We have had our one-off adjustment in Ireland and it won't be repeated in my life time.
The property development industry will remain alive and well and very happy to supply new product at prevailing prices and this is what will prevent a second boom in property prices and disappoint a lot of expectant millionaires.
Next week in the continuation of this article, I will look at the long term property investment outlook in Ireland.
Bill Nowlan is a consultant property advisor and town planner
