Dublin offices are too dear and sales at the prime end of the market have effectively paused

Over the past year, office vacancy has risen more rapidly in Dublin than in almost any other European location. However, the pricing of Dublin office investments has adjusted by less than the European average.

Investors remain attracted by Ireland’s demographic profile, our cultural links and the success of our foreign direct investment model. But Dublin offices are just too dear compared with other locations, and investment sales, particularly at the prime end of the market, have effectively paused.

The relaxation of pandemic restrictions propelled global economic growth to 6.3 per cent in 2021. However, this rebound triggered an inflation surge that quickly forced monetary authorities to engineer a return to more sustainable growth by raising interest rates. To comprehend the impact of this on commercial property, it is useful to know that offices serve two economic purposes, in two distinct markets.

In the occupier market, landlords lease space to tenants who need it for their day-to-day businesses. Rising rates and slowing growth have caused start-ups and business expansions to slow. Combined with hybrid working, which has enabled employers to trim space-per-employee ratios, this has dragged on office leasing.

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Take-up in Europe fell by 23 per cent year-on-year in the first quarter of 2023. However, the decline in Dublin was 41 per cent. The importance of the information and communication technology (ICT) sector in Dublin’s occupier mix helps to explain this.

Tech accounted for half of Dublin office take-up between 2017 and 2021, with global brands such as Meta, LinkedIn, Amazon and Twitter all establishing large-scale office campuses. However, at a global level, the tech industry has seen significant job cuts over the past year, and hybrid working is more prevalent in this sector. Consequently, ICT’s share of Dublin office take-up has halved in the past 15 months.

Last year was the biggest one for Dublin office completions since the global financial crisis, with more than 200,000sq m of new space delivered

Coinciding with weaker demand, office supply is peaking. Last year was the biggest one for Dublin office completions since the global financial crisis, with more than 200,000sq m of new space delivered.

A similar amount is likely this year, before the development pipeline eases considerably in 2024. These supply/demand dynamics mean that Dublin’s office stock is currently expanding faster than space can be consumed, causing vacancy to rise. In fact, over the past 12 months, Dublin’s office vacancy rate has risen faster than in all but one of the 39 European office markets in the above table.

Higher interest rates also affect the other key market that office buildings serve. In the investment market, investors buy tenanted properties for the rental income that they produce.

The price they are willing to pay for these future cashflows depends on several factors. The “risk-free rate of return” sets a lower bound. If investors can earn 3 per cent per year from low-risk, interest-bearing bonds, their expected return on office investments must exceed this. This premium is required to compensate for the illiquidity and additional risks associated with property – including risks that affect the certainty of future rental incomes.

Increased yields

As interest rates rise, fixed income products become more attractive. Therefore, yields must move out to keep property investments competitive. In practice, this means that investors will pay less now than before for buildings with a given stream of contracted rental income. The horizontal axis of the graph bears this out; as interest rates have risen over the past year, prime office yields have increased in virtually all European markets.

This is where Dublin is an outlier. Only Barcelona has seen a bigger rise in office vacancy over the past 12 months

Logically, we should expect a sharper rightward move in occupier markets where there is more vacancy. This is because vacancy undermines the certainty of future rent-rolls by reducing rental growth prospects and elevating void risks. Again, our graph confirms this – the upward-sloping trendline indicates that investors generally pay less for a euro’s worth of future rental income in weaker occupational markets.

[ David McWilliams: Who is going to rent all these expensive offices now? ]

[ A third of Dublin’s available office space is leased out but not being used ]

This is where Dublin is an outlier. Only Barcelona has seen a bigger rise in office vacancy over the past 12 months. But prime yields in Barcelona have widened by 100 basis points compared with just 75 points in Dublin. More importantly, in the 20 markets under the shaded area of our graph, prime office yields have risen faster than in Dublin (indicating faster price adjustments), despite less severe vacancy increases or, in some cases, falling vacancy.

Small investment markets such as Dublin lack the transactional flow to provide real-time pricing visibility. Without direct comparable evidence, vendors are anxious not to undersell their properties, while buyers do not want to pay too much. The result is stand-off, and no new-build prime offices have sold in Dublin in the past six months. Investment agents are correct to say that Dublin remains a compelling investment proposition, and investors are patiently waiting in the wings. But, based on the evidence presented, capital values still have some way to soften before more deals can be done.

John McCartney is director of research at BNP Paribas Real Estate Ireland.