Buying entire apartment blocks - a new trend?

With values on the floor overseas investors are now considering purchasing Irish residential property in bulk

WE COULD well see some overseas investors purchasing entire residential developments for investment purposes over the next 12 months.

Although this will be a new trend for Ireland, in many other places – like the US, Scandinavia, the UK and Germany – the residential sector attracts investment from funds, property companies, Reits (real estate investment trusts) and other such investors who buy primarily for the income return with the potential for capital growth.

It is regarded as a relatively safe form of investment with predictable returns and standardised, professional management.

There are a number of reasons why overseas investors are now considering purchasing Irish residential property in bulk.

The private rental market is performing well, particularly in urban areas. Apart from buying at depressed levels, bulk buyers can expect and demand a substantial discount from the, largely theoretical, break-up value of a block or scheme. This offers a potentially lucrative exit strategy when a normally functioning market returns.

The residential sector is unaffected by Government proposals around upward-only rent reviews, so it has a relative advantage over commercial investment, and stamp duty is considerably lower.

The legal framework is more flexible here than in many jurisdictions. Security of tenure in Ireland, which only comes into play four years into a tenancy, is not particularly onerous on a landlord.

The FRI (full repairing and insuring) leasing system in commercial property is peculiar to the UK and Ireland. Investors from the US and Europe are used to being responsible for repairs and maintenance as well as, generally speaking, shorter leases. Therefore, they do not view residential investment as requiring a disproportionate amount of hands-on management in a way that a UK or Irish landlord would.

The Irish market is new to overseas investors and so they will carry out substantial due diligence before making any commitment. There are nuances in the market particular to Ireland, such as the bias towards furnished units to cater for short-term lettings, which form the bulk of demand.

Overseas investors will be conservative in terms of location and so confine themselves to prime or near prime urban areas, principally in Dublin. Therefore, large amounts of residential development around the country simply will not be on their radar screen.

Professional residential investors require 100 per cent control of their investment which means that schemes where some units have been sold to individual investors or owner-occupiers may not be considered.

In terms of pricing, a professional investor will look at the actual and potential rental income of a development and factor in non-recoverable outgoings, such as repairs, maintenance, insurance, management, utilities, statutory charges, letting and legal fees. A suitable sinking fund will also be provided to enable future capital expenditure on lift replacement, roof repairs and other periodic but significant costs.

The investor will arrive at a net operating income figure which will be capitalised at their required rate of return. This can be as low as 5 per cent in prime locations in Germany or the UK but is generally higher elsewhere. In speaking to overseas investors, I have found a range of 6.5 per cent to 9 per cent typically applies, depending on the nature of the investor, location and quality of the development.

The more than 50 per cent drop in the value of apartments in Dublin from peak has rendered many schemes insolvent. The willingness and/or capacity to crystallise large write-downs has been a major impediment to banks (including Nama) selling these assets.

The easy option has been to rent out the units and use the rental income to keep the loan as near performing as possible while hoping for an uplift in the market. However, this is not sustainable in the long term, as the prospects for any discernible increase in values are remote at this juncture, especially in the context of a stagnant market.

The break-up option is not realistic, as it could take many years of individual sales to recapitalise an apartment block of any size.

On the other hand, the option of a sale to a single, professional investor of an entire block, scheme or estate has a number of attractions.

These include: the buyer is well funded with access to non-Irish banks and substantial amounts of equity; certainty of execution – the counter-party risk is low as these are professional investors with a reputation to protect; speed of execution – once a deal is agreed a single contract can quickly be signed and closed in a relatively short timescale; the logistics of a single sale are much more streamlined than a multitude of sales to a disparate group of private buyers, with a resultant cost efficiency; and competitive bidding – as there are a number of these investors it may be possible to generate competitive bidding and hence a price premium, especially on prime assets (this is impossible in a break-up sale process).

The downside, from a vendor’s perspective, is the bulk discount a single buyer would require. Traditionally, a bulk sale of an apartment development, or a substantial part of it, would attract a discount of up to 20 per cent of the value based on individual sales. This is in the context of a pre-sale of a development which recognises the value that a buyer is bringing in de-risking that development.

In the context of an already built scheme a discount of 10 to 15 per cent is more appropriate but the same logic applies as the buyer is taking away all the risks associated with a break-up sale.

Guy Hollis is managing director, CB Richard Ellis, Ireland