Returns up 5% in second quarter

Commercial property's performance to the end of June was the best in five years, writes Jack Fagan.

Commercial property's performance to the end of June was the best in five years, writes Jack Fagan.

The commercial property market is thriving. Not only have the overall returns improved for the fifth successive quarter, but the performance in the three months up to the end of June was easily the best in almost five years.

Total returns in the SCS/IPD index increased from 4.5 per cent in the first quarter of 2005 to 5 per cent in the second period.

The results reflect an income return of 1.3 per cent and a capital growth of 3.7 per cent. The rate of capital growth from 3 per cent in the first quarter stemmed from a faster increase in rental values and a healthier fall in yields.

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With such a good start to the year, commercial property now seems certain to do even better than it did in 2004 when year end returns reached 11.6 per cent. The overall returns for the 12 months up to the end of June stood at 17.3 per cent compared to 12 per cetn at the same point last year. Add to that the fact that the final three months of the year is generally the strongest quarter and the end result could be quite impressive.

Irish equities made a remarkable recovery in the three months up to the end of June, moving from minus 2.8 per cent to plus 10.1 per cent. Gilt returns also strengthened from 1.6 per cent to 5.3 per cent, making property the weakest performing asset in the second quarter of 2005. However, taking a view over the first six months of 2005, property has delivered superior returns of 9.7 per cent, comfortably exceeding the 7 per cent achieved by both equities and gilts.

The index shows that over the first six months of 2005, total returns at the all-property level have been 9.7 per cent, a substantial improvement on the 4.4 per cent and the 6.9 per cent achieved in the first and second halves of 2004 respectively.

The rate of rental value growth increased slightly in the first half of 2005, to 1.7 per cent from 1.5 per cent in the second half of 2004. However, the main driver of performance has been acceleration in the rate of decline in yields.

Over the first six months of 2005, the all property equivalent yield declined by 29 basis points, adding 5.3 per cent to capital values. This was double the fall recorded in the second half of 2004, when a 15 basis point decline in yields boosted capital values of 2.6 per cent.

The steady improvement in returns at all property level over the first half of 2005 belies contrasting fortunes for the three major sectors of the commercial property market.

Offices have seen the most notable improvement in performance over this time - total returns have almost doubled from 2.7 per cent in the first quarter of 2004 to 4.7 per cent in the second quarter of 2005. Over the same period, industrial returns have also inched upwards, from 2.8 per cent to 3.3 per cent, but retails, while remaining the best performer, have seen total returns slide from 7.2 per cent to 5.9 per cent.

The dip in retails can be attributed to a slowdown in the rate of rental growth, which has eased from 4.1 per cent in the fourth quarter of 2004 to 2.6 per cent in the second quarter of 2005.

Office rents remain fairly uninspiring, according to IPD, improving marginally over this period, from minus 0.1 per cent to 0.2 per cent.

While retails have the better rental trend, offices have benefited from a more favourable yield trend. This office equivalent yield fell by 17 basis points in the three months to June 2005, boosting capital values by 3 per cent. A more modest 11 basis point fall in retail yields added only 2.5 per cent to capital values.

Although at the overall level office rents remain rather nondescript, there is evidence that rents are beginning to pick up in certain pockets of the market.

Dublin 1 offices recorded a 1.3 per cent gain in the second quarter of 2005. Although welcome, this development should be treated with caution, according to IPD.

It says it would be unwise to call the beginning of an upturn on the basis of one quarter's evidence, particularly when in nearby Dublin 4, office rental values fell by 0.5 per cent.