The EMU picture is a lot clearer now than it was about a year ago, when the whole idea of convergence was threatened by the inclusion of the Club Med countries in the Euro bloc. Now that the final group of countries participating is decided and a time frame is set, it is time to revisit the issue of the likely influence EMU is going to have on the property market over the next couple of years.
Similar to our economic performance, Ireland is quite out of step with our European neighbours in relation to our property markets. For example, office vacancies are at a record low in Dublin (2.5 per cent) and are relatively high in the larger markets such as Berlin (12 per cent), Amsterdam (11 per cent), and Brussels (10 per cent). Residential prices continue to rise rapidly here, while our European neighbours presently have sluggish housing markets. Yields for commercial properties are hardening significantly here, while in Germany, for example, yields are stable to rising.
There are several reasons for Ireland being out of step with our European neighbours in terms of property markets, not the least of which is the outstanding economic growth taking place here. Another reason for our outstanding performance in the property markets is the low interest rates coming during a time of rapid growth. These low interest rates are thanks to EMU, because the economic cycle of the other EMU countries will not allow interest rates to rise significantly without risking a recession.
Some analysts are saying that interest rates (3-6 month DIBOR) are set to fall anywhere from 0.5 per cent to 2 per cent over the next six months in order to achieve a convergence with the Euro 11. With the level of economic growth taking place in Ireland at the moment, it is unlikely that interest rates would be falling without EU, given our current growth patterns.
With EMU looming, we have a relatively clear picture of the next six to seven months. On January 1, 1999, all the rules change concerning currencies and interest rates. Lower interest rates, continued economic growth, and currency stability are on the cards for the first two years of EMU. But what will happen to the property markets after January? Well, property fundamentals should come back into play like never before. Property investors will be able to "comparison shop" for investments across Europe, without significant exposures to currency fluctuations or interest rate differences. So economic growth with property fundamentals such as low vacancy rates, rising rents, and supply coming on line are likely to be the key determining factors when these investors go looking for opportunities.
Where are these investors going to look for opportunities when they are able to move all over Europe? Well, obviously they are going to turn to those markets with the best prospects for growth, including Dublin, Paris and Amsterdam. Why Dublin? Our office vacancy rates are extremely low, with take-up far exceeding supply coming on-line. The success of the IDA in attracting foreign investment has meant that industrial properties are in great demand, with the resulting prime yields hardening to 7.5% at present (two years ago, the yield was 9.25%).
Retail spending has been extremely high, with multinational retailers looking for space in order to enter the Irish market. The result is unprecedented demand for prime retail space and a surge in out-of-town shopping developments. As if these reasons where not enough, total return figures from IPD suggest that total returns for commercial property have been averaging over 20% during the past three years, with returns of 24.9% last year.
In the other markets, Paris and Amsterdam, investors are waiting for property slumps to end, not the situation here.
Ireland is one of the only property markets within the Euro 11 showing very strong growth characteristics across all sectors. For example, comparable statistics for Berlin indicate that all property total returns were 3.72% in 1997. In Brussels, total returns were 8.9% for 1997. Paris showed 1997 total returns of 14.75%. By comparison, Ireland is performing extremely well. Given more convergence in interest rates as well as no currency risk after next January, foreign investors will look to Ireland as a very good opportunity in comparison to their home markets, resulting in even more demand for prime investment properties.
Convergence in interest rates may only be the beginning, the convergence of property investment markets may soon follow. For example, money will be more mobile than ever across Europe. Investors will have greater choice than ever in placing investments of all types, including property. The characteristics of the local market will play a big difference in returns, but benchmarking will be done on a Europe-wide level rather than on a country by country level.
If one uses prime yields as an indicator of these local market conditions, then there is room for convergence still left. Take a look at prime office yields, for example. In Dublin, the initial prime yield is 5.5%. In Berlin, this yield is 5.5%. In Paris, the initial yield is 6.5%. The average prime yield for office markets within the Euro 11 Bloc is 6.78% and hardening significantly. Eastern European yields are significantly higher than this average.
Our average also does not take into account the lease terms that are advantageous to investors in Dublin, with leases differing greatly across EMU member countries. (For example, Paris leases are for significantly shorter terms with the traditional FRI lease considered unusual.) With Dublin commercial property rents still considerably lower than our Euro partners, there is considerable room for office rental growth using this indicator.
Our European counterparts will not be the only players entering the fray for investment opportunities. The Euro currency will be used in a market slightly bigger than that of the US, and should be a stable force for European economies.
REITs, publicly quoted property investment companies in the US, are beginning to see the advent of the Euro as their best opportunity to invest in European property. Many REITs see European markets as stable in relation to many US markets, with vacancy rates in offices, for example, much lower across Europe than in the US (Some rates in the US are as high as 25%). With the single currency looming, many REITs have been investing heavily in Germany, France and The Netherlands. With Irish property markets showing relatively high growth, it will only be a matter of time until REITs throw their money into the market here.
What does EMU mean for property markets in the medium term? More competition for already scarce prime investments. With the investment property market already tight, the result will be higher capital value growth and lower yields for all property investments over the next 12 to 18 months. Welcome to Euro-land.
