In the first quarter of this year, Irish investors accounted for 20 per cent (representing £272 million) of total overseas investment activity in the UK, only being surpassed by the Germans. With value of sterling at an all time high, why do Irish investors continue to invest in the UK?
The explanation for continued Irish participation in the UK on such a scale is simple - stability, rental growth and attractive yields.
In terms of stability there is a huge contrast between the UK markets and their European counterparts. Leaving aside economic stability, stability is measured in terms of lease length and covenant strength.
Broadly speaking, in Europe offices are let for terms of five years and single let property to 10 years often with an option to renew for an additional five years. Retail is usually leased for longer periods, say 15 years, and an industrial lease is typically five to 10 years.
In the UK, despite the recent increase in tenants' negotiating strength, leases in all sectors will be for at least 15 years (not forgetting that under existing UK landlord and tenant legislation, the tenant has the option to renew its lease for a further 14 years) and 25 leases are still common in some sectors.
For Irish investors the perceived covenant strength of a tenant is a factor that needs to be carefully considered especially as they will be unfamiliar as to which UK and overseas companies are considered financially secure. Investors who buy "income" are termed yield and covenant players, and to them security is critical. For example, where a property is acquired and the income is over-rented many investors view the investment as a form of "bond", i.e., a fixed-term security providing a fixed-term return.
Where this is the case it is only done with the anticipation of capital growth through a movement in yield. Consequently, investors place a great deal of reliance upon tenants' ability to pay the rent throughout the lease.
Growth in income is a serious concern to any investor. The five-yearly "upward only" rent review provision remains the most common form of rent revision in the UK and this affords a landlord security that rents will rise in line with the market and its locality.
From an economic and investment standpoint, the strong performance of the UK economy, coupled with returns on real estate investment in all sectors (with double-digit real returns anticipated within the next two years), underpinned most Irish investors' interest in speculating in the UK in 1999 and in the first quarter of this year.
As far as total returns are concerned, last year total returns on UK property rose to 14.5%, which to put it into some form of perspective, was the fourth year in succession that total returns have been above 10 per cent. Performance was lifted by rising rental values and a quarter point fall in equivalent yields. Both trends gathered strength after a weak start to the year, in step with recovering confidence in the UK economy.
Since 1994, sustained growth in property income and rental values, plus a modest fall in yields, have produced a solid property return of 11.2 per cent per year. With low inflation, the real property return of 8.2 per cent has been well above its long-term average.
On top of this, entry and exit costs in the UK remain low (5.76 per cent in the UK, compared with 8.42 per cent in Ireland) relative to those of most other European markets, despite the successive increases in stamp duty.
The UK market is also more transparent than many others and therefore information on market conditions is more readily available. Tight planning constraints, higher building standards and other supply constraints act to minimise downside risk to capital values.
The structure of a typical lease on UK property is particularly attractive. Although most lease terms are negotiable, the terms generally agreed between parties will favour a landlord in the UK as illustrated by the relative benefits of longer leases, fewer tenant break options, upward only rent reviews, less onerous repairing obligations and lower transaction costs. Moreover, the gross to net income ratio is much lower on UK properties since the tenant bears the cost of insurance, rates and both structural and internal repairs.
The disparity between European currencies and sterling will not remain forever. With forecasts suggesting GDP growth in the UK of 2.7 per cent in 2000 (as opposed to the European average forecast of 3.6 per cent), there is strong evidence to suggest that the UK has been disadvantaged in delaying its decision to join EMU and there is increasing pressure on the UK Government to get its house in order and bring sterling in line with its European counterparts.
The only issue that remains is "when" and not "if" this will happen.
When parity returns, I suspect many Irish investors who have sat on the sidelines will wonder why they did not invest in the UK, when the fundamentals of sound investment are plain to see. Especially when one compares the high yields on UK property with five year swap rates making property a self financing investment. Bearing in mind that most financial institutions will now lend 100 per cent loan to value (sterling) with recourse to assets in Ireland and the subject asset in the UK, it still makes sense to invest in the UK!
David Eggers, of DTZ Sherry FitzGerald's investment department, has recently returned to Ireland from the UK, where he worked for four years
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