Lenders limit credit to developers against oversupply of space

Lending agencies are continuing to tighten the supply of credit to property developers, despite the ever-rising demand for commercial space in Dublin.

According to one bank, this is a means of controlling the market's development to guard against oversupply down the line which could cause it to collapse.

"It all starts with the flow of funding. If that stays stable, then you're not going to get speculative development. If that is controlled, a situation where oversupply becomes a problem is not going to happen," says Mr Tom Browne, director of banking at Anglo Irish Bank.

A senior AIB spokesman agrees. With some of the leading institutions increasing their exposure to commercial property lending by up to 25 per cent in the past three or four years, he says a preference is emerging for growth at a slower rate.

"All the banks have got significant growth in terms of portfolio weighting. For that reason, there is probably an element of a liquidity issue in the marketplace.

"The pace of growth is an issue as well as overall weighting. Lending of a very recent origin does lend a higher risk profile to the portfolio."

AIB's spokesman said its policy was confined to property developers. He added, however, that many developers required less credit for new developments because gains from previous investments in recent years were especially strong.

Limiting credit may be a prudent practice for the banks. But for tenants and others seeking office space in Dublin city, this may feed into a growing shortage of good prime location accommodation. With this in mind, higher rents seem inevitable.

Yet property adviser DTZ Sherry FitzGerald says there may be good news on the horizon because certain larger developments currently in the planning process will come on stream before the end of next year.

Some 310,000 square metres of office space were under construction at the end of June in Dublin, according to its latest market review. Of this space, 63 per cent was in the city's suburbs. Of the total, 22 per cent was prelet and 22 per cent was reserved.

"Fears of oversupply in the office market may be escalated by the increases in `under construction' and `availability' figures. However, once pre-let and reserved figures are taken into account, these increases are not as significant."

Even so, DTZ forecasts "exceptional" take-up levels for office space and says upward pressure on rents is "unlikely to ease" in the short term.

"Other factors such as rising building costs, labour shortages and a shortage of larger lot sizes will further heighten inflation," it adds.

According to one property insider, who asked not to be named, cost analysts on a major Dublin project have recently sought to factor in construction cost inflation of 35 per cent by the end of 2002.

This factor cannot be underestimated, says Mr Killian O'Higgins, managing director at DTZ. Rising property prices can absorb significant inflation in construction costs, he says. "Potentially, over the longer term, we're storing up bigger issues."

On rents, Mr O'Higgins says there is every indication that the "psychological barrier" of annual rents of £40 per sq ft will be breached by the end of the year.

Mr Des Quinn, manager at the commercial and development division at Hooke and McDonald, says such rates are already being sought "but not necessarily achieved". For space in good inner city locations, he says potential tenants should expect to pay in excess of £30 per sq ft.

Such is the shortage of supply, however, that many landlords are declining to offer leases to certain companies in anticipation of doing a deal with larger organisations with "AAA" credit ratings.

This offers landlords the advantage of secure, high-quality covenenants which are unlikely to be broken for the duration of the lease, says Mr Quinn.

For smaller companies and those at an early stage of their development, this means office space comes at a premium or may not be available at all.

Says Mr O'Higgins: "Rental inflation in the office market in Dublin is being driven by dot.com type companies. Because the covenant isn't strong, they're having to compensate by paying higher rent."

Start-up firms face particular problems, says Mr Peter Coyle, a director at Enterprise Ireland with responsibility for development. This is especially so in the software business, which is growing rapidly.

Two factors are at work, says Mr Coyle. "These companies tend to grow rapidly so they need a flexible lease situation. They need opportunities to expand with minimal hassle. They will not tie themselves, going forward, to long-term leases because the business is changing so fast.

"The critical player is the techie - the software or computer engineer who tends to be young and wants to live, work and socialise in the city centre."

Given these demands in a market where space is already in short supply, Mr Coyle says certain landlords have placed particularly demanding qualifications on the leases they offer.

Anecdotal evidence, he says, suggests that some are even seeking personal guarantees to underwrite leases.

"I've also heard stories about landlords seeking equity in companies and, generally speaking, looking for lease terms designed for yesterday's world."

Space with high-spec access to broadband computer networks is in "severe shortage". This also fuels increasing rent charges.

Yet for certain companies, the "connectivity" factor is more important than annual rents. "There's a possibility that even young companies will place developments offshore. It's not a question of being able to meet the rents," says Mr Coyle.

Either way, the banks appear to have a different view of the development market - where loans are especially large - to the residential mortgage business.

"A lot of the institutions and banks reckon they have a significant exposure to the property market and don't want to add to it," says Mr O'Higgins. "Banks are looking for increasing security. But it's not just a credit squeeze. They're also squeezing requirements."

Mr Browne says: "There's a natural demand there, but funding it has been more controlled."