Market takes a serious hit after longest running boom

The commercial property market has taken a serious hit after the longest ever running boom. Returns this year are unlikely to exceed 6 per cent - a long way short of the peak years when annual returns hovered between 24 and 39 per cent.

The eight years of phenomenal results up to last December have served the pension funds and the life insurance companies well and brought significant wealth to hundreds of private investors. In that time, the private sector has invested close on £2 billion (€2.54bn) in commercial property and probably half as much again in the UK in the last two years alone.

Unlike previous booms, this one was primarily fuelled by tenant demand from the technology, telecom and financial services. It was all driven by high economic growth, falling interest rates and historically low vacancy rates in offices and industrial buildings. Everyone involved did well out of it until last summer when it became clear that the boom had finally run out of steam.

The slippage since the September 11th events in the US has gained momenum and with increasing signs of a recession on the way few people know how to call next year. The dependency of the property market on a thriving economy for its success is once again dawning on an industry that had almost forgotten that it is after all a cyclical business.

Even with base bank rates now at a historic low of 3.25 per cent and mortgage rates generally available at 4.5 to 5.5 per cent, the slowdown cannot be avoided because of the scarcity of new tenants and the retrenchments being pursued by other companies in the light of the threatened global recession.

There is, however, increasing optimism over the past fortnight that the US economy will bounce back by the middle of next year and if this happens some forecasters believe a recovery in Ireland could be on the way in the early part of 2003.

In the meantime, office developers in the Dublin suburbs with newly completed space on their hands have already resorted to cutting rents and offering a range of incentives including rent free periods to attract tenants.

The differential between rents in the city centre and the suburbs has become even more pronounced as the demand weakens. New office blocks in west Dublin can be rented for as low as £10 (€12.70) per sq ft but in the south Dublin suburbs the rates generally vary between £14 and £16 (€17-€20) per sq ft.

There is already a considerable volume of completed space overhanging the market in Sandyford and the adjoining areas. Worse still for the developers concerned, there is currently a massive 1.8 million sq ft of space under construction in this location alone and inevitably the incentives will be enhanced even further to attract the few tenants still looking for space.

Agents marketing new office schemes in Sandyford have the extra difficulty of trying to divert attention from the chaotic traffic conditions during peak hours.

They can only remind companies that things should get better when the next stage of the M50 is completed and the Luas light rail system is running.

That is likely to be one of the considerations facing Friends First as it prepares to make a final decision on whether to rent up to 80,000 sq ft in either Sandyford or at Cherrywood where the road network looks more promising.

The decision by this company to relocate from the city centre to the suburbs is significant for another reason: the move will enable it to greatly reduce its overheads at a time when costs are being continuously scrutinised in most firms.

Other companies concerned about the high cost of renting in the city centre may well follow suit even though it would probably mean losing some staff.

For the first time in years there are several new high quality city centre office blocks hitting the market at rents between £35 and £43 (€44-€54) per sq ft. That might seem a bit on the extravagant side in the present climate but inevitably there will be takers for all of them given the strong preference by many high profile companies for city centre locations.

The general fall-off in demand for space has also had a serious affect on the industrial market, pushing up the vacancy rate to 11 per cent, the highest for several years.

The overall take-up this year was significantly lower than in 2000 and like the office market, is not expected to recover until the economy starts growing again.

The financial institutions have been virtually out of the investment market during the past six months and all the indications are that they will be biding their time over the coming year because of disenchantment with unit-linked funds and the fact that portfolios are deemed to be overweight in property compared with other asset classes.

This should give a clear run to the private investors but as in the past, they will be concentrating on well-located retail and office buildings with a secure income. A retail building on Dublin's Wicklow Street which has just been sold for £1.3 million (€1.82m) - representing an equivalent yield of 4.2 per cent - will be the type of safe investment most in demand during the difficult year ahead.

Elsewhere yields for most properties are slowly but surely drifting outwards but they are still a considerable distance below those available in the UK.

Not surprisingly, Irish investors have again been acquiring an increasing number of commercial buildings in London and other major cities in the expectation that there will be capital and rental growth over the next few years.

Such growth is not likely to be found in the Irish market until the present economic cycle bottoms out.

Until that happens most investment activity here is likely to centre on the retail market where rents are still rising, unlike those in other sectors.

The competition for shops on Dublin's high streets should ensure a continuing growth in rents.

However, with prime yields in some cases as low as 3.5 per cent, it is by no means certain that rent increases will be sufficiently high to impress fund managers. A lot will depend on the performance of retail sales in the new year.