The money rolls in as the returns get squeezed

Dublin's property boom has not been confined to the residential market. And despite the recent headlines blaming investors for driving homes out of young buyers' reach, traditionally the more lucrative area for investors has been commercial property.

That market is now booming, driven by a sheer weight of money. One result is that there is now a real fall-off in returns, or yields as they are known to the market.

Leo Roche, director of property lending at ICC Bank, attributes the buoyancy to the increasing role played by professional people earning very high salaries. While some are directing their excess cash at the equity market, others are opting for commercial property, though that has now become too expensive for some the players.

According to Mr Roche, the more sophisticated the investor, the more they are inclined towards commercial property. And it is far more common now for private individuals to buy good quality investments, even on Grafton Street, which were traditionally the preserve of institutions.

Investors come in all shapes and sizes, from the professional who wishes to build up a pension fund or a trust fund for children with perhaps a flat or apartment as collateral, to speculators buying up office buildings and taking a position.

The boom in the Dublin market has driven yields down to extremely low levels, and market professionals are now questioning the wisdom of some investments.

Traditionally, yields should be a function of anticipated rental growth, but now appear to be more influenced by falling interest rates and the banks' willingness to lend.

Yields in Dublin commercial property are currently around one percentage point lower than even a year ago. Prime investments in Grafton Street - and they rarely become available - can be as low as 4.5 per cent, Henry Street, 5 per cent; while the very best office investments now vary between 5.5 and 6 per cent.

The returns on prime industrial investments are also on the low side at 7.75 to 8 per cent.

Bill Phelan, managing director of The Phelan Partnership, warns that value is now very difficult to find in the retail market. He points out that retail rents only increase if turnover per square foot increases and in a small country with a set population, there are limits to how much rents can grow. Large-scale developments over recent years including The Square in Tallaght, Blanchardstown and the Liffey Valley, which will open in October, means that further trading opportunities are becoming more scarce.

Offices, on the other hand, are still a reasonable bet, according to Mr Phelan. More and more firms are looking to move into town and are willing to pay increased rents.

The other major category of commercial tenants are traditionally in the market for industrial premises. But Mr Phelan notes that more of these prospective tenants are now looking to buy premises. As they can now borrow for a fixed rate of under 8 per cent, they are not generally prepared to pay the landlord a yield of 8 per cent.

As a result, London and other parts of the UK are attracting more and more Irish buyers. The argument for buying in the UK is heightened for anyone who believes that Britain will join monetary union. According to Declan McKiernan, manager of banking at Anglo Irish Bank, many investors believe a UK decision to enter monetary union will lead to enormous capital gains as rates fall dramatically.

The most popular banks in the UK for many Irish investors are German banks Depsa and Hypo and Anglo Irish. However, NatWest is beginning to target the sector and branches of AIB and Bank of Ireland are also picking up some business.

Yields in London are also far higher than Dublin, with 9 per cent generally achievable for offices, 6.5 per cent or 7 per cent for retail and 8.5 per cent or 9 per cent for industrial. However, rates are also higher in the UK at present, although Mr McKiernan says that five-year loans are popular, as investors hedge themselves in case of a speculative attack on sterling before it enters the single currency. Memories of the Irish currency crisis appear to inform much of this thinking.

The one problem with investing in the UK is the differential between the pound and sterling. Most banks will only loan 80 per cent of the value of the property, which means an investor has to absorb the currency differential for the remaining 20 per cent. However, an investor with collateral in Ireland can sometimes borrow 100 per cent, eliminating the currency problem altogether.

But wherever the money is being borrowed, there is intense competition for business, which is reflected in the amount of interest which the lenders are charging over the inter-bank, or Dibor, rate.

Investors with a large amount of collateral are now paying only about 1 per cent above the inter-bank rate in Ireland, although the more traditional margin is still about 2 per cent to 2.5 per cent above Dibor, which currently stands at 3.8 per cent for one month.

One possible catch which investors should be aware of is a clause which allows the bank to demand repayment "on demand".

It was this clause which caused havoc in the London commercial property market in the late 1980s as banks pulled the plug on loans which new criteria determined may have left them overexposed. Some banks are understood to insert the clause as a matter of policy while others only include it for business which they determine is more speculative or risky in nature.

On the other hand, investors can also expect more flexible conditions for their loan. Many banks will only demand life assurance to cover a small part of the loan, which can save substantial sums, particularly for older investors.

There is little consensus among investors about the best rate or term to borrow for.

Fixed rates are becoming increasingly popular, although some investors, nervous about missing out on a fall in rates, are only fixing out to 2000 or 2001.

However, with many properties on five yearly rent reviews, others are opting for five-year fixes.