We may look back on the years 2016-2021 as halcyon days for financing conditions for all assets classes. With the European Central Bank in the thrall of quantitative easing (QE), European funding rates spent an extended period of time at all-time lows. Few countries benefited more than Ireland. Once the head of the ECB at the time, Mario Draghi, announced the intention to do “whatever it takes” to defend the euro, Irish sovereign funding costs raced down to 0 per cent and even dipped into negative territory for a period of time. Investors effectively paid the government to borrow. This made the returns available on alternative assets such as real estate appear very attractive in terms of risk/reward versus the “risk-free” rate that the government was paying.
Combined with Ireland’s positive growth trajectory, the return available on Ireland’s commercial real estate moved quickly from the distressed levels reached in the wake of the global financial crisis down towards levels that reflected the renewed confidence investors felt towards the Irish “story”. In addition to the investment returns available on Irish real estate, the interest rate that investors were borrowing funds at to purchase assets also fell, making the overall return profile from investing in Irish real estate particularly attractive. For example, the yield available on prime Dublin offices fell from 7.5 per cent to 4 per cent over this period but this was still considered attractive to international investors when you consider our positive growth dynamics and that the equivalent returns available in other European cities such as Paris or Madrid were closer to 2 per cent and 3 per cent. Moreover, being able to borrow from banks at levels as low as 1-2 per cent to fund real-estate investment has made for a very compelling case.
The market has changed dramatically in 2022 as the spectre of inflation hangs over economies globally as central banks race to reverse the liquidity released into the financial markets by raising interest rates and winding down the QE programmes of the previous 10 years. Sovereign bond markets have responded accordingly. Irish 10-year Government bond yields are now at a more ‘normal’ level of 2.20 per cent to 2.30 per cent from an all-time low of negative 0.3 per cent reached in December 2020 — we are once more paying positive amounts of interest to global investors as a reward for buying Irish bonds. This is a fast and significant change in financing rates for Ireland, but it is more modest than the movements experienced by some of our European peers. Spain’s equivalent 10-year yield has moved by 275 basis points (bps) over the same period while French rates have moved by 260 bps. UK gilt yields have risen sharply by 300 bps since the lows of 2020. In this regard, Ireland has outperformed other countries as investors’ perception of Ireland’s creditworthiness has improved since the dark days of the sovereign crisis.
So, what does this change in financing rates mean for Ireland’s real- estate sector? The long-term societal trends continue to look constructive for Ireland’s prosperity. The recent population census data demonstrated clearly that the long-suspected increases in our population are actually taking place, as we breach a population of more than five million people in the Republic. Couple that with the ongoing amounts of foreign direct investment that Ireland attracts from overseas companies and it is clear that the State offers a unique combination of growth opportunities housed within the largest trading bloc in the world, the European Union. Demand for the myriad profile of built environment this new population requires far outstrips supply. Investors remain confident that despite any short-term blips triggered by global forces, Ireland remains an attractive place to invest for the long term.
Investment in real estate in times of inflation holds potential upside for investors that other assets classes, such as bonds, lack. Sovereign bonds have fixed yields and redemption amounts — as an investor you get back the same amount you lent to the Government and the coupons you earn in the meantime don’t change. During inflationary times, this means the effective or ‘real’ amount you are earning is diminished once you take account of rising prices. If recent history is anything to go by, real-estate values rise steadily over time so that holding real-estate assets during periods of inflation means that investors preserve their returns against the effect of higher general prices in “real” terms.
For so many reasons, we hope this period of sustained inflation begins to cool so that central banks can begin to communicate when and at what level they expect interest rates to peak for this cycle. While we may never again see the ultra-low funding yields for generations to come, funding will still be available at rates attractive enough to support investors continuing to pursue the opportunities that Ireland offers.
Myles Clarke is managing director of CBRE Ireland