Finding value as a quiet market comes to life

Those with cash are looking to get back into commercial property

Private Wealth Management

Before the crash, commercial property and residential buy-to-lets used to be a routine part of most private wealth management portfolios. Rental yields were high and capital appreciation was solid. It’s hard to believe that just five years on from such a devastating collapse, both sectors are staging a convincing comeback.

Commercial property, in particular, is showing every sign of outstripping the fragile recovery in the economy as a whole. While GDP growth tipped back into negative territory at the start of this year, in the capital’s office market, vacancy rates are falling and prime rents are rising.

So rapid has the turnaround been that IDA chief executive, Barry O’Leary, warned during the summer that a shortage of prime commercial property in Dublin could hamper the agency’s efforts to attract overseas businesses.

Government policy, and in particular the 2012 Budget, has been crucial in creating this positive environment, according to real estate advisers, Savills, who say that:

– reduced commercial stamp duty has stimulated activity by enhancing total investment returns

– a capital gains tax waiver on deals completed before the end of this year has provided a strong incentive for long-term investment

– the introduction of REIT (real estate investment trust) legislation and the launch of the Green REIT in June has given another injection of confidence.

“More than €1 billion has been invested in Irish commercial property so far this year, compared to €545 million during all of 2012,” says Domhnaill O’Sullivan, director of commercial at Savills. “By the end of the year, that will probably top €1.5 billion.”

High-profile US private equity investors – such as Kennedy Wilson, Blackstone, KKR, Lone Star, Oaktree Capital, Carlyle and Apollo – have been the main movers behind this extraordinary drive to acquire commercial property value, says O’Sullivan.

In fact, Savills advised Kennedy Wilson in the €306 million purchase during the summer on the “Opera portfolio”, which included Stillorgan shopping centre, Merchant’s Quay shopping centre in Cork, KPMG’s offices on St Stephen’s Green, and the Bank of Ireland headquarters on Mespil Road in Dublin 4.

Along with those overseas buyers, Irish funds are active again and Irish high-net-worth individuals – those who have emerged unscathed from the financial crisis – are back in the market and finding plenty of purchasing opportunities, says O’Sullivan.

Many of the latter, and quite a few “family offices” (private companies managing investments and trusts for a single family), have been buying through qualifying investor funds (QIFs), which have a minimum subscription of €100,000, are regulated by the Central Bank, and, crucially, are exempt from tax on income and gains.

So is this a real buying frenzy? Or is it to some extent at least symptomatic of the fact that, as O’Sullivan points out, there’s been essentially no commercial property built in Ireland since the start of the downturn and that inactivity is making itself felt?

Ann Hargaden, chairman of Lisneys and head of its investment department, believes it’s the latter.

“The reality is that nobody has been building speculatively in Ireland for as long as seven years,” she says.

“Prices initially fell through the floor. Nobody was interested because the banks weren’t funding acquisitions. But when the international funds started looking because they believed there was real value to be had, that started pushing up the prices.”

Even those with cash will not invest unless the price is right. “They may have cash, but they are looking for a high return when they spend it. In many cases, they’re looking for IRRs (internal rates of return) of 15 to 20 per cent over five to seven years.”

The companies looking for for more space in Dublin include all the household high-tech names, it seems, Facebook, Amazon, Yahoo, Google, Twitter, LinkedIn. On the Irish side, names include Arthur Cox, KPMG, William Fry, and Bord Gáis.

While the price per square foot was about €25 or so three years ago, says Hargaden, now prime property around Grand Canal Square is making €35 to €40 a square foot, with plenty of incentives. At the height of the boom that would have achieved about €55 a square foot.

“So things are climbing back up, but they’re still slow, relatively speaking,” she adds. “The next stage is that building will re-start.”

What the commercial property market and residential buy-to-let market have in common in the closing months of this year, it seems, is cash.

“The typical buy-to-let buyer at the moment is frequently someone who has cash to spend,” says Michael Grehan, managing director of Sherry FitzGerald Residential.

“There’s around €150 billion on deposit in Ireland at the moment.

“Many people didn’t feel they would get real value at the height of the boom, but they’re ready to buy now – if the price and the returns are right.”

So what should potential buy-to-let investors be wary of?

“Well, property is a great investment,” says Grehan, “but you have to buy well, and an investor should be mindful of the cost of owning a property.

“Service charges can be up to 10 per cent of rent. There’s residential property tax. There’s sourcing and managing of tenants. There are inevitably empty periods. There’s the cost of wear and tear even if the property is appreciating. Rents can fall as well as rise . . . and, of course, buy-to-lets are not as easy to finance as they were a few years ago.”

Whereas at the height of the boom, property could sometimes account for 75 per cent of a client’s asset portfolio, says Tim O’Rahilly, a tax partner at PwC, now it more likely to be 10 to 15 per cent, combined perhaps with equities, cash and bonds.

“People are more conscious of the tax implications of their purchases. They are doing more due diligence. They’re looking at after-tax cash flows and how they meet debt repayments.

“They are treating property as if they were putting money into a company and wanted to know how it was going to be used. Overall, I’d say we’re seeing a far more sophisticated type of investor.”