Weak demand for office and industrial space means the commercial property market has a difficult year ahead. Jack Fagan, Property Editor, reports.

The commercial property market is bracing itself for a tough year in 2004 largely because of weak demand for both office and industrial buildings. The threatened slowdown comes at a time when the appetite for property investment has never been stronger largely because of a low inflation and low interest rate climate.

The buoyancy of the past year when a record €800 million-plus was spent on Irish investments disguised the poor returns from both the office and industrial sectors. The situation was saved once again by the thriving retail sector which remains the driving force within the market. Retail put in a particularly strong performance in the third quarter, showing returns of 22.1 in the year up to the end of September. Even with a one sided maket doing well, , the indications now are that all property returns for the calendar year should exceed 10 per cent, a vast improvement on 2002 when the growth was only 2.2 per cent.

The search for investments was so intense this year that yields for both prime retail outlets and older office buildings were pushed down as institutions took advantage of the strong market to offload a surprisingly large stock.

With investment demand completely outstripping supply, Irish investors moved in ever greater numbers into the UK and Continental markets, spending a whoppi ng €2 billion in areas where the choice is plentiful and where returns are generally higher. The Irish are now the second largest investors in the UK after Germany. Many of them are flush with cash after Ireland's longest ever property boom which lasted for eight years until 2002. They were also helped for most of the year by an abundance of inexpensive money. However, that changed in recent weeks when interest rates started moving up. Liam Lenehan of Hamilton Osborne King says the Irish investors in th UK are "debt driven and very sensitive to higher interest rates." He had noticed a slowing down in this market in recent weeks.

However, the modest increases in Euro rates expected over the coming months are not likely to halt the push into Continental markets

Apart from the €2 billion invested in commercial property, Lenehan estimates that the Irish also spent around €250 on residential properties mainly outside London where the best rental returns were available.

At home, investment activity is likely to be quieter in the coming year because the shortage of available stock and and the huge volumes of vacant office and industrial building overhanging the markets. The slowdown in lettings and the fact that the vacancy rate has risen to 14 per cent has not stopped speculative development in the city where Treasury Holdings are seeking tenants for a 9,290 sq m (100,000 sq ft) block at Burlington Road an d where Liam Carroll of Dunloe Ewart is building an even larger office complex of 20,000 sq m (215,280 sq ft) at Barrow Street. Tenants are still likely to emerge sooner rather than later for both schemes, underlining the two-tiered nature of the city centre and the suburban office markets in Dublin. Activity on the outskirts of the city is at its slowest level for a decade and only low interest rates is saving some developers unable to find tenants.

Letting agents are not expecting any significant resurgence for some considerable time after a pick up in economic activity and a broader recovery on the stock markets. In the meantime, few firms are expanding and the banks and high tech companies are looking at ways of offloading leases entered into in better market conditions.

It is a different matter entirely in the retail market where there is still strong competition for high street shops. Equally, developers like Castlethorn can pick and choose their tenants for the planned Dundrum Town Centre which is likely to become the premier shopping complex on the south side of the city. It will have a first rate mix of tenants and several international multiples making their first appearance in Ireland.

A return of the good times and higher interest rates will inevitably bring the institutions back into the investment market but with the fast moving private investors now holding sway, the funds will have to smarten up their act and concentrate on the highest value investments if they are to make any impact.