Co-ownership by institutions of the larger investment properties on the Irish market has been a growing trend in recent years and one that is likely to continue in 2001, providing a firm foundation for commercial property over the coming year.
There has always been a level of co-ownership of commercial property but it has become an increasing phenomenon with the growth in capital values in the market in recent years giving much needed liquidity to the marketplace. Among the examples last year were the purchase of St Stephen's Green House in Dublin for £22.5 million by a combination of Irish Life, New Ireland and Bank of Ireland Asset Management. The Square in Tallaght has more than 10 owners while the Nutgrove Centre is owned by AIB Investment Managers, Irish Life and Bank of Ireland Asset Management.
Co-ownership is not restricted to funds, of course. Private investors have been linking up in recent years and, as a result, have become a significant force in the commercial property market. So, too, have developers who have looked increasingly at the options of retaining a share in their developments alongside other investors.
One of the main incentives behind this development has obviously been the strong increase in capital values which we have seen in recent years. That has encouraged funds to join forces for some top-of-the-market properties which might unbalance their portfolios were they to go it alone. Joint ownership allows them to maintain a more widely balanced portfolio spread across a range of properties.
There is also the fact that it is easier for funds in Ireland than in the UK to come together to share ownership of an investment. In the UK this is done on the basis of a formal limited partnership, while in Ireland it can be done on the simpler and more flexible basis of a tenancy in common.
Other advantages relating to co-ownership are that it can improve the liquidity of an investor's holding and it also plays a role in diversifying specific property or covenant risk. It may also allow funds to bid for larger buildings in portfolios which can give them a competitive bidding advantage where lot sizes are extremely large.
On the negative side, it does mean entering into a partnership which can increase management time significantly and might lead to disputes on decision making. Co-ownership is not necessarily suitable for everyone, especially where potential partners have differing aims and where ownership is shared among a significant number of investors it can become cumbersome.
The key to a successful co-ownership arrangement is careful drafting of the initial documentation. Probably the most important aspect is the pre-emption rights that either party is granted. These effectively provide each co-owner with the opportunity to purchase the other's interest if it becomes available, prior to putting it on the open market.
There are a number of mechanisms as to how this can be treated. These range from straightforward agreement on price to introducing the role of an independent valuer to ascertain what should be acceptable. One of the drawbacks of a preemption agreement is obviously that there is a loss of control over the successor in title.
We can expect to see a continuation of this trend in 2001 as continuing economic growth and cuts in interest rates ensure that demand for well-located and good-quality investments will be maintained. The phenomenal growth of some recent years, like the near 35 per cent rise in values in 1998, will not be repeated in the near future. Instead, we expect to see double-digit growth this year, probably in the mid teens, as the market settles into a more sustainable and realistic pattern.
The market has begun 2001 against a background of fears of recession in the US but it has remained in optimistic mode, based on a combination of factors. While the immediate future of the American economy is of interest to everyone, the prospects for Europe, and particularly the euro area, are brighter. And the prospects for the Irish economy remain particularly positive, helped by strong Government budget surpluses, considerable fiscal flexibility and a continuation of the economic momentum created over the last few years.
In relation to property in particular, the wave of interest rate cuts spreading from the US to the UK and the euro zone means that yields may not look as tight as they had become by the end of last year. At that time they were seen to be putting a ceiling on the prospects for capital growth. Now that the euro's interest rate cycle has peaked, there is greater scope for capital values to rise. How much will depend on the extent of the interest rate cuts and on the continuing expansion rate of the economy.
Yields on prime office space are between 4.75 per cent and 5.25 per cent; on retail space between 3.75 per cent and 4.25 per cent; and on industrial property between 6.25 per cent and 6.75 per cent. Rental growth in the retail sector is particularly strong, reflecting the buoyant consumerism created by economic growth and tax cuts. Second generation office space, mainly located in the prime areas of Dublin 2 and Dublin 4, is also experiencing strong rental growth with a lot of catching up to be done in rent reviews.
Such factors will obviously underpin capital values along with the other checks and balances at work in the market. For example, the expected fall in interest rates will balance the constraints implied by increases in building costs and the tighter availability of development funds.
The growing reluctance of banks to lend to any but those with the best track records has provided an important safety valve. In effect, it has prevented the natural exuberance of the market from indulging in a potentially dangerous bout of speculative building, particularly in the city centre of Dublin. As a result, the market is less vulnerable to cooler international economic winds than it might have been. This comment should be treated with caution with regard to the M50 locations where there are undoubtedly signs of oversupply and considerable exposure to the dot.com sector.
The balance of factors at play in the market at present points to another positive year for property investment. Returns will not match the highs of recent years but they will remain strong and will continue to confirm property's role as in an important risk diversifier in every investment portfolio.
John Moran is Investment Director of Jones Lang LaSalle
