Although the performance of Irish commercial property has slipped slightly this year, the UK has seen a similar deterioration, with the result that the gap in returns between the two countries has remained substantial.

According to the SCS/IPD Index, total returns on Irish property were running at 28.2 per cent in September, comfortably ahead of UK property returns of 12.6 per cent.

The immediate cause of the downturn in the UK has been an increase in yields, signalling an adverse shift in investor sentiment. Whereas the all-property equivalent yield fell by 0.18 percentage points last year, it has inched up by 0.08 points during the first nine months of 2000.

The upturn in yields reflects increasing concern among investors at prospects for rental growth in the retail sector. The UK clothing market is currently in the middle of a fierce price war and the resulting squeeze on profits has forced many long-established multiple chains to close stores.

While investors' income is generally protected by long leases, the increase in second-hand space has led to a sharp slowdown in rental growth in town centres. The annual increase in shop rental values slackened to 4.0 per cent in September from 5.5 per cent in May.

By contrast, UK offices and industrials have continued to perform quite strongly, with total returns of 15.7 per cent and 15.5 per cent respectively, in September.

Offices have gained from a revival in rental growth in central London, currently running at 15 to 20 per cent, while returns on industrials have benefited from a modest decline in yields.

While Irish property returns have also declined this year, they have remained more than double those in the UK, reflecting the strength of the Irish economy. Rental value growth in Ireland has shifted up a gear, accelerating to 18.8 per cent over the year to September, contributing to a 22.2 per cent increase in capital values.

However, the latest quarterly index gives some evidence that the favourable decline in yields may have come to a halt. During the first nine months of 2000, the all-property yield dropped by just 0.09 percentage points, compared with a decline of 0.52 points during 1999. The Irish all-property yield in fact rose in the September quarter, albeit by one basis point.

Putting the results for this year in context, the UK market has now been upstaged by Ireland for the best part of six years (as illustrated by the chart above). Over the six years to September 2000 the SCS/IPD index return stands at 224.7 per cent per annum, more than double the 10.6 per cent per annum return derived from the UK Monthly Index.

The performance differential can partly be attributed to the 2.4 percentage point yield gap that has opened up between the two markets. Strong rental value growth has also driven the exceptional performance of the Irish market. Rental values have risen by 10.5 per cent per annum over the six years, compared to a modest 3.6 per cent per annum increase in the UK.

Looking forward, year-end returns for the Irish market will most probably be lower than in 1999, but should remain in the upper 20s, while 10.6 per cent is one of the latest forecasts on the UK market based on the IPD Monthly Index.

Phil Tily is an analyst with Investment Property Databank