When the history books get written 2023 will be remembered as a transformative year for commercial real estate (CRE). Insiders call it “price discovery” but to everybody else the market has simply stalled due to a yawning chasm between the price expectations of sellers and buyers.
Normally full employment, a relatively confident consumer, and a strongly performing stock market would indicate a somewhat healthy CRE market. Au contraire, CRE is under severe stress. The numbers speak for themselves. Across Europe investment volumes are down 55 per cent in the first three quarters of this year compared with 2022. Ireland has fared even worse with volumes down by 71 per cent.
The reason is that higher interest rates, in a sector that traditionally revolves around leverage, are hurting valuations and destroying sentiment. More worryingly we are probably still in the early stages of a protracted market correction. It’s glaringly obvious that investment yields for marginal investors are nowhere near attractive enough to entice them back to the market. Especially when debt securities and cash-on-deposit provide better risk-adjusted value.
Therefore some re-equitisation and deleveraging must play out for values to recalibrate and to restore liquidity. This process is not known for its rapidity, and usually attracts hedge funds and private equity, first-off, seeking high-octane returns. However, receivership activity has commenced, and we are seeing bank loans recapitalising below par.
As ever opportunities still exist for selective investors. Like the proverbial curate’s egg the market is good in spots….but only a few!
Logistics is one such bright spot with a robust performance driven by population growth, the e-commerce boom and the need for efficient supply chain solutions in an island economy like ours. Warehouse and distribution centre demand has soared, with genuine rental growth potential, even in the short term.
Another silver lining is that life has sprung back into the once sick man of real estate, retail! Segments like essential services and grocery retail are robust, and the sector is enjoying a second-coming, with levels not seen since 2017.
This is in stark contrast to the uncertainties facing other traditional sectors. Offices are under acute stress, with cyclical pressures combining with structural shifts for the perfect storm. Sectoral issues have seen tech firms take a back seat in the leasing market. Furthermore, the rise of remote and hybrid work models has led to a re-evaluation of traditional offices. Occupiers are rationalising their space and seeking flexible, tech-enabled, sustainable office solutions. This has led to a bifurcation in the market; high quality, well-located office properties maintain their rental value while older, less efficient buildings struggle. Brown office to green apartment conversion strategies can happen but only if capital values become so cheap it allows an alternative use, with developers’ pathway to profitability already very narrow.
The private rental sector (PRS) had shown remarkable resilience and stability. With low vacancy rates and high market rents, the sector attracted domestic and international investors in their droves. However, although it is still seen as a stable asset class the relative return investors are demanding meant the only viable exit in town for developers this year was to public bodies. Hence Q3 was the first time since Q3 2015 that no PRS was traded in Ireland.
Ireland’s demographics and growth prospects remain compelling if assets are correctly priced, and professional investors are biding their time, waiting for a more favourable macro-environment. However, the immediate outlook remains challenging. A moderate recession is possibly looming as stubborn inflation and high interest rates impact growth. The all-segments capital value index for Irish property is down 13.5 per cent in the last year and volumes in the real estate market may struggle well into 2024; buckle up!
