Ireland’s investment property market limped out of the blocks with just €160.5 million of income-producing assets changing hands in the first quarter of 2024. This is the lowest total since Q3 2012 and, to put it in perspective, the amount of capital invested in Irish property was only 37 per cent of that invested during the quietest quarter of the Covid pandemic (Q2 2020).
The sluggish velocity of trading reflects the fact that the price-discovery process remains a work-in-progress; In the face of higher interest rates and unresolved structural challenges in occupier markets, many vendors have simply not softened their price expectations enough.
The squeeze on deal sizes reflects multiple factors. Weak occupational markets and structural changes to lease terms have been deducted from the average value of investment properties in Ireland, and this is ultimately becoming reflected in the value of assets that trade. Compounding this, rate hikes have impacted the cost and availability of debt capital for leveraged transactions, leading to tighter budget constraints.
At the same time there has been a compositional shift towards cheaper regional markets, segments where the price-adjustment process is further advanced, and buyers who have an appetite for ‘wet’ investments that require more asset management.
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Offices
The office sector has traditionally been the mainstay of the Irish market, attracting almost €14 billion of capital between 2004 and 2019, and accounting for nearly two-fifths of total investment spending during this period. Since then, it has trended progressively lower, retreating to just 7.8 per cent in the first quarter of this year.
The slowdown reflects cyclical and structural factors. In the occupier market, tenant demand is challenged by the inactivity of tech firms which has left a large vacuum in take-up. ICT accounted for more than half of office leasing in Dublin between 2017-2021. However, the 2022 tech shock triggered a round of global headcount reduction that is still under way. As a result, tech has only taken 20,000sq m (215,278sq ft) of office space in Dublin over the last year. Unfortunately, this has coincided with a spike in new office supply, causing vacancy to rise.
The tech-hiring slowdown will pass in due course and, as an established global tech hub, Dublin’s office market will benefit. But other factors impacting the office market are longer-term and more structural in nature. Compounding the challenge of sluggish tech leasing, remote working has weakened the link between job growth and office demand. There is emerging evidence that, while the number of people working remotely in Ireland has stabilised, they are still spending more days at home on average. It is uncertain whether the sharp reduction in the office-space-per-employee ratio that resulted from the hybrid-work revolution will be fully reversed.
In addition to this, structural changes to leases have made future rental income streams more uncertain. Lease contracts signed after February 2010 no longer contain upwards-only rent review mechanisms. Furthermore, over a 20-year period, lease terms have gradually shortened. The standard institutional office lease in Dublin was once a 25-year commitment, with 30-year leases not unusual. However, the benchmark term for prime office buildings has gradually been pared back to 15 years and, across a mixed-quality basket of assets, the average term is significantly shorter.
In line with this shortening of leases, the average time to first lease break has also reduced. The fact that these changes have now continued over more than two decades, and through multiple leasing and development cycles, suggests that they are structural and, on average, they make the future income stream that is being sold with office investments less certain.
A shift in preferences at the top end of the market towards energy-efficient green buildings also represents a structural challenge for the office sector. There is now an almost linear relationship between Ber ratings and headline office rents in Dublin city, meaning that capital values are now highly sensitive to buildings’ energy performance. However, most Dublin offices are not A-rated and therefore many require significant capital expenditure to future-proof against environmental stranding and to achieve top rents.
All of these factors are weighing on the prices that are being achieved in transacted office deals. In many cases, however, bid-ask spreads have been too wide for deals to happen because of vendors’ reluctance to accept lower prices in the absence of comparable evidence. This is particularly the case in the prime Dublin city centre market where no new-build offices have been sold since the third quarter of 2022. In this context, it is very positive for the market that negotiations for the purchase of 40 Molesworth Street, a redeveloped block in one of Dublin’s most prime pitches, were reportedly at an advanced stage as Q1 closed.
Retail
While office investment is struggling, retail has been enjoying its strongest share of the action since 2016 (although, given the low overall turnover, the absolute value of trading in retail assets remained approximately two-thirds below the 10-year quarterly average).
Some €69.06 million of retail assets traded in the quarter, accounting for 43 per cent of the total. This trend has been driven by several factors; On one hand, the defensive properties of some retail segments – including grocery, convenience and retail warehousing – have attracted capital in a more uncertain macro-environment. This continued in the first quarter with two sizeable retail parks – Gulliver’s Retail Park in Santry and Kilkenny Retail Park – trading for €28.3 million and just under €25 million respectively in the second and third biggest deals of the quarter.
In contrast to offices and logistics buildings, which tend to cluster in well-defined, dedicated locations, the various forms of retail property are distributed across towns, villages and neighbourhoods throughout the country
While secure income is undoubtedly a motivator, value has been another key driver of capital into retail property. There are two dimensions to this. Firstly, the market has now had a considerable time to price-in the structural challenge of online shopping and, as a result, retail property has been subjected to more repricing than logistics or offices (where the structural challenge of remote working is more recent)
Secondly, by its nature, retail property is more geographically dispersed. In contrast to offices and logistics buildings, which tend to cluster in well-defined, dedicated locations, the various forms of retail property are distributed across towns, villages and neighbourhoods throughout the country. This has provided opportunities for yield-driven investors to seek-out mispriced assets in vibrant provincial towns where the occupational risks do not justify the regional discount. Reflecting this, 73 per cent of all retail investment in Ireland since the start of 2022 has been outside of Dublin.
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In addition to these factors, the supply of retail investment opportunities has become more liquid with a number of international private equity investors seeking an exit and with the Irish funds seeking to rebalance their portfolios. As noted in previous commentaries, high street units in Dublin’s prime retail streets rarely came up for sale in the past as many were locked-into institutional ownership. However, more of these assets have become available in recent years. Since the beginning of 2022, 23 shops in Dublin 2 have changed hands, including six on Grafton Street. A further three have traded on the nearby Wicklow Street, along with two properties on College Green.
PRS
As previously reported, the outward movement of interest rates, and the structures of Ireland’s rent-control system, have curtailed institutional investment in the private rented sector. However, somewhat against the run of play, the biggest deal of Q1 was German fund KGAL’s purchase of 104 apartments at Shackleton Park in west Dublin for €42 million. There is a strong pipeline of apartment development in Dublin. However, at current yields, the main sales outlet for developers is likely to remain Government-funded bodies.
Dr John McCartney is a director and head of research at BNP Paribas Real Estate
