Don’t expect a new ‘normal’ any time soon in the property market

Someone asked me recently what the new property norm will be like and when it will arrive. As we start into the upswing of a new property cycle having come from the depths of one of the worst global crashes, it is worth reflecting on what the new cycle might have in store.

The first thing to say is that there is no “normal” in property markets. They are always in flux, driven by conditions in the wider economy. The starting point in a property cycle is a recovery phase and the absorption of any overhang in supply. As businesses grow, they need space.

A maturing phase follows as new supply comes on stream, then an oversupply phase, followed by a decline which may or may not turn into a crash landing.

Property cycles typically last about seven years. The last boom should have ended in about 2004 (seven years after 1996) but went on and on, which made the ending of that cycle far more damaging.

However, there is never a guarantee of severe market correction after a boom and the restricted amount of development capital and more prudent lending should see a controlled cooling of the market as this cycle evolves.

Maturing phase

Ireland’s current cycle started in about 2012, but as some market sectors pass through recovery and approach the maturing phase, others remain fairly dormant. Retail is going through a restructuring convulsion brought on by internet shopping, oversupply and changes in shopping patterns. It is a cycle within a cycle and it is very hard to predict. I pass on retail other than to say that good CBD units and the best located suburban shopping centres with strong surrounding demographics will do well.

Offices are the easiest to predict. The scarcity of CBD Dublin offices should continue for another two or three years and, if take-up continues at its 20-year average of 1.6 million sq ft per annum, then according to CBRE, quality Dublin grade A CBD rents are projected to reach €69 per sq ft before increased supply and developer competition for tenants leads to a projected softening back to the low €50s.

The lack of speculative bank funding for development and the new upward and downward rent reviews, should create a more cautious approach to development than we have seen in the past. However, an oversupply of space is still possible but very much dependent on how long the strong take-up continues.

Warehousing and industrial property lag some way behind. Demand is still being met from the old stock of buildings inherited from the crash and prices are still significantly below replacement cost. This can’t last forever and for good industrial buildings, values are likely to go up in advance of new supply coming online and probably to a rent of €12 per sq ft. This level is necessary to remunerate new projects.

My big concern is about the residential market both for letting and for owner occupation. Dublin is not building anywhere near the number of new homes that is required. The population is growing rapidly and there is also strong pent-up demand.

There is an ongoing need for 22,000 to 27,000 new homes a year across Ireland and 8,000 to 10,000 new homes a year in Dublin (Goodbody 2014). Against this backdrop, just 8,301 residential units were completed in 2013 with 16 per cent in Dublin.

The economy needs new housing but supply is almost static. A solution is elusive. The causes of scarcity are manifold: the decimation of the development and land speculation industry (that provided shovel-ready sites); a slow and restrictive regulatory and planning system; a shriveled construction industry; and scarcity of risk development finance (funding is available once development risk is removed).

There are also significant changes in consumer demand for housing, particularly a desire for city centre living and for shorter commutes to work.

As at March 2015, Dublin property prices have recovered about 44 per cent from the lows of 2012 but are still down significantly from 2007 levels.

So how is the residential cycle going to evolve? Scarcity will be the watchword and property markets do only one thing when supply is short and demand is high: prices will rise significantly.

Notwithstanding price growth slowing, I can see a further 25 per cent/50 per cent increase in rents and prices depending on location over the next few years. The Central Bank credit limitations have bitten and are constraining purchaser demand. The pressures for their relaxation will grow and grow – but should not be yielded to. Otherwise we will go straight into another property bubble. However, this places even more pressure on an already constrained rental market.

Aggregate costs

Costs are also a driver of house prices and the aggregate costs for a developer of providing a three-bed semi is now approaching €300,000 – that is allowing €30,000 for the site or about €500,000 per acre. Rising land prices, scarcity of tradesmen and of shovel-ready plots will also affect on housing prices and rents.

To conclude, we are at the early stage in the cycle where demand exceeds supply in most sectors, but replacement costs and supply constraints are pushing up prices and will continue to do so for several more years – and much longer in the case of housing. However, there is currently little evidence of property speculation in the market and this will help to ensure that growth will remain controlled as will the slowdown.

Bill Nowlan is chairman of WK Nowlan Property and a director of Hibernia REIT plc. The views expressed in this article are personal opinion and are not those of either organisation.