With property values still falling, Jack Faganexamines the Q2 results and, below, the IPD's Phil Tileylooks at the broader picture

AN ACCELERATION in rental falls has stifled recovery in the Irish commercial property market, driving steeper capital depreciation over the three months to the end of June. The latest report from London researcher Investment Property Databank (IPD) shows that capital values declined during the quarter by 3.5 per cent compared to 1.8 per cent in the previous three months.

The precipitant rental decline – triggered by aggressive tenant bargaining, rising vacancy rates and weak consumer spending – was down 7.5 per cent over the quarter and a compounded -30.6 per cent across the entire 18 months that rents have been falling. Over the first half of the year, rents have fallen by 10.6 per cent.

At a broader market level, yields finally appear to be stabilising – all property yields have moved by less than 10 basis points over the last 12 months, ending the second quarter at 8.2 per cent. The net effect of falling rents and stabilising yields is a quarterly capital depreciation which is almost twice that of Q1.

Within the main retail and office segments, the steepest price adjustment in Q2 was in Henry Street and Mary Street where the write down of capital values reached 7.1 per cent. Capital depreciation on Grafton Street was much shallower at -2.9 per cent.

In the office sector, capital values fell by 3.9 per cent in central Dublin while the rest of Dublin slipped by an additional 10 basis points at -4 per cent. Of the two, central Dublin offices continue to see the bigger falls in rental value, down by -7.3 per cent compared with -5.6 per cent outside the city centre. IPD’s findings are based on a sample study of 308 properties with a value of €2.5 billion. Earlier this month, a more limited study by Jones Lang LaSalle suggested that capital values fell in Q2 by 4.7 per cent, -1.1 per cent more than the 3.5 per cent figure suggested by IPD.

Phil Tily, IPD’s newly appointed managing director for the UK and Ireland, said the worsening in rents was not a wholly unexpected outcome from Q2 results as all three sectors had been under persistent pressure for some time. “While there are tentative signs of an economic recovery manifesting, the retail sector has been hurt by squeezed income. Any recovery in consumer spending will likely take some time to gain traction.” Tily said limited expansion of existing businesses together with few new occupiers likely to come to the market in the near term continued to put downward pressure on office rents. Furthermore, tenants had bargained hard to win greater lease flexibility – enhanced by legislation that scrapped upwards-only rent reviews.

On a more positive note, Tily said yields finally look to have stabilised after a volatile three years, while the supply pipeline across the sectors remains tight. This could help create competition for limited stock when a recovery does materialise.

Property values now back to 1999 levels

THE STORY of Ireland's commercial property market in recent years is a complex one. It is intertwined with the credit crunch as well as the interchange of domestic market dynamics and capricious swings in property investment confidence.

To put this into numbers: five years of unbroken capital growth up to the third quarter of 2007 was eroded in just 18 months. But this is not the end; capital values are still falling. Since market peak, Irish values have fallen by 58 per cent – based on the IPD Irish Quarterly Index – which takes commercial property prices back to mid-1999 levels.

But the data is not all negative. Tentative signs of a domestic economic recovery, supported by improving international economies, and stabilising yields, at 8.2 per cent, are the first positive signals influencing the market. 

Three years have now passed since the credit crunch hit and set in motion the most rapid property re-pricing cycle of any market during any recorded period. With this in mind, it is worth analysing the market's behaviour over this period and considering how Ireland could be wellplaced to recover rapidly from a low base. 

Ireland's property market has a track record of volatility, principally because it is relatively small and is linked to an economy heavily dependent on the wider national economy.

A dominant cause for Ireland's dramatic re-pricing has been the evaporation of bank finance to support investment as banks were caught up in the credit crunch.

The consequences of this unprecedented evaporation in liquidity snowballed: capital values plummeted, and with no bank finance to support potential investors buying property at distressed prices, a stagnant transactional market saw confidence weaken further, causing further write-downs. The National Asset Management Agency (NAMA) is the Irish government's attempt to unblock this bottleneck. 

NAMA will acquire underperforming or defaulted commercial property loans helping to restore liquidity and with it market confidence.

Looking ahead, many global economies are entering a recovery phase, a good sign for Ireland, which is also showing early signs that it is turning the corner. The combination of the government's fiscal and monetary policy measures, together with a sustained low interest rate environment, will strengthen the potential for Ireland's property market recovery. That said, credit availability will remain very constrained for the foreseeable future.

With or without the credit crunch, which turned the liquidity – and confidence – tap off, Ireland's property market was a bubble ready to burst.

In less than five years, values had risen by 71 per cent (based on the IPD Irish Quarterly Index).

By any measure, this was an unsustainable  growth rate. But as fast as the ascent was, the descent was far quicker. There are three notable phases to the yield and rental trend over the near three-year cycle. 

In the first period, between September 2007 and December 2008, yield impact was sharply negative, which indicates yield expansion, while rental growth decelerated before turning negative at the end of the first period. During this period, capital depreciation was at its most aggressive.

In the second phase, from Q1 2009 to Q1 2010, the pace of yield expansion eased quarterly while rents began falling. Yields even returned to modest compression over the six months to March 2010. By March, the quarterly rate of capital depreciation had eased to just 1.8 per cent, a tenth of the rate at the market's peak quarterly fall. However, this period also contained the deepest commercial property rental decline in recorded Irish history. 

The third and final phase – the second quarter just passed – has seen the rate of quarterly capital depreciation worsen to 3.5 per cent. While yield expansion was responsible for the bulk of the re-pricing over the cycle, in the latest quarter, it is continued rental decline that has driven the latest write-downs. 

Over the near three-year long cycle, the retail sector has been hardest hit, driven by falling consumer spending, rising unemployment prompting downsizing and rising vacancy rates. Across the market, tenants have bargained hard to win greater lease flexibility, enhanced by legislation scrapping upward-only rent reviews.

Henry and Mary Street took the hardest capital value hit of all Ireland's segments – with a 68.2 per cent fall in the last two and a half years, 10 percentage points steeper than the all-property average.

While there are tentative signs of an economic recovery manifesting, disposable income has been squeezed to such an extent that a recovery in consumer spending may take some time to gain traction.

On a more positive note, with the supply pipeline in the retail sector remaining tight, this could push up prices for existing stock when the recovery materialises. In the central Dublin office market, capital values have fallen by 56.9 per cent.

Similar to the retail sector, there are expectations that few new occupiers will come to the market in the near-term, placing greater downward pressure on rental levels.

The re-pricing of property as an asset class looks to have run its course. However, the future capital movements – and investor performance – remains intrinsically linked to the fortunes of the economy, both domestic and international. At home, the economic fundamentals still look troubled, which has driven performance south again in the short term.

But given the scale of the near 60 per cent write-downs to date, and the stabilisation of yields, the market is arguably wellplaced to recover more quickly from a low base than was initially anticipated.

Phil Tily is managing director of IPD (Investment Property Databank) UK and Ireland