The office market in Dublin is in a state of flux. As recovery deepens, inexorable laws are at work. Prices go up whenever rising demand meets a shortage of supply. So it is with the “explosive” increase in office rents in the capital.
The spectacular growth presents a number of slippery questions. One rather pressing anxiety centres on the declining availability of top-quality accommodation for big multinational investors. Another centres on the danger of a bubble emerging as more and more new developments, which take two years to build, are rushed out in pursuit of increased demand for office space. Yet more debate surrounds the absence of Irish bank funding for such developments.
All of this comes as the National Asset Management Agency (Nama) advances a grand plan to develop a vast new business zone in Dublin’s docklands to rival Canary Wharf in London, Seaport in Boston and Marina Bay in Singapore. This is a forward-looking endeavour, high in ambition and with potential to sustain thousands of jobs. Right now, however, the office market is highly constrained.
The matter spilled into the open a week ago when it emerged that Denis O’Brien, the billionaire businessman, had secured a rental deal at €60 per sq ft for the six-storey office block he is building at the junction of St Stephen’s Green and Earlsfort Terrace.
The building itself will not be ready for a year so O’Brien’s arrangement with aircraft leasing firm Aercap is a telling exemplar of where the market is heading.
Offices at the very top level currently command some €47.50 per sq ft, says Marie Hunt, executive director at consultants CBRE. It follows that the O’Brien deal, on the old Canada House site, marks quite a turnaround from the hardy days of the crash.
Rents collapsed when Ireland’s economy nosedived. In 2006 and 2007, the market rate for an A-grade office was €65 per sq ft. As disaster struck the rate more than halved virtually overnight to €27.50 per sq ft, a level that would never sustain the investment required for a large modern block.
“You couldn’t afford to build offices at that rate,” Hunt says. “For that reason and because debt completely dried up, nothing was built for five years.”
Still, the continued flow of big foreign direct investment (FDI) projects provided a ready market for such offices as came on stream in the aftermath of the crisis. The upshot is seen in a heavily restricted market right now just as the economy revives.
“You didn’t have to be Sherlock Holmes to see this coming,” says Declan O’Reilly of letting agents Knight Frank, who was involved in the Aercap transaction but does not discuss it.
“There’s a lot of demand. Last year the take-up in the market was 2.4 million sq ft. In quarter 1 this year, it’s 450,000 sq ft. Fundamentally, on the demand side the market remains strong. The difficulty we have is the vacancy rate, particularly for prime stock in Dublin, which is below 2 per cent. That’s a market in crisis.”
IDA Ireland, the inward investment agency, is already on record expressing concern about the shortage of office supply.
Although large multinationals don’t lack for money when it comes property costs, the current Irish market presents a particular challenge. In business circles the sense remains that companies are just about getting by, thanks to an increasing flow of refurbished, older offices in Dublin. Still, such properties tend to be smaller than the larger accommodation sought by bigger groups.
“You can get office space, but you’ll pay top dollar for it,” says a person familiar with this scene. “These are make-and-mend solutions rather than new-builds.”
Grown-up world
Two particular issues are in play in the multinational arena, which is at the centre of foreign direct investment policy. First, expanding tech-sector firms often seek to take up office space in reserve so they can quickly build up operations once an initial phase is complete. This simply adds to growing demand for office space. A notable example is Facebook’s move last autumn to take a second block adjoining its new Grand Canal Square base less than three months after it moved in.
Second, The Irish Times understands that some multinationals have encountered last-minute demands from Dublin landlords for a higher rent level when settling final lease terms at the very end of a negotiation. True, this is the grown-up world. In the eyes of some market entrants, however, such practices are not exactly helpful amid testing market conditions. As job creation intensifies, such conditions may well worsen before any improvement.
An assortment of new properties are set to come on stream in coming years – but not just yet. A key question, therefore, is whether the current stock can meet rising demand without losing new investment projects due to the jump in rents or the sheer lack of new space in Dublin’s central business district.
“Whether Ireland can afford to wait two or three years until that new supply comes in – that’s the question no-one can answer,” says one senior observer.
Even though the overall vacancy rate in the city at large is around 12 per cent, the fact remains that many firms have a clear preference for postcodes 2 and 4 in which the shortage of top quality space is at its most acute. An alternative, of course, is to look beyond Dublin altogether to regional locations in which rents are cheaper. That doesn’t suit everyone, however.
Unavoidable lag
John McCartney, director of research at Savills Ireland, foresees “very little” delivery of new stock this year. “We have perfect visibility on that,” he says.
“Between 1990 and 2010, the average completion rate was about 130,000 sq m (1.4 million sq ft) and we’ve had virtually nothing since 2010. Our estimates are that we’re going to have about 50,000 sq m in 2016 and then, in 2017, 240,000 sq m and – again – very strong building in 2018.”
Moreover, McCartney says another 54,000 sq m of space has been taken out of the market for redevelopment. “This is contributing – and is going to contribute – to the explosive growth in rents.”
The danger in all this is that the unavoidable lag in new office supply to chase rising demand in the immediate sense could overshoot the market, precipitating a collapse in rents.
A further spur to the market is increase in capital values, which follows rising rents. The most recent International Monetary Fund (IMF) report on Ireland says capital values rose 30.7 per cent year-on-year in the last quarter of 2014. This was the fastest growth since 1999, although price levels are still 56 per cent below the peak and still about 30 per cent below pre-boom levels. “The volume of turnover in Irish commercial real estate in 2014 was higher than in the mid-2000s, with 37.5 per cent from offshore investors,” it says.
"From almost 10 per cent in early 2012, initial rental yields on commercial property have declined substantially to 6 per cent in [quarter four of] 2014, yet they are still somewhat above the 5.2 per cent yield in the UK, and the premium over the 0.84 per cent yield on 10-year government bonds remains sizeable." Market participants say prime office yields in Dublin right now are at 4.75 per cent, very-attractive vis-à-vis sovereign bonds. Although the IMF says low domestic credit growth limits risk, there is risk nonetheless.
“The international search for yield appears to be a significant factor driving Irish commercial real estate markets,” says the fund. “Yet further strong inflows into commercial real estate could eventually generate over-building and risks of future slump in prices.”
The lack of Irish bank funding for new offices is a legacy of the crash, in which losses on commercial property loans accounted for more than half the €64 billion public recapitalisation of the banks.
As a result, Irish banks no longer lend for speculative office developments, insisting instead on pre-let contracts as precondition for loans and/or an equity component in the investment.
This is a source of considerable complaint in property and developer circles, no matter what the IMF says about risk in the market and the need to maintain the resilience of the surviving banks.
At the level of the banks themsevles, there is no overt sign of any change in policy. Tom Parlon, chief of the Construction Industry Federation, draws a distinction between Nama-backed projects and schemes outside its realm. “Funding is still very challenging. Obviously there are a number of Nama-supported ventures as well. In fairness they’re probably the best and most likely to succeed,” he says.
Indeed, Denis O’Brien’s St Stephen’s Green project is seen to reflect his capacity to provide a far greater level of self-funding than most remaining developers could source.
The same goes for the redevelopment of the former Bank of Ireland headquarters at Baggot Street by Larry Goodman, the beef magnate.
There is always the possibility, of course, that foreign lenders would fund Irish developments. German and American banks – among them Deutsche and Wells Fargo – are known to have had a look at some potential deals in Dublin. Certain Chinese and other Asian investment firms are also said to examined potential opportunities in the city.
Campus-style accommodation
After all, there is no shortage of projects in the works. These include: a Kennedy Wilson site with potential for some 32,5000 sq m at Sir John Rogerson’s Quay; a Ballymore/Oxley development with a potential 60,000 sq m at North Wall Quay; an Oaktree/Bennett initiative with a potential 28,000 sq m at Hanover Quay; and two Hibernia REIT projects at Windmill Lane and Sir John Rogerson’s Quay with potential for more than 23,000 sq m.
Some of these are backed by Nama, which has a Government mandate to develop a new FDI hub in Dublin’s docklands.
The area is now designated as a strategic development zone with special planning rights – approvals granted by Dublin City Council cannot be appealed to An Bord Pleanála.
The zone is twice as large as the International Financial Services Centre, tailor-made for the banking world in the 1990s.
In focus for North Lotts/Grand Canal Dock, but not exclusively, are the tech and ancillary sectors. The aim is to create campus-style accommodation in the mode of Google, with offices set alongside apartment, leisure and retail outlets. Total area: 22 hectares. Potential office space: up to 360,000 sq m.
If only some of this was available right now.
