Video ID:
9157
Job Number:
7275
Meta
Description:
Darren Sriharan and Andrew Hook discuss the case for Irish Commercial Real Estate.
Bookmarks:
0|The case for commercial property
92|Presentation outline
117|Supporting real estate
166|Diversification benefits
205|Other advantages
289|Cyclical case
366|Investment market
474|Office yield
543|Office cycle analysis
621|Risks
658|Eurozone uncertainty
741|Movements
Duration:
00:30:51
Recorded Date:
11 April 2013
Video Image:
Transcript:
Presenter: Hello, good morning everybody, and welcome and thank you for joining us to hear the case for Irish commercial property, a real estate update. We’re sitting here in the studio in the heart of the City of London very close to the Bank of England, and I was just looking around last night and there’s a lot of building going on, so it seems to be very much a different environment here in London as compared to Dublin. And some lovely names for some of the buildings, the Shard, the Walkie Talkie, they’re certainly a sight to see. But anyway we’ll get on, given where Irish property values had fallen to at the height of the global credit crisis and the extreme economic challenges faced by the economy, where are we now? Is there light at the end of a seemingly endless tunnel?
I’m joined this morning by an expert panel of my colleagues. I have Darren Sriharan, Global Real Estate Analyst, and Andrew Hook, Fund Manager. I’d ask you as well, there is a question button on your screen, whereby you can submit questions. Unfortunately if you’re online by a telephone you won’t be able to ask any questions but please do use the button to ask questions. We’ll take them here at the end of Darren’s presentation. So without any further ado I’m going to hand over to Darren for the presentation, thank you.
Darren Sriharan: Thanks. To give you a quick overview of what we’ll be covering during this webinar, I’ll begin by discussing both the strategic and cyclical cases for Irish commercial real estate. Andy will then talk you through ongoing issues in the Irish market, citing specific areas that investors need to remain aware of. I’ll then finish off with some concluding comments on why one should consider investing in Irish commercial real estate, before we then turn to Q&A.
Turning to slide 3, we look at the strategic factors supporting Irish real estate. One of the key features is the attractive absolute return performance. Despite the very poor performance of the Irish real estate sector in recent years, the IPD Ireland Index shows all property total returns have averaged 8.8% per annum over the last 29 years. The grey line in the chart shows another redeeming feature of real estate, which is the stable income returns that is provided historically. According to the IPD Ireland All Property Index, income from Irish property has only once fallen below 4% per annum over the 29 year history of the index. Real estate is generally considered an income producing asset class that can provide secure and certain cash flows.
The next slide shows that real estate provides diversification to an investment portfolio through its low correlation of government bonds and equities. Our studies show that over the past 17 years Irish commercial real estate has had a fairly low correlation with returns from equities and government bonds. Equities tend to lead the economy as investors factor in future trends, whereas the real estate cycle typically allows the broader economy for supply and demand response slowly to changes in growth and employment conditions. The result is a low correlation between real estate and equities.
Turning to slide 5, we look at further benefits associated with investing in real estate. And these include those associated with liquidity and transparency. We believe that Ireland is one of the best established property investment markets in the world. It ranks among the top 15 countries in Jones Lang LaSalle's 2012 Real Estate Transparency Index.
Real estate is considered to offer inflation protection, some commercial real estate leases benefit from indexation against the retail price or other inflation indices, providing a highly effective inflation hedge. Additionally, despite being a cyclical asset class, the robust income generation from property contributes to its low volatility. Unlike equities, the price of which can change significantly by the minute, the value of real estate has a relatively low level of volatility. Also real estate is a real and tangible asset, although a physical structure might need replacing, the land on which real estate is built will always have a value. In addition real estate is an asset that can be improved by active management such as refurbishments, planning use changes, or lease renewals. This is unlike an investment into an equity or bond fund, where generally a fund manager has little or no scope to add value to the individual holdings.
Slide 6 takes us onto the cyclical case for Irish property. A key development across Europe is that near term risks to the economic outlook have decreased significantly since mid-2012. We can see on the chart on the left hand side that the yields on two year Irish government bonds have moved in significantly from their record highs in July 2011, following the strict implementation of the Irish bailout programme. The chart also shows that concerns surrounding Italian public debt and the Spanish banking sector were at extremely elevated levels in mid-2012.
The ECB’s announcement of the outright monetary transactions programme and the launch of a permanent European stability mechanism fund have helped to ease the immediate fears of the Eurozone breakup. As the market’s conviction that the ECB can succeed in managing the Eurozone crisis has grown, government bond yields in Spain and Italy have remained relatively subdued. While our view is that the Eurozone will remain in a recession this year, we anticipate that Irish GDP will expand by 0.7%. A more sustained recovery is expected from 2014 onwards as Ireland starts to benefit from the prolonged period of economic adjustment.
There are also signs of a recovery in the real estate investment market, with the final quarter of last year showing a very sharp rise in transaction levels. The volume of transactions in Ireland in the fourth quarter of 2012 reached €331million, the highest level since the third quarter of 2007. Over 60% of this investment was from overseas investors, and increased investment activity is expected this year. Sorry, there are signs that the Irish [unclear 00:06:34] markets are bottoming out, with rent appearing to fully adjusted to reflect both the weak levels of demand and excess levels of supply in the property market. Following rapid declines in 2008 and 2009 rental decline eased very significantly in 2011 and prime rents were stable in 2012. In real terms prime office rents are now down to 1985 levels while prime retail rents are at late 2000 levels. We believe rents have bottomed out and are forecasting modest rental growth this year before picking up from 2014.
The Dublin market has been characterised by oversupply for many years following a development boom around the turn of the century. Very weak demand combined with continued speculative development from 2007 to 2009 saw the vacancy rate increase very rapidly. In fact the Dublin office vacancy rate stood at 21.4% at the end of 2012. However net additions are expected to be negligible in the coming years. The office market saw no net additions as a percentage of stock last year, and this is expected to be the same for 2013 before a very minimal pickup next year.
Slide 8 takes us onto our office yield thermometer chart. We believe Dublin offices are relatively cheap compared to other markets, and this chart illustrates just why. The cyclical low points, the levels that prime office yields declined to in the boom years leading up to the global financial crisis, while the cyclical peaks show how far yields moved out during the downturn. As you might expect, the core office markets, the Paris, Munich and London, have seen some of the most yield compression and are near their cyclical low points. However Dublin has seen very little inward yield movement, with its yield still close to peak levels and over 150 basis points higher than other major European markets. The Dublin office market looks relatively attractive, the prime yield standing at 7.3% as at the end of December 2012. Given the degree of repricing that has taken place, investors in Dublin now appear to be compensated for risk to a much larger degree than investors in for example Madrid, despite some similarities in the dynamics existing in each market.
Slide 9 shows that office yield cycle analysis, and is another great example of Dublin appearing position for a cyclical recovery. Markets in the top right red coloured quadrant are seeing yields compressing when compared to their position a year earlier, but their yields are below long term averages. The bottom left quadrant contains office markets where yields are expanding and their yields are above long term averages. Dublin on the other hand seems uniquely positioned in the top left quadrant, yields have become to compress but are well above their long term averages. So we believe there is scope for significant yield compression in Dublin compared to other prime markets, and now is a good time to increase exposure to the market.
The following slide shows unlevered market level returns for prime European commercial real estate markets. We believe Ireland offers attractive total returns compared to most European markets. We are currently forecasting Irish all property total returns for the 2013 to 2017 period of over 12% per annum. The yield compression expected and an improving rental outlook has led to our strong forecast for total return performance. Returns are expected to strengthen in each of the next five years.
As we describe in the next slide, risks involved in investing in Irish real estate remain elevated; however we believe investors are sufficiently compensated for these risks by current pricing expected returns. I will now hand over to Andy to discuss the reasons for caution and optimism.
Andrew Hook: Darren, thank you, and good morning everyone. I’m afraid it does always turn to the fund manager to dwell on the reasons perhaps for some caution in the market, but I’ll hopefully give you also a few good flavours as to why we firmly believe in this case. Taking firstly the continuing Eurozone uncertainty, as Darren alluded to earlier, Mario Draghi’s announcement last year on the OMT programme successfully moved away the risk of contagion from the market, but I think that also need to be looked at in the context of the negative GDP growth that was experienced in 2012 of –0.5%. Our forecast is for negative GDP growth to continue in 2013 at -0.3% for this year.
We also have to consider that we’ve just seen a bail out of Cyprus, and obviously that’s involved protracted negotiations that obviously seemed very uncertain at the time. Equally there’s a lot of press speculation surrounding Portugal and Slovenia, and clearly also yesterday’s announcement by the European Commission that France needed to do more to reform and get itself back on a growth path. So there are certainly some risks there, but I think the important message that we would like to leave with you is that the contagion risk is significantly reduced from where it was in the first six months or so of 2012.
In terms of movements within the Irish property market, many agents and participants do cite a certain lack of clarity emanating from NAMA at the moment. What we’ve heard from various participants is that whilst there are a lot of investors who are kicking the tyres of Irish real estate held within NAMA, and then further going on to enter discussions surrounding pricing, doing limited due diligence, NAMA have in many cases disappointed those investors by ending negotiations or discussing that actually the initially discussed pricing is not relevant, and thereby people are putting a lot of work into the market, but in fact gaining nothing from it. And in fact the agency community are telling me that they’re less willing to work speculatively for investors, given the lack of conversion in the market, so I think that does need to be understood.
Taking the next two points, I think the Irish real estate market needs to be seen in the context that the recovery will largely be focused around the Dublin market, and what that really means is that the opportunity set is fairly limited, not least because following the crash what was defined as core real estate within Dublin has certainly contracted itself. And so I think for all investors that means that there are relatively few prime assets available and that has to be seen against an increasing number of investors. The good news is however that quite a few of those investors, ourselves included, certainly are in it for the long run, and in fact investors that hadn’t been present in the Irish market have in many cases gone on to set up offices in Dublin and therefore are showing some commitment rather than seeking to ride this as a quick cycle event, and then getting out once pricing has moved.
There are certainly other issues relevant to buying real estate today within the Irish markets. I’m sure everyone is familiar of the current case law within Ireland, and certainly the Bewley’s case and the Reox case will mean a lot to many of you. Following on from those, I think it’s important to note that as an investor both of those cases are somewhat limited on their facts, and so they shouldn’t be seen as affecting the entire market; however what it will mean is that investors will certainly have to focus and concentrate on increased due diligence of lease documentation and lease terms when looking to buy within Dublin. And so whilst that’s a note of caution, as I say I think it should be seen that it doesn’t really affect the ongoing investment in the market.
Insolvencies do unfortunately continue, particularly amongst the retail sector. The retail environment within Ireland is still challenging, and that is despite the backdrop of an improving economy. Clearly we’ve seen HMV going into administration recently, and I’m sure you’re all aware that B&Q are currently in examinership. What we’ve done as a landlord and fund manager is ensure that we’ve worked well with tenants within the portfolio, and we really see that to being a key to surviving what has been a difficult market and then benefiting from recovery as scenarios turn more positive.
So we’ve engaged with tenants. We’ve actively worked with them to allow lease negotiations and increase flexibility around payment terms. We think that maintains value for our investors within the portfolio, whilst giving tenants the breathing space that they may require and then allows them to go on and benefit from improved markets conditions once that recovery pushes through. And we’ve very much seen that that tenants that were assisted are now starting to turn the corner as the improvements in the economy increases.
I think a further final factor that leaves us with some optimism is the introduction of REITs which of course was much heralded last year when it was announced. There hasn’t been much action so far, and I guess that’s not surprising in a way, but I think the ability to create the restructure should help the markets in the medium term. And what I mean by that is that that’s certainly being talked about as a potential exit route for a number of the NAMA held portfolios. I think also for investors coming into the markets who are able to aggregate some sort of scale within the Irish markets, that also leaves the possibility of an exit strategy whereby they maintain the ownership of the property in parts, but are also able to increase the investor base within those portfolios.
So I don’t think that will happen in the short term, and for reasons outlined earlier around some of the risks that still continue, but we do see that REITS will play an important part as the recovery continues, both within Ireland and Europe as a whole. So I’ll just hand back to Darren to conclude.
Darren Sriharan: Thanks Andy. So to summarise what we’ve covered today, the strategic case for commercial Irish real estate is strong. It offers attractive absolute returns while providing diversification benefits to a balanced investment portfolio. Capital values and rents appear to have bottomed out now and provides cyclical opportunities for investors. Yields are very high by historical standards, offering investors sufficient compensation for current risks. The Irish market potentially offers strong outperformance relative to other European markets, and current prospects more than sufficiently compensate investors for market risks. A selective investment strategy designed with an acute awareness of risk is appropriate. It should have a focus on core assets in prime locations with long leases to strong tenants. In our opinion we believe that now is an opportune time to reappraise the merits of Irish commercial real estate. I’ll now hand over to Brian.
Presenter: Thanks very much. Thanks very much Darren. Thanks very much Andrew for a very interesting presentation. Please remember you can certainly ask questions live by the ask the question button, and we’re getting a number of them coming in now, so please keep them coming, we’re delighted to take them here live. A couple here on the screen, one from David Walsh, thanks David for your question. In your opinion is there any chance of a change to upward only rent reviews in legislation? Andrew, do you want to take that one?
Andrew Hook: Brian, thank you, and thank you David. Yes certainly, I mean it’s a very live area of law and amongst the legal community in Ireland there’s been significant discussion on the topic. I think that, as I said in the presentation, the facts of that case are quite specific regarding Reox, and it was certain that the Reox case will go to appeal. I think most people within the legal community do expect that Reox will be overturned at appeal. However that’s going to take two years, and it remains that Reox is for the time being good law, so I think yes there’s uncertainty but we’ll have to see what the appeal court says when that decision is made.
Presenter: Thanks Andy, I can just see one coming in here that’s probably pretty easy to answer straightaway, the current vacancy rate on the fund?
Andrew Hook: The current vacancy rate is at 6.3% on the Irish property fund.
Presenter: Thanks Andy. Thanks Damien. There’s another question there about the 25% of the fund held in cash, will that act as a drag on the performance over the next five years Darren or Andrew?
Andrew Hook: Yeah, I’ll take that one, thank you. Yes, if it persists it is likely to act as a drag. However the reality is that it won’t exist as cash in that percentage. The cash is at its current level because of the sale of Irish Bank Centre. We have since that point been working with agents in the Dublin markets to look at further investment opportunities. We continue to do so. I think it’s fair to say we’re being very picky over what we want to invest in, and we will make further investments, likely to be in the office sector but we continue to bide our time to make sure we get the right opportunity for the fund.
Presenter: Darren, you might like to add to that.
Darren Sriharan: Just mention to that the forecast figures that we ran through earlier on today, that’s referring to prime unlevered market level returns rather than fund level returns, so it’s good to just clarify that as well.
Presenter: Perfect, there’s another interesting question here from Donald Geraghty of Geraghty Insurances: many retailers are looking for rental reductions in high street areas, all of these were signed on upward basis only, are they not better off negotiating with tenants rather than leaving these vacant, what is the future for retail rents, an interesting question.
Darren Sriharan: It is. I mean we’ve, as I indicated when I talked through slide 11, we’re very much of the view that negotiating with tenants, particularly or solely where we see that there’s a business plan in place and future opportunity, you’re much better off keeping a tenant in the store and working with them to make the business a success, so as I say you can benefit from the uplifts in rental possibilities when the market recovers. It is difficult though, if tenants aren’t paying rent and there doesn’t look to be any future for them, then in some cases you’re better cutting your losses and looking for a new tenant who is able to come in with a realisable business plan and move the fund forward.
Andrew Hook: Yeah, and just to follow on from that as well, as I said earlier on we feel that prime retail rents are around the late 2000 levels and we do feel that rents have started to bottom out in the prime end of the market. So we expect a significant pickup in the back end of the next five years at least, but within the next 12 to 18 months we do feel it’s bottomed out and there is a significant sign of scope for recovery in the retail rental market.
Presenter: Andy, there’s a question here from Tom Flinch: what was the reason for the 1.5% drop in the fund last month, is it related to the HMV and other recent tenant issues, or is there further bad news to come on that?
Andrew Hook: Yeah, I mean it was regrettable obviously that the fund suffered some negative performance at the end of March. That was due to the HMV insolvency in the Grafton Street property. I’m pleased to say that we’re currently in discussions with three international brands to take over that space within the store, and we’re progressing those as quickly as we can. The negative impact was largely due to the fact that the unit was significantly over rented and clearly rental rates have dropped significantly on Henry Street and on Grafton Street. So we are in a difficult point, but we hope to have some good news on the reletting of Grafton Street shortly.
Presenter: Very good, Darren, just one for you, the 12% per annum forecast over the next five years, that’s a very surprising figure, I’m sure to a lot of people back in Ireland and you’ve covered that very well, but if you could maybe summarise the main factors driving that figure.
Darren Sriharan: Yeah sure, well I guess I’d stress again the focus is on high quality assets here, and the main drivers would be the level of the yield compression itself, so in fact the current yields are close to peak levels and 150 basis points above the long term average, there is significant scope for yield compression. And also the improvement in the rental market itself, so as we’ve said we think rents are bottoming out at the moment and the case for improvement and the scope of the improvement possible is fairly significant.
So we think those two factors combined contributed to our very positive total return numbers. But I’d also add that from a relative pricing perspective, Irish real estate looks very cheap relative to most income producing asset classes in Ireland. Government bond yields are at record lows across Europe and as we look at yields on the more higher risk corporate bonds and high yield bonds, those have moved in significantly over the last 12 months or so, and this seems to be a sign that investors are searching for yields and there’s a greater appetite for risk out there.
Presenter: Thanks Darren, another question coming in from Alan Goulding I see: is Dublin the only area showing signs of recovery, is there a bit of localisation going on Andy?
Andrew Hook: Well I think there is stabilisation in other city centres and other regions. I’m not, our focus on the recovery prospects is really around Dublin, just because of the liquidity and interest that’s been shown in that market, I’m certain there will be decent opportunities in other centres. However as a major manager, I don’t think the liquidity is there yet to really seek to invest, purely because pricing points can’t be seen at the current time.
Presenter: I see a question coming in here from John Gethin: to what extent what the Q4 2012 real estate volumes attributable to fire sales?
Darren Sriharan: From my opinion a lot of the real estate volumes in the final quarter were from overseas investors, and I think there was just the general interest and the kind of belief in the state of the Irish market and the feeling that the recovery is coming led to greater interest rather than fire sales volume, fire sales from property owners within the Irish market themselves.
Andrew Hook: Yeah absolutely, and I think the market really backs that up. I mean I think the time for fire sales has passed, there will be certainly properties released because of issues with banking covenants or through difficulties with refinancing. But I think in terms of fire sales and the attributable pricing, that’s not something that we expect to see going forward.
Presenter: It’s more of the Dublin market coming on major international radars now if you like.
Andrew Hook: Yeah.
Presenter: There’s a question here, can you discuss details of leases or terms of leases, are there any break clauses, has there been any rent reductions and have any tenants defaulted on rents. That’s one very large question. You may not be able to go into huge detail on that but maybe can you give us a flavour in that sort of?
Andrew Hook: Yes, absolutely, I mean yes we’ve outlined that HMV obviously went into administration and there was a de factor default on their lease. Clearly that’s disappointing but in many cases no surprise in its equivalence of what we’re seeing over here in the UK at the moment. Typically leases are being signed with break clauses in place. I mean obviously as landlord we’re trying to negotiate those out as far as possible. However it is a difficult market and as landlord you have to be seen to be realistic when negotiating.
Presenter: That’s super, and there’s one easy question here I see coming in: is there any gearing on the fund at the moment?
Andrew Hook: No, none at all, absolutely none at all.
Presenter: Okay, there’s some tremendous questions coming in. There will be time after the call, you can submit your questions and we’ll be delighted to take them. You can email them in or not. Any final thoughts guys before we wrap up?
Andrew Hook: Well perhaps just to say, I mean it has been a long road to recovery, I think it’s good to see that there’s some sunshine around the corner, albeit that we do expect to see a couple of bumps along the way.
Presenter: Super, I hope, thank you very much for dialling in in huge numbers, I believe we had close to 500 coming in online and on the phone this morning, so thank you very much for your interest. And I hope you found it very interesting and informative and perhaps even surprising webinar. There is a paper written by Darren and this is now available through your broker consultant, so please get in touch and ask for your copy. Finally I’d just like to thank you again for joining us in such numbers and I hope you found it very helpful and interesting. Thank you all this morning and good morning.
Important information
Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 31 March 2013.They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Some of the information within this document is based upon Aviva Investors estimates. It is not to be relied upon for the purpose of making investment decisions.
Warning: Past performance is not a reliable guide to future performance. Warning: The value of your investment may go down as well as up. You may get back less than you put in. Warning: These funds may be affected by changes in currency exchange rates. Warning: A deferral period may apply to withdrawals and/or switches from certain funds. Please refer to your product documentation for further details.
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13/0399/31072013
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