So says the Central Bank of Ireland which yesterday issued a financial stability report examining debt and the Irish financial sector. Of narrow interest on here is what the report had to say about future trends in house prices (bizarrely, nothing) and commercial property prices (quite a lot, mostly positive). The Bank has concocted a series of indicators which suggest that Irish commercial property prices which have already dropped 65% from peak values, may now be substantially undervalued by reference to economic indicators – employment, GDP, rents and “consumption”. Indeed on average the Bank considers commercial property to be more than 30% “undervalued” – mind you, using the Bank’s own figures, it would have thought that commercial property was undervalued by 12%, 28%, 30% and 32% in 2008, 2009, 2010 and 2011. This is what the Central Bank says:
Or to put it another way, if you bought a €100m property in 2008, you might have expected that to increase by 12% to get back to what the Central Bank thinks is the “proper value”. Instead three years later, your €100m property would be worth today, wait for it…€60m with the Jones Lang LaSalle index falling from 880 in Q4, 2008 to 527 in Q4, 2011.
Even with the benefit of certainty on the Upward Only Rent Review issue, new tax incentives to buy and hold commercial property and the straight-forward reduction in stamp duty on transactions from 6% to 2% in the December 2011 Budget, commercial property rose by just 1.1% in Q4, 2011 and if you strip out the stamp duty reduction, the fall would have been 2.6%, following falls in the previous four quarters of 4.2% in Q3, 2011, 5.7% in Q2, 2011, 1.5% in Q1, 2011 and 3% in Q4, 2010.
The importance of stability and recovery in commercial property prices is stressed in the Central Bank report, but it might be worth again saying that the National Competitiveness Council believes that property is still over-valued by reference to its rental potential and underlying commercial worth to businesses operating in the State.
@ NWL There was an article in yesterday’s Guardian http://www.guardian.co.uk/business/2012/mar/23/shop-vacancies-rise-highest-four-years, which is also reflected here.
Much existing occupied commercial spaces also look in danger. The number of bank branches will certainly fall. Internet shopping has already completely changed the book and travel trades and is gaining ground in clothing. While there is a small pick up in the restaurant trade, margins are tight and failure rates are historically very high and landlords can be left waiting for their rents. Even existing strong covenants are suspect.
A quick visit to Georges St, Dún Laoire should be organised for anyone who believes that even current prices can be maintained, particularly in secondary locations.
There is also a crucial problem even with a UORR lease in place – it is finite. Once the existing lease is over, any replacement lease will be under different legislation. Assume for example you are offered a property with a blue chip client and the lease has ten years to run. In calculating the return you will have to assume the likely value of the property in ten years under a radically different lease. UORR, for valuation purposes anyway is dead already
The bank has little or no evidence on which to base its view that the near term future trend is upwards. There has been no significant sale closed and of the two main property investment sales contracted in Dublin, neither have been completed. One of them is significantly at risk and the other is “sensitive” at this point.
Until the UK banks start to sell and until NAMA stops withholding assets from the market, neither the central bank nor anyone else can call a bottom. The CB can say that it is cyclically out of sync with the mean, but it cannot forecast that the market has not further to fall.
P.S. In any event the CB report is limited as it assumes the mean over a period from 1994 to 2011. By anyone’s perception that is probably the most volatile cyclical period ever experienced in the Irish property market and is certainly not a period on which one should seek to establish a mean on which to gauge future price trends. That analysis should at least stretch to the beginning of the sixties when we entered the Lemass era.
As George Soros would tell us, markets over-react at the top and the bottom of cycles and this one is not finished yet.
CBI needs to brush up on its math skills. Return on commercial property is not determined only by the cost of the property. There is another number involved in the equation, rents. If one assumes that rents will remain constant or even robust, well then the price of commercial real estate may very well look lovely indeed. However, reversion to the mean can happen with BOTH numbers falling. As mentioned above, there is a strong argument to be made for rents to fall. Additionally, keep an eye on Germany. As China becomes more an internally focused economy, (soft or hard landing aside) German exports will fall and its economy will contract significantly. In short, the EU has a lot more problems than just the periphery.
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