Oh sweet Mother of God – nostalgia as property industry talks up Irish property prospects

“overall, and reflecting on my comments above in a balanced way, I am of the view that there will be an increased level of transactions in the industrial sector and the re-establishment of it as an alternative to what was the traditionally favoured office and retail sectors” – Nigel Healy, European director/ Industrial director at Jones Lang LaSalle

I must say I feel uncomfortable examining this contribution from Jones Lang LaSalle’s European director , Nigel Healy in today’s Irish Independent because JLL is a decent company with a good grasp of the state of the property market, but hopefully by restricting this blogpost to above-the-belt facts, the debate might have some decorum . By the way the Independent describes Nigel as JLL’s “European director”, the Q4,2011 industrial sector review from JLL describes him as “Director, Industrial” – this distinction might make more sense as you read on.

The newspaper article is headlined “surprise over foreign interest in industrials” – “industrials” referring to industrial premises, factories and warehouses. I don’t think anyone is in the least surprised that foreign and indeed domestic buyers are at the very least kicking tyres and building a picture of prospects for Irish property. NAMA reported last year that it was seeing 75 investors every week, many from overseas.Irelandis the global poster-child for a collapsed property bubble so of course there will be interest. However, for most investors in search of a quick buck, the perception that property is being given away is quickly dispelled, and potential buyers are finding that sellers – with NAMA or banks standing behind them – are holding out for what sellers – or NAMA or the banks standing behind them – believe are realistic, and not derisory, prices. But make no mistake about it, there is colossal interest in our property market. And that shouldn’t “surprise” anyone. Converting that interest into completed transactions where buyers find suitable property at an agreeable price – that’s the challenge and so far, there is precious little evidence of that happening.

Nigel then says “clearly the levels of return, coupled with the potential for real rental growth, are factors” Well yields on industrial property are indeed attractive at 8-12%. That’s 3-4 times what you’ll get in the best deposit account and by historical standards are very attractive indeed. But JLL seems to have a blind-spot with yields. You might recall the late Brian Lenihan saying in September 2009 that “the fall in property values has pushed up property yields. Yields are now above their long term average, and this suggests that values are bottoming out”, and that echoed the views of JLL’s managing director at the time John Mulcahy who has since become NAMA’s Head of Portfolio Management, and the Agency’s most senior property man. Yield is simplistically rent divided by value. So you buy a house for €100,000, you rent it for €12,000 a year, then your yield is 12%. But BOTH the rent and the value of the property can change. So rent might fall to €10,000 and your yield would become 10%, or the property could halve in value to €50,000 and your yield could become 24%. When economies are under extreme stress these are the types of change that take place so normal yield analysis goes out the window – normal yield analysis says that if yields are high, buyers will pile into property as an investment and that will push up the price of property which will reduce yields to “normal” levels, assuming rents stay the same. And if yields of 12% are currently available on industrial space that tells me that even the market thinks capital values or rents have further to fall.

Now what about rental growth in the industrial sector? Rents are indeed down 50% from peak. But why should that mean they increase from here. Because says Nigel “the take-up in industrials is higher than last year which in turn was an improvement on the year before” and “given that a significant portion of the market is affected by obsolescence and take-up is increasing, albeit very modestly, it follows that supply will constrict and values will be underpinned”. In order to be able to have a complete belly-laugh at this, you need to understand what is meant by “take-up”. If companies A,B and C rent 100,000 of new space in 2010 and companies D,E and F rent 120,000 of new space in 2011, then there is a 20% increase in take-up. But take-up doesn’t take account of space handed back to the landlord. So in 2011 company D might have been renting a 50,000 sq ft facility in Naas but they decide to move to a 30,000 sq ft facility in Celbridge. “Take-up” doesn’t take account of the 50,000 sq ft facility vacated. And consequently “take-up” doesn’t by itself indicate higher total demand for industrial space, it may simply mean companies are taking advantage of lower rents in new facilities or are simply downsizing. This phenomenon was alluded to recently in the context of the Dublinoffice market by…. JLL!, who say in their annual outlook on the office market “It is likely that take-up will be at similar if not higher levels than 2011, with approximately 315,000 sq.ft. already reserved for Q1 2012. Despite the fact that no development is planned in the short-medium term, it is conceivable that the vacancy rate could increase in 2012 with a number of larger properties coming back onto the market as a result of break options.”

Nigel then goes on to consider demand, and the absence of any real detail is truly impressive. “there has been an increasing number of potential occupiers looking for larger distribution facilities in the 100,000 sq ft plus category” We’ll take Nigel’s word for it, though it would be more credible if we knew who these “potential occupiers” were. Nigel does drag in an unnamed “UK-based agent” who apparently claimed that there wasn’t a “vast choice” of property available at a suitable price. “Vast”?!

Nigel then reaches the first of his great – and unsupported – conclusions. He says “so if we have established that rents are relatively low..” but he has not established that at all. Just because rents have fallen 50% from peak doesn’t mean they won’t fall another 10%, and it might be worth pointing out that the National Competitive Council recently claimed commercial property prices in Ireland were over-valued and didn’t reflect “underlying potential for adding value or earning market rent”. So at the very least, it is debatable that rents are “relatively low”

And then we have the second great – and unsupported – conclusion when Nigel says “the realisation that the capital values above [€59-80 per square foot] are substantially below replacement cost must give further comfort to the investor that the long-term value of the asset is underpinned” Below “replacement cost”? Really? Now to replace an industrial building, you would need a site, building materials and labour. Sites are down 80-95% from peak, building materials are mixed but labour is set to come down with changes to Registered Employment Agreements – action 1.12 in Monday’s job plan – “enact legislation to reform wage setting mechanisms” So €59 per square foot is below replacement cost?

Nigel concludes his infomercial with “overall, and reflecting on my comments above in a balanced way, I am of the view that there will be an increased level of transactions in the industrial sector and the re-establishment of it as an alternative to what was the traditionally favoured office and retail sectors” So Nigel who specialises in the industrial sector at JLL has reflected on his own comments?  And in a balanced way? And convinced himself, whose career and prospects depend on transactions, that there “will be an increased level of transactions”

Oh sweet Mother of God!

Hopefully as Ireland’s various property sectors eventually stabilise, we will see an improved standard of contribution, evidenced and supported with facts and detail, which will allow more reasoned debate than has prevailed in the past . And with that in mind, I ask that comments on this or Nigel Healy’s contribution be directed at above-the-belt facts rather than assumed motivations.