Property & Construction News - Commercial Review 2011: Mixed bag for commercial market

The commercial property market is full of contrasts. On one hand, the occupational end of things is doing quite well, with the levels of take-up reasonably good when compared with 2009 and 2010. On the other, the investment market is at a complete standstill pending the government's decision as to whether it will ban upwards-only rent reviews in existing leases.

Focusing on the occupational markets, the retail, office and industrial sectors all performed relatively well, particularly in prime areas. Vacancy is falling across all sectors in prime locations and, in general, take-up of accommodation is similar to pre-2005 average levels.

Commercial rents peaked in the latter half of 2007 and now seem to be at the bottom of the cycle. Lisney's rental indices show that, on average, commercial rents are down approximately 48 per cent, with office rents down by as much as 55 per cent.

In the office sector, take-up in the first nine months of the year was almost 131,000 square metres, surpassing the level achieved in 2010 as a whole (125,000 square metres). We estimate a year-end figure of over 160,000 square metres, which is in line with the 15-year average, excluding the boom period of 2006 to 2008.

The largest deals during the year include Google's purchase of Montevetro building on Barrow Street, and lettings to Paddy Power in Belfield and Bank of Ireland in Burlington Plaza.

Unsurprisingly, Grade C buildings (obsolete or nearing obsolescence) are only securing a small proportion of market activity. In the first nine months of the year, such accommodation only accounted for 4.2 per cent of all take-up. With rents for better quality buildings so low, occupiers are now able to secure good quality, well-located buildings on excellent terms.

This will lead to some issues towards the end of 2012 when very little Grade A (new and never occupied) stock will remain available. With only 11,100 square metres of new space completed so far this year, the vacancy rate continues to fall, and is likely to maintain this trend given that there are no new schemes planned for completion in the short term. However, vacancy is still at historically high levels, with the overall Dublin market at 21.2 per cent, but with certain suburban areas over twice this figure.

Moving to the industrial market, overall activity levels are similar to 2010, which is good news as it points towards steady demand. We estimate a take-up of between 140,000 and 170,000 square metres this year, depending on whether or not a number of large deals are completed by year-end.

Since the summer months, we have seen an increase in the number of smaller transactions of less than 1,000 square metres. The reason for this seems to be that some small businesses now have a bit more clarity on how their business will perform over the coming year, and are therefore willing to enter into very flexible leases to reflect this.

With the larger transactions, demand is being driven by logistics operators connected with the food and medical sectors, but this demand is not to the same degree as was seen in 2010.

Over the 12 months to the end of September, available industrial accommodation decreased by 2.6 per cent. This figure would have been greater but for a large number of premises coming to the market through receivers. Overall, the vacancy rate for industrial property in Dublin now stands at a rate of about 17 per cent but, as with the office market, there are wide variations across geographical areas.

In the retail market, trading remains tough. Central Statistics Office statistics illustrate that the volume and value of retail sales are still falling, down 21 and 26 per cent, respectively, since mid-2007, while consumer sentiment remains low.

Rents in this sector have fallen by an average of 40 to 50 per cent from the peak of the market, and for the past two to three years, new international retailers to the Irish market have been taking advantage of this and signing deals on flexible terms. Their interest is focused on prime high streets and in prime shopping centres, and examples include Hollister, Republic, Name It, Forever 21 and Abercrombie & Fitch.

A number of transactions were completed on Grafton Street during the year, indicating that the street's decline may have been arrested. Such deals include lettings to Disney and Skechers, and a sale to Brereton Jewellers.

Another notable development during the year was the first round of rent reviews in Dundrum Town Centre, where arbitrators awarded Zone A rental increases of about 50 per cent on initial rents. However, it must be remembered that many of these rents date from two to three years prior to the centre opening.

Single price and supermarket discount retailers are making up a large proportion of market activity as a result of expansion plans by a number of operators, such as 99p Stores (trading as Euro 50 Stores) and Poundland (as Dealz). In the supermarket sector, Iceland is expanding into a number of areas around the country.

Also in the supermarket sector, the Musgrave Group has reached an agreement to purchase Superquinn, which will push its market share ahead of Dunnes (at 22.9 per cent) and just slightly behind Tesco (27.9 per cent).

Availability on prime high streets and in core suburban shopping centres is reducing. While it is difficult to track exact vacancy levels, we have sought to monitor prime retail units in the Dublin market where no trading is taking place, ie a 'shutter count', and found that at the end of quarter three, unoccupied units on prime high streets and in prime shopping centres ranged between 1.6 and 5.4 per cent of the total number of units.

Moving on to the investment market, following some improvements towards the end of 2010, yields began to move out again during the year. When combined with some further falls in rents (albeit minor falls compared to previous years), capital values fell further. The IPD indices show that values are down by just over 63 per cent since the peak of the market in 2007.

The retrospective rent review proposal is having a major impact on the market, and will continue to do so until the government makes its mind up. In fact, it is the single biggest issue that has faced the investment market in a generation. We were promised draft legislation after the summer Dáil recess, however at the time of writing this has still not materialised.

At this stage, whether you are for or against the legislation is almost irrelevant - what is important is that something is done immediately, as the government's inaction is creating such uncertainty that the investment market is effectively dead.

During the early part of the year, a number of transactions that were agreed in 2010 fell through because of the proposals, the most notable of these being the sale of the Liffey Valley shopping centre. As the year progressed, potential purchasers sat on the sidelines waiting for the government to make a decision.

For the year to date, there have only been five significant investment transactions, totalling about €174 million, of which 77 per cent relate to special purchaser deals, ie Google and Penneys acquiring the accommodation they already held under a lease (Gordon House, Gasworks House and Chapel House).

In reality, investment turnover is only about €39 million, which is shockingly low. Even given the poor state of the property market, this is an exceptionally low level. Even in 1996 (before the property boom), investment turnover was €250 million, 44 per cent more than the €174 million experienced this year (and 543 per cent more than the €39 million figure). There were 30 more individual transactions completed in 1996.

Looking towards 2012, there are a number of positives to focus on.

Ireland has regained some ground in terms of competitiveness and certain occupiers are now making the decision to commit to Ireland - Google is a prime example of this. In the office sector, we estimate that there are combined occupier requirements of more than 100,000 square metres in the Dublin market, which is excellent news for take-up next year. Most of these companies have a preference for the city centre.

If you consider the prime city locations of Dublin 2 and 4, there are only 78,500 square metres of Grade A space available, and it is understood that much of this is under active negotiation. For larger occupiers requiring 5,000 square metres or more of brand new accommodation in this area, there are currently only five buildings to choose from.

It is likely that this scarcity issue will come to a head towards the end of next year, but the economics of the market are not sufficiently readjusted to make speculative development feasible yet - it may take up to two years for any significant growth to resume.

With industrial property, larger stock is again becoming limited, particularly accommodation greater than 10,000 square metres in the Dublin south-west region. In addition, Ireland is becoming a key location for data centre developments, with a number of high profile operators choosing to locate in Dublin.

During the year, companies such as Data Reality Trust, Amazon and Google secured sites for data centre schemes. With energy and labour costs continually improving, and if the correct investment is made in Ireland's bandwidth infrastructure, the country could become a leading international centre for data providers.

The drop in prime vacancy rates, coupled with an increase in the number of international retailers seeking representation in Ireland, gives cause for some optimism in the retail market. Nevertheless, it is likely that retailers will continue to adopt a cautious approach, with many becoming increasingly innovative and flexible in a bid to drive turnover and margins.

While rents now seem to be relatively stable - at or close to the bottom of the cycle - if the proposed changes to the historic rent review structure are implemented, we may well see yields settle at or about 100 basis points higher than historic levels.

The 20-year average prime retail yield is 5 per cent, and the office yield is 6.25 per cent. Yields settling closer to 6 per cent and 7.25 per cent will have major implications for Irish banks, Nama and pension funds, as it translates into a further 20 per cent reduction in capital values.

All things considered, commercial property performed reasonably well during the year, with perhaps the lack of any real investment transactions being the major disappointment. Hopefully, 2012 will witness further improvements, with renewed overseas interest from both occupiers and investors.

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