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Monthly Monitor - April 2023
The deterioration in the international economic environment during 2022 has created a level of uncertainty for investors and occupiers in the Irish commercial property market. This uncertainty, coupled with higher interest rates, is affecting property values, with the MSCI index of capital values down 5.35% for the year to 31 December.
We believe this trend is likely to continue in the short term, though the underlying domestic real economy continues to perform strongly, and occupier demand is holding up.
Despite the negative sentiment CBRE report that over €620mn investment transactions occurred during the first quarter of 2023.
The level of occupier demand for office property in Dublin led to a total take up of 2.6mn sqft during 2022 with over 800,000 sqft taken in Q4 as reported by Knight Frank.
This contrasts with the commentary in some quarters that the new phenomenon of hybrid working would lead to a collapse in demand for office space.
The reality is that most office workers have returned to the office for at least part of their week and most employers are keen to facilitate this by ensuring an attractive office environment. Savills report that Dublin is slightly ahead of the European average in terms of office occupancy rates, with average occupancy now 55% and growing – although Savills do not expect it to recover to the pre-Covid norm of 70%.
The sharp reversal in the technology sector was more impactful on the Dublin office market, especially during the second half of 2022. This sector had been most active over the past few years typically accounting for over 50% of total space take up and most of this has been based on leases for 10 years or more.
Up to 1mn sqft of this space has now been placed back onto the market to sublet and this “grey space” coupled with the volume of new accommodation under construction will lead to a softening in rental values for the time being. Meanwhile CBRE report that the volume of office space taken up in Q1 was just 280,000 sqft, well down on the 10-year average for the first quarter of the year.
The focus of demand is shifting to buildings which have high sustainability credentials, and this will underpin the value of such buildings particularly in suburban locations where rents are typically around 50% of the rates payable in the city. It is noteworthy that 36% of the office space taken by occupiers in Q1 was in suburban locations according to CBRE.
As 2022 progressed, the rise in consumer price inflation and the ‘cost of living crisis’ impacted consumer sentiment, albeit Irish retail spending proved relatively resilient, especially in the grocery and convenience sectors.
However, the impact of rising energy costs and mortgage rates was keenly felt on many domestic F&B operators and the increased cost of fitting-out retail space also came more into focus for prospective occupiers.
Consumer confidence has recovered somewhat in the first quarter with the Consumer Sentiment Index in January at its highest level since June 2022. Retail sales in February were up 3.6% relative to the same month last year.
We expect rent levels will be broadly stable in 2023, with perhaps some small growth in prime shopping centres and high street locations where vacancy is trending lower.
The industrial and logistics sector has seen sustained momentum buoyed by low availability and above average demand, which in turn is fuelling pre-letting activity and continuing to support rental growth.
The volume of space taken up in 2022 was the second highest ever at 3.8mn sqft according to JLL and this momentum has carried into Q1.
Prime industrial rents in Dublin are now in the order of €11.50 per sqft and are expected to rise further during the second half of 2023. In addition to the scarcity of quality accommodation, the uplift in rental values is also reflective of rising build cost inflation.
The relative performance of the Irish economy remains a powerful underpinning of the real estate market with Irish GDP up 12.2% during 2022 and modified domestic demand up 5.6% over the same period.
This growth, combined with healthy Government finances, a comfortable debt/GNI ratio and elevated levels of household saving all support a positive view of the Irish economy. It is not surprising that international investors remain active with four of the top five investment transactions in Q1 2023 featuring overseas investors.
New commercial construction activity has declined significantly during 2022 and this inevitably means that little new space will be delivered into the market once the existing batch of projects currently underway are completed. This reduction in new supply coupled with higher construction costs will underpin values.
Investors are likely to continue to be attracted to property as a real asset class given its ability to deliver a high-income yield. The average yield on the MSCI Irish property index is 5.8%, twice the yield available from 10 year Irish Gov bonds. Furthermore if previous experience is a guide, property rents will grow in line with inflation over time.
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