A beleaguered domestic property market has done little to help the cause of Irish pension funds. Gail Moss reports

The best thing to happen to Irish property investors last year was undoubtedly the government's decision to shelve its plans to retrospectively ban upwards-only rent reviews for existing commercial leases.

"This decision should help move the property market, which has been stagnant over the past year, partly because of a high degree of uncertainty over this issue," says Jerry Moriarty, policy director at the Irish Association of Pension Funds. "It was very difficult to price property because of the negative impact of the planned changes, and a number of potential sales to overseas purchasers appeared to have stalled. This decision will now bring some clarity to the way in which these leases are valued."

December's Budget also contained two other measures to help the property market appeal more to investors, in particular those from abroad: stamp duty on commercial transactions was slashed from 6% to 2%; commercial properties acquired during 2012 will be exempt from capital gains tax when sold, provided they are held for at least seven years. These changes were an early Christmas present for institutional investors in the country's stagnant property investment market, where activity flat-lined last year.

One of the few exceptions was the sale of the 210,000 sq.ft. Montevetro office building, Dublin's tallest, to Google in February 2011. Real Estate Opportunities, the seller, received €99.9m in cash.

However, this was an owner-occupier deal, rather than an investment transaction, and elsewhere there was little cheer. "There has been little or no new building in Dublin for the past four years or so," says Joseph O'Dea, senior investment consultant at Towers Watson. "There is also very little cash available for renovation. Potential tenants are often reluctant to take on new leases unless developers can come up with the money needed for upgrade."

But this is not without its plus points. "The effects of this are now starting to be felt, and it's providing a bit of support for the top end of the market," says O'Dea, "But property values probably haven't stopped falling."

O'Dea says that few Irish pension funds are currently allocating significantly to Irish real estate. "However, there is some pressure on funds to invest in Irish infrastructure," he says. "There is a theory that pension funds might be exempted from the levy if they agree to do this. We expect more clarity on that during the course of this year."

A recent development has been the setting-up of the Irish Infrastructure Trust from Irish Life Investment Managers, which will target investment in Irish assets and new infrastructure projects in Ireland. It has already received investment commitments of €300m from institutional funds.

At the beginning of 2012, two prestige office blocks in Dublin - One Warrington Place, and Riverside 2 at Sir John Rogerson's Quay - were believed to be under offer for more than €60m between them, having attracted a large amount of overseas interest.

But there is still a long way to go before the commercial property market wins back investors' confidence. The annual total return for the 12 months to the end of September 2011 was -6%, according to the SCSI/IPD Ireland Quarterly Property index. The best performer was the office sector, with a negative total return of 4.5%. Industrial property lost 5.3%, while retail made a whopping 8% loss.

The average capital loss over the period was 14.4%, with offices losing 13.5% of their value, and both the other two sectors losing 15.4%. Average income returns over the 12 months to the same date were 9.7%, with industrial properties the best performers at 11.8%, and retail again the worst, at 8.6%. Offices delivered 10.2%.

"Our experience is that both Irish and overseas pension funds are attracted to the higher-yielding, low-risk property investments that are likely to be available in the Dublin investment market," says Niall Gaffney, chief executive at Irish Property Unit Trust.

Over the past three years, the trust has been offering its investors net income yields of up to 8% pa. "Given the removal of the market uncertainties and the reduction in stamp duty, we are expecting some yield compression over the next three years," says Gaffney. "The Irish market is characterised by a broad spectrum of investors that have been sitting on the sidelines over the past 24 months or so, and we expect to see this money come into play over the course of 2012 and 2013."

Gaffney says that as a place to invest and to do business, Ireland - and principally Dublin's CBD - is now very competitive by comparison with its European regional city peer group. This is largely because of improved economic fundamentals.

In particular, as recently as last September, Ireland enjoyed a record trade surplus of €4.7bn, thanks to sectors such as pharmaceuticals, services and agriculture. Nevertheless, the retail sector is still down in the dumps.

"The government's austerity measures are taking spending out of the economy," says Moriarty. "People are saving because they are worried about the future. So retailers are struggling, and a number are closing deals with owners giving them more favourable contract terms."

A number of property investors are therefore looking overseas, and where they do invest in continental Europe, pension funds are looking for safe havens. O'Dea says Irish institutions tend to invest in core European funds (for example, north-western Europe), rather than in the Mediterranean states.

But Gaffney sees more promise in the domestic market. "Many domestic pension funds have diversified their property exposure," he says. "However, the income yields now being offered by the Irish market, coupled with the potential for a recovery play over the next five years or so, is encouraging some funds to look again at the sector. Experience would suggest that the core European markets are not necessarily going to offer superior returns or lesser volatility, or indeed greater liquidity."

But the great unknown is still whether the Irish market is within sight of a sustainable recovery.
According to CBRE's Irish Commercial Property Outlook 2012, the three-year decline in capital values will come to an end during this year.

But there will still be competing pressures on rents. "Despite the underlying levels of vacancy in the office sector, the scarcity of modern grade-A buildings in the central business district, coupled with the complete lack of new development in the pipeline, will ultimately force rents for prime buildings gradually upwards," according to the report. "However, a good number of office buildings are due to come back on the market to let in 2012 and this will alleviate pressure to some extent. Rental growth is therefore unlikely to materialise in the Dublin office sector in 2012."

Moriarty agrees that the coming year might herald not so much the beginning of the end of the property slump, but the end of the beginning. "At some stage property will become more attractive as an investment because the falls in value have been so significant," he says. "But how much further they have to go is the big question."