Investors who understand only too clearly the -rationale for international diversification can do little with their domestic portfolios but wait. But the attractive pricing of Irish property might offer hope, as Gail Moss reports

On the first Thursday in February this year, the Irish Times bucked a recent trend by publishing a property supplement, its first in several years.

The property crash had led to the emaciation, and finally extinction, of the supplement.
So does its sudden reappearance, albeit in relation to the residential sector, reflect a renewed interest from institutional investors in property, after a period when it had all but ground to a halt?

It appears not, according to Joseph O’Dea, senior investment consultant, Towers Watson.

“Few, if any, funds are allocating to Irish property,” says O’Dea. “Pension funds typically only have it as a legacy holding. Significant losses and low liquidity are causing people to say they don’t want to hold this asset class.”

The Irish commercial property market is still in the sick bay. The annual total return for 2010 was -2.4%, according to the SCS/IPD Ireland Quarterly Property Index.

However, capital depreciation was 10.7%, driven by a 19.3% fall in rental values, the second consecutive steep fall. This extended the peak-to-trough fall in valuations over the past three years even further, with retail units in Grafton Street, Dublin’s principal shopping street, plummeting by nearly 70%.

Income returns for the year - at 9.2%, the highest in the index’s 16-year history - reflected the increased risk premium.

And the picture is bleak across all sectors. Vacancy rates for offices in some areas are as high as 25% or 30%.

“Clearly rental incomes have come under a lot of pressure as businesses, particularly retail, are struggling,” says Jerry Moriarty, pensions policy director, Irish Association of Pension Funds. “The consumer side is slow, with people seeing their incomes cut.”

However, Moriarty says that industrial property is faring slightly better because of the export-led economy.

O’Dea says that historically, Irish pension funds investing in real estate stuck mainly to domestic property, with some larger funds venturing into the UK market.

“In more recent years, with the advent of the euro, some funds have begun investing in pooled European real estate,” he says. “Any Irish pension funds allocating capital to real estate now will generally do so through a range of options including REITs, pooled funds and funds of funds on a European or global basis.”

The heavy bias towards domestic property had, however, been recognised in recent years as risky.

“Over the last couple of years, pension funds had started to diversify abroad, mainly into the UK and the rest of Europe,” says Joe Byrne, managing director, employee benefits & investments, Willis. “But now, there isn’t the cash around for deals, because banks aren’t in a position to lend. Furthermore, pension funds got caught by the fall in values and can’t sell what they have. So their property strategy is to sit tight on any holdings, and not put new money in.”

As with investing outside Ireland, the modest size of most pension funds is also a factor that inhibits their ability to invest direct.

And the lockdown rules for property unit trusts requiring that all unitholders are treated equally when properties are sold and money becomes available for redemptions mean it is difficult to get out of these unit trusts.

Furthermore, the pension big guns are not very active either, at present.

“Our experience is that the more mature DB pension funds are in many instances close to their maximum traditional property weighting, so they are not active investors,” says Niall Gaffney, chief executive, Irish Property Unit Trust (IPUT). “However there are increasing signs that some schemes are willing to consider the current high-yielding income attributes of prime Irish real estate.”

He says: “For instance in Q4 2010, we received over €28m in new investment funds from the domestic pension sector. The pension funds concerned hold the view that the asset class looks historically cheap. As IPUT is throwing off a net income yield after costs of 8%, they believe that the medium-term risk is priced into that yield.”

Nevertheless, Gaffney does see a chink of light through the gloom. 

“In addition, there has been a significant level of interest from overseas buyers,” he says. “There is now pent-up demand from overseas, as well as some domestic equity investors, to take advantage of the historically low asset price levels. Towards the end of last year, we saw some transactions involving UK and German buyers for properties on Grafton Street.” 

Indeed, given this potential lifeline from abroad, some property unit trusts including IPUT are in the process of considering becoming regulated funds; their unregulated status is viewed as a potential disincentive to foreign investors.

Standard Life Investments (SLI) has recently moved the Dublin office sector up to “neutral” from a “light” rating.

“The ban on upward-only rent reviews has made it less attractive,” says Jennifer Richards, head of SLI, Ireland.

“But prices have fallen quite a lot, and we think the valuations now make it worth a look.”
Liquidity in the main pooled Irish property funds used by Irish pension plans remains low.
However, O’Dea says that there has been some interest, with limited buyers for units in the secondary market.

But he notes: “There does not seem to be enough confidence in the local real estate market for the secondary market to grow substantially. There will have to be more international investors for that to happen.”

And he reiterates the general consensus that an end to the gloom is some way off.
“Most people don’t hold a positive view on Irish real estate,” he says. “The main question is when will they get their money back, and how much will they get back. It won’t be reinvested in Ireland.”

“The fall in market values seems to have levelled off,” says Byrne. “But unless overseas buyers act as a catalyst, I can’t see it picking up. However, there are good long-term opportunities for those people prepared to sit it out.”