A recovery in the Irish property market looks some way off but Irish pension funds hold on for the upturn. Gail Moss reports

Irish pension funds are sitting tight on their property portfolios, waiting for the storm to subside and valuations to reach some sort of equilibrium.

"We're doing nothing at the moment," says Pat Ferguson, chief executive of the Construction Workers' Pension Scheme, whose €66m property portfolio, 7% of the entire fund, has lost 60% of its value in the past couple of years. "We are not going to dispose of it because in time it will come good. But property is not an asset we want to invest in more of at the moment, because it is too risky - there is too much uncertainty as to how long the recovery is going to take."

The fund's property portfolio consists of three retail units and three office blocks in Dublin (worth €35m), and a €31m holding in the Standard Life Investments European Property Growth Fund.

Ferguson says: "There are no real signs the market is improving, and we think it could take till mid-2011 to recover. At the moment, there are better opportunities elsewhere."

IPD figures show that capital depreciation in the Irish property market finally began to ease in the last quarter of 2009, with a 4.9% decline, the lowest in almost two years. As a whole, 2009's decline, at 28.9%, was shallower than 2008's record fall of 37.5%. But there is still a 55.6% cumulative fall, since the property market peaked in September 2007, to claw back.

Returns on Irish commercial property last year also underperformed both equity markets - which delivered 29.9% according to the ISEQ Equity Index - and bonds, which returned 3.6%, according to the JPM GBI 7-10 Years Index.

Jerry Moriarty, director of policy, Irish Association of Pension Funds, says: "Most Irish pension funds invest in commercial property, and that's gone through a lot in Ireland. Rents are under pressure because tenants can't afford them."

What is also having a negative impact, says Moriarty, is the government ban on upward-only rent reviews which came into effect on 28 February this year. "It only applies to some leases, but it will have an effect on valuations," he says. "Overall, the situation continues to be grim. The recession here has been worse than in most other European countries and the economic recovery is lagging behind everyone else."

IPD also reported a change in the drivers behind the current property decline. During 2008, in the early part of the recession, yield pressure was the overriding influence on capital depreciation, while rental growth held positive, at 2%.

During 2009, however, yield pressure eased while rental growth fell quarter-on-quarter, producing an annual rental value growth for the year of -22.4%, driven by recessionary pressures in the wider economy.

However, the relative strength of some other economies has not been enough to tempt many investors overseas, says Jennifer Richards, head of Standard Life Investments, Ireland. "The message from consultants is more about looking away from Ireland and into Europe," she says. "But I think it will be a struggle to convince them they need a property allocation at all. They are more concerned about the underfunding issue right now."

Some of those pension funds which do invest abroad use the SLI European Property Growth Fund. However, they do not see their nearest neighbour as a stepping stone to continental Europe.

"Institutional clients have ignored our UK property fund, even though it is hedged into euros," says Richards. "To them, the UK is just another country in Europe. There is also very little appetite for our global REIT fund which was launched two years ago."

And she is as gloomy as the rest in terms of the short-term outlook. "Officially, the Irish economy is expected to return to positive growth some time this year, but given that the economy revolves around construction and the stimulus has disappeared, there are still a few painful years ahead of us," she says.

SLI's own research team is expecting a further decline of 15% in valuations of Irish property, along with some more rental declines. "We expect poor economic fundamentals well into next year," says Anne Breen, head of property, SLI. "Generally, the occupier market will be weak. Also there will be potentially distressed sellers into 2011."

Breen says there is a marked oversupply in the office market, especially the city fringes in Dublin, with yields currently running at 7.5%. Retail yields are between 6.5 and 6.75%. "Irish pension funds are sitting on what they've got, but not necessarily by choice," says Stephen Ryan, senior investment consultant, Mercer. "Many pension schemes that hold property have a lot of exposure to the domestic market and the average weighting to Irish property in open-ended pooled funds is over 80%. And this market is close to totally illiquid."

Ryan says there are, however, some opportunistic continental buyers trying to pick up assets at attractive yields. He is also aware of one UK manager looking for opportunities.
In the retail sector, where unit sizes tend to be smaller compared with the office sector, an investor can pick up a retail holding for a relatively small sum. "Investors need to spend a lot more money for an office block though," notes Ryan. The Tommy Hilfiger store in Dublin's Grafton Street was bought last September by German asset manager DekaBank for around €25m.

Some bank branches have also changed hands recently, on a sale and leaseback basis, though the buyers were individual investors rather than pension schemes.

According to Ryan, the retail sector is different in many ways from the office sector. "Unfortunately, there is very little going on in the office sector," he says. "And rising unemployment has hit occupancy." The office sector dominates the Irish property market, unlike in the UK, where retail is dominant.

Meanwhile, over the long run, Ryan sees a possible shift in the nature of property investing by pension schemes. "Defined contribution (DC) pensions are growing very fast in Ireland, as elsewhere, and DC schemes have a much greater need for liquidity than defined benefit schemes," he says.

"So we might find more interest in alternatives to traditional pooled property funds, such as listed property companies and derivatives. There is also likely to be much more emphasis on international diversification."