Rise of the Irish 'cash boxes'
A recovery in the Dublin property market has enabled the arrival of Ireland’s first-ever REITs. Russell Handy reports
Ireland’s commercial real estate turned a corner last year. Up until then properties and loan portfolios were cherry-picked by a handful of first-wave investors. The country’s recovery has coincided with a rise in appetite for two newly launched commercial REITs.
Demand for Irish property has surged. At the start of this year, Cushman & Wakefield estimated that there was as much as €10bn of unmet demand for Irish real estate.
Franklin Equity Group portfolio manager Ed Lugo sees potential to obtain “good yields” on Irish investments – coupled with the greater likelihood of a recovery over the next five to 10 years.
Transaction volumes – still some way from their 2007 peak – began to reach respectable levels last year. Cushman & Wakefield estimates that €1.87bn was invested in 2013. By the halfway point this year, €1.7bn had been invested in Irish real estate, including direct investment of €800m, according to JLL.
Just as in Spain, investor confidence has been a key driving force behind Ireland’s recovery. Google’s €99m purchase of the Montevetro building in Dublin’s ‘Silicon Docks’ for its European headquarters in 2011 is generally viewed as a game changer, going a long way to restoring confidence. Dropbox, Facebook and Twitter have also set upshop there. Occupier sentiment has also played its part.
For Ray Crowley, equity analyst at Davy, Dublin’s office market was experiencing “reasonably healthy” office take-up during the downturn, coupled with constrained supply – with land locked in ownership with financial institutions.
“Investment agents may not have had a good time in 2009-11, but if you were a leasing agent, then you were doing reasonably well,” says Crowley. “Leasing activity levels were what some early investors took note of.”
According to Hibernia REIT chief executive Kevin Nowlan, the level of occupational demand has been a “great saviour” for the Dublin’s office sector.
CBRE head of research for Ireland, Marie Hunt agrees. “We’ve had five years of undersupply, and anything that does get proposed takes between two and three years to build,” she says. “Investors can see rental growth is now on the table.”
Dublin’s imbalance between supply and demand could increase, with further upward pressure on prime rental values. Prime headline-quoting rents rose 25% in 2013 and by a further 15% in the first half of this year. Rising rents usually stimulates more development.
With property values improving, yield compression has changed the investor type. Investors chasing higher returns – the first wave of ‘hot’ money, as one market observer described it – are now heading for the exit. The change of investor profile is a natural consequence of pricing.
“The buyer profile has changed as we’ve moved through the cycle,” says Crowley, pointing to a wider range of investor types, from private equity to local and foreign institutional. “We’re starting to see the more longer-term investors look at this market.”
In mid-2012, German investor AM Alpha bought Riverside II, a Dublin office property, for €35.6m. Opportunist in its investment approach, the Munich-based firm then sold the asset to an Irish institutional buyer last year. AM alpha managing director Martin Lemke tells IP Real Estate it had initially intended to keep the property “for some time”.
“We would have kept the building but the offer we received was so attractive that we decided to sell,” Lemke explains. “We had gone into Ireland when there were concerns for the future of the euro-zone, at a time when pricing was very decent.”
But the Ireland of today is not overheated, Lemke said, refusing to rule out further acquisitions. “The market seems more mature now – but that does not mean we would not go back there,” he says. “It’s still a very interesting place to invest and I would expect yields to continue to come down.”
If Ireland’s commercial real estate sector has normalised, then it may have much to do with the country’s ongoing deleveraging process. Investors are taking confidence from the progress of asset and loan sales by banks.
In special liquidation, IBRC sold around €20bn of loans, while Certus/Lloyds Ireland, Ulster Bank and Danske Bank all continue to deleverage. Permanent TSB, rescued by the Irish government in 2011, is selling a €10bn Irish commercial real estate loan book over the next three years.
“Investors like the visibility on deleveraging,” says Hunt.
But the National Asset Management Agency (NAMA) has been the primary source of product for opportunistic investors. It has been feeding the market as it disposes of legacy loans, and aims to sell €9bn by the end of 2016 and be completely wound up by 2018.
“The quantum of deleveraging has created a great opportunity,” says Nowlan.
Green leads the ‘blind-pool’ REITs
First-wave investors – many being private equity – who have already bought properties from banks or debt in loan-to-own strategies now need a secondary market to sell to. Which is where REITs come in.
CBRE estimates that more than 40% of all property investment purchases over €1m in the second quarter of this year were by REITs.
Whether it was a result of impeccable timing or a stroke of luck, Green REIT was Ireland’s first to float. Listing in July last year, Green was oversubscribed and raised an initial €310m from BlackRock, Investec, Paulson & Co, PIMCO and TIAA-CREF.
Approximately a third of the company is now owned by institutions with US investors dominating.
“They recognise the investment opportunity, and are the predominant source of equity for recovery markets internationally,” says Green REIT chief executive Pat Gunne.
Green was responsible for the biggest transaction in the first half of this year, spending €375m on a portfolio of properties from Cosgrave’s Project Sapphire portfolio. Green focuses on office, industrial and retail assets, but may consider residential or multi-family assets as part of mixed-use portfolios.
Six months after Green’s listing, the REIT was joined by Hibernia, which raised €385m when it floated in December and has been investing off-market in Irish real estate. The two REITs, both externally managed, were sold ‘blind’, highlighting the importance of reputation.
“In a small market like Ireland where names mean a lot, investors want to know who they’re dealing with and not worry about tarnished reputations from the last boom,” one observer says.
Still dealing with the consequences of high leverage, Ireland’s real estate sector is now making a clean break from the past. The country’s government capped leverage levels at 50% in an attempt, along with other measures, to lower the risk profile of REIT activity. Green and Hibernia have guided LTV levels of 35% and 40%, respectively.
The Irish government, explains Crowley, used REIT legislation to lower the risk profile of REIT activity. As well as the 50% LTV cap, other conditions were also put in place, including a restriction on development activity to 15% of a REIT’s net asset value. Legislation also stipulated that at least 75% of the market value of owned assets related to property rental business, with at least three properties and none accounting for more than 40% of NAV, albeit with a three-year grace period.
Both REITs are managed by well-known industry names. Green is managed by Gunne and Stephen Vernon, while Hibernia’s Nowlan – a former NAMA portfolio manager – is the son of Bill Nowlan, who lobbied the Irish government for a REIT regime.
Franklin Equity has a preference for “well-respected” managers with strong track records, according to Lugo.
Ireland’s blind REITs, or ‘cash boxes’ as they have become known, were born out of a lack of existing listed property companies. In the case of the UK, existing listed companies simply converted into REITs.
“Only a handful of property companies survived the crisis,” says Hibernia REIT’s Nowlan. “So blind pools really became the only possible choice.”
Nowlan, who expects Ireland’s REIT sector to grow, doubts more blind-pool cash boxes will appear. More likely, he says, is the emergence of specialist REITs – such as the Canadian-owned Irish Residential Properties REIT which floated in April, raising an initial €200m.
“There’s probably room for a retail-focused REIT,” he says.
Hibernia, Nowlan says, is concentrating its investment efforts on its “core market” of Dublin, with a preference for offices ahead of retail, industrial and residential properties and loans.
“I see us as a Dublin specialist,” Nowlan says. “There would have to be a very good reason to go beyond that.”
In the company’s preliminary results in March this year, Nowlan told shareholders there was “intense competition” for quality assets, with asking prices above Hibernia’s assessment, and the upturn progressing quicker than it expected. With REITs enjoying a two-year tax exemption on debt deals, Hibernia invested in loan portfolios at the start of this year, buying a loan portfolio from Ulster Bank. For the first 24 months, profits arising from the proceeds of debt assets are not considered as bad income.
Loan portfolios will continue to supply stock for investors in the Irish market. Kennedy Wilson has invested in both property and loans through its London-listed closed-end fund. Having listed in the UK in February, the company had built up a £1bn portfolio by the end of June, a third of which is in Ireland.
Low-interest-rate environments are good for Ireland’s real estate industry, says Gunne. “The rental yield premium versus the so-called risk-free rate is at its highest,” he says.
Competition for Dublin’s real estate shows no sign of calming. JLL expects more than €4bn of property and loans to be transacted by the end of this year. More REITs may emerge. A focus on property outside the city walls of Dublin would be welcomed.