Returns in the Irish market tend to lag those in the UK by six months and, as that market hasn't bottomed out yet, expect yields here to widen, writes Seán O'Neill

THE VOLUME of transactions in the Irish property market reached around €2 billion for 2007. In contrast, mid-way through 2008 volumes had only reached €250 million.

This latter figure will have increased somewhat by year end as more product comes to the market but the result will still be a significant fall in volume by any standards. So how does this compare to what is happening in the rest of the world?

Overall property sales worldwide for the first half of 2008 totalled just over $300 billion (over €200 billion). This was a decrease of around 50 per cent compared to the same period in 2007.

What was evident in the figures, however, was a shift in focus from the traditional established markets of western Europe to emerging markets such as India, Brazil, Russia and China. One can only assume that the attraction of high returns and the expectation of yield shifts in western Europe was the rationale behind this trend.

Higher financing costs made lower yielding "safe" markets unaffordable and these low yields were perceived to have only one way to go. Emerging countries, like those mentioned above, accounted for 25 per cent of all property sales, compared to a year ago when they accounted for just 10 per cent.

Large developed economies were hardest hit by current events. Activity in the US, UK and Germany was reduced by around 60 per cent, with activity in countries such as France, Canada and Sweden falling by around 50 per cent.

Interestingly, China replaced the UK as the second most active country while Japan overtook Germany for fourth place. Combined with growing investment in its emerging markets, Asia now accounts for one third of global property transactions - doubling its market share in just a year.

Globally, yields for property are facing significant upward pressure as the credit crunch has made finance more expensive and decreased overall leverage. In addition, the slowing international economy has dimmed the prospects for rental growth and increased the perception of risk throughout the property sector causing the difference between yields and risk-free interest rates in each country to widen. This reflects the overall risk and income growth potential of property investments as currently perceived by investors.

For example, while overall yields in the US are up by around 0.25 per cent, US Treasury rates have widened by over 1 per cent. This reflects the switch in investor sentiment from optimism to pessimism in the past year.

By this measure the outlook for property has eroded most in the US, UK and France and also Hong Kong - all of which saw the differential between yields and risk-free interest rates widen by around 1 per cent between 2007 and the first half of 2008.

It is likely that the second half of 2008 will be somewhat different as the effects of the credit crunch spread to the property markets of emerging economies. Yields will continue to shift outwards in the established markets and the difference in returns between the "older" and "newer" economies will tighten. This is likely to result in an increase in focus in the safer markets and a yield shift and value reduction in the emerging countries.

So what does this mean for Ireland?

Our research indicates that over the past 20 years returns in the Irish market have on average lagged those of the UK market by around six months. Obviously there were some exceptions to this during some of the years of the Celtic Tiger. The same trend has been evident over the past year, as we see the downward trends and returns which started to occur at the latter end of 2007 in the UK only really taking hold in Ireland during the summer.

Many investors in Ireland look to market trends in the UK for guidance and it is likely, until we see some evidence of a bottoming out in the UK market, that a recovery will not take hold in the Irish market.

What we are seeing now in the Irish market is a shift out in yields to put us more on a par with other developed Western economies with a similar interest rate environment to ourselves.

One of the issues coming more into focus now is Irish commercial stamp duty rates which, at 9 per cent for most transactions, makes trading in property in this country expensive. As loan-to-value ratios decrease, the amount of stamp duty to be paid increases significantly the amount of equity required by investors.

In weighing up the merits of various investment opportunities, investors seeking better cash-on-cash returns will invest in places like the UK where stamp duty rates are 4 per cent. This will act as a further drain on equity/cash from the Irish market and the economy.

In my view we are likely to see some further yield shifts with returns in mature markets, such as the UK and the US, becoming increasingly attractive. This may shift the focus of activity back to the more developed economies once again and it is likely that these markets that have been hardest hit will be the first to recover.

• Sean O'Neill is director of investments at DTZ Sherry Fitz-Gerald