Back after the break: is now the time to take a punt on Irish commercial property?

It’s back. With international investors ploughing into commercial property, it could be a good time to take a punt on Irish property. But how can you tell your Reit from your property fund, and what lessons have been learned from the property bust?

The investment case
Commercial property is the talk of the town. International investors like Kennedy Wilson are active in the market and property analysts are talking of an "extremely busy" first quarter of this year, with almost €1 billion invested in 37 transactions, according to CBRE. That compares with €1.8 billion in 96 transactions for the whole of 2013.

Nonetheless, smaller investors appear to be a lot more cautious this time around.

Rory Gillen, founder of Gillen Markets, sees "no huge enthusiasm" for commercial property in the current environment. Bobby Hassett, a director with Investec Wealth & Investment, agrees.

“You have to distinguish between those who were badly burned and are trying to repair themselves, from those who have cash and capital and who are looking for investment returns”.

However, there may be an investment case to be made for commercial property all the same.

“The value is there,” says Gillen, pointing to average rental yields of 6.9 per cent and a recovering office market, which means that, over time, if the economy progresses, “rent should recover further”.

“The key drivers of long-term returns – the initial rental yield, rental income growth and affordable interest rates – are, at last, nicely aligned,” he says, adding: “There is a good base for the rental levels as they are at the moment, and indeed there is a case to be said that rents have fallen too far”.

Ultimately, investing in commercial property is a play on the Irish economy.

“I see very few risks, but the economy could stall and we could be in a deflationary mode for quite a while,” says Gillen, adding that investors should be taking a five-year view on commercial property investment.

For Hassett, the biggest risk to the downside is a situation where the Irish economy deteriorates, noting that “another shock to the system would be quite difficult”.

Before taking a plunge this time around, it might be wise to first consider some of the things that can go wrong when putting money into property.

Back in 2009, these pages reported on how “investors are stuck with an investment which is rapidly falling in value and is very difficult to cash in”. At the time, investors were rushing to get their money out of commercial property funds. In response, fund managers imposed a six-month ban on cash redemptions in a struggle to keep their funds liquid and prevent a fire sale of properties.

Typically, funds keep a buffer of about 10 to 15 per cent of assets in cash to meet the demand for withdrawals. In September 2009, this cash buffer had fallen into negative territory.

Since then, however, the cash buffer held by funds has rebounded, as cash has once again started flowing into the funds. Friends First, for example, has an allocation of about 17 per cent to cash.

Another feature of property funds which came home to roost when the bubble burst is that an encashment penalty may be imposed for early withdrawals. Typically, this figure is about 5 per cent, depending on how long the investment had been held.

Funds may also change how they price a fund from an acquisition basis to a disposal basis, when more money is going out than coming in. This could result in an investor earning a lower unit price.

Irish Life’s property fund, which had been priced on a disposals basis around that time, has now reverted to an acquisitions basis, “reflecting the fact there are positive inflows to the fund”, the fund manager says.

Diversification is another key point to bear in mind. While the days of putting all your money into Irish property and Irish equities are gone, this is not to suggest that making an allocation to Irish commercial property would be imprudent.

“There is nothing wrong with putting 5-10 per cent into it,” says Gillen, although Hassett strikes a more cautious note.

“There is definitely an investment case for Irish property but people should also diversify and use something that gives them a wider international exposure.”

Gearing is another issue to consider in commercial property investment, although it’s unlikely to be an issue for investors just now given the dearth of debt financing.

Previously, it wouldn’t have been unusual for a syndicate to be funded with 70 per cent debt, but such a high level of gearing can quickly make an okay deal turn horrible as the evidence of the past few years illustrates starkly.

“Look to ensure that there’s not too much gearing in a fund,” advises Hassett.

The Reit option?
Introduced in the Finance Act last year, real estate investment trusts (Reits) offer Irish investors a new way of accessing the local property market.

Reits are quoted companies that own or operate property, such as office blocks and shopping centres, and they are now the primary way of listing commercial property around the globe.

They enable investors to indirectly access the residential and commercial property markets, by buying shares in property companies, which are either listed on a stock exchange or sold privately

Reits are bought and sold, like shares, via a stockbroker, and are thus a considerably more liquid way of investing in commercial property than the traditional options on putting your money into a single property or a small number of properties.

“Reits, because they’re quoted on a stock exchange, should have more liquidity. The problem is that if there is a downturn, they do tend to be quite volatile,” says Hassett.

Traded like equities, Reits are also taxed in a similar way. You’ll pay tax at your marginal rate on dividend income, and capital gains tax on any gains, which, at 33 per cent, is lower than the rate charged on funds (41 per cent).

This means that if you’re carrying forward CGT losses, it may be possible to offset your Reit gains against these to reduce your tax bill.

At present, two Irish Reits have launched – Green Reit and Hibernia Reit – while Canadian property company CapReit is also expected to list a €200 million Irish reit shortly, and more may follow, concentrated in a particular sector.

A property fund
After taking a hammering in the bust, property funds are slowly recovering, and, after a few tortuous years, have moved back into positive territory.

Aviva’s property fund, for example – whose holdings include Riverside, on Sir John Rogerson’s Quay, and Ormonde House on Earlsfort Terrace – returned 8.6 per cent in the 12 months to February 28th. However, it is still in the red on both a five and a 10-year basis.

Similarly, the F&C fund offered by Friends First is up by 10 per cent on an annual basis, but is in the red on a three-, five- and 10-year basis. Irish Life’s fund is up by 32 per cent in the 12 months to end-February, bringing its three and five year returns back into the black.

If investing on a lump-sum basis, you will need considerable funds to lock away. Irish Life has a minimum investment of €20,000 on its fund, or €3,000 for a lump-sum pension contribution.

However, you can also pay into the fund on a monthly basis, via a minimum €50 contribution to your pension. And, from next month, the fund will be made available as part of Irish Life’s regular savings options, for a minimum monthly investment of €250.

Charges vary at Irish Life, ranging from between 1-1.25 per cent for a lump-sum investment, falling to 1 per cent on a pension investment, and rising again to 1.5 per cent on the insurer’s new regular savings option.

Friends First imposes an annual management charge of 0.75 per cent.

For Gillen, there may be better value to be had in a property fund at the moment, as he considers that Reits are “trading at premiums”.

Consider what you're investing in
Whether it's a Reit or a property fund, consider the properties in each of the funds before making a decision.

“What’s very important is the asset that you are buying into,” says Hassett. “Most investors are hoping to invest in higher-quality property. What’s equally important is how the management team implement a strategy”.

For example, while the office market has started to recover, the retail and industrial sectors continue to lag.

You also might want to consider whether you want an investment that has an exposure to the residential market. Irish Life’s fund, for example, has a 53 per cent allocation to offices; 37.9 per cent to retail; and 9.1 per cent to industrial.

You’ll also need to consider whether you want a product that is fully invested or not. Aviva had a 37 per cent allocation to cash as of February, which means that if it doesn’t move to re-invest, you could be paying a premium to have a lot of your money tied up in cash.

Similarly, the Hibernia Reit is 32 per cent invested, although it has made three acquisitions since listing on the stock exchange in December.

Buy your own property
The difficulties of buying a property either yourself or in a syndicate, are manifold. Firstly, you will need extensive cash resources to do so; it's much riskier as you'll have no diversification and will be dependent on a single tenant; it could potentially be very illiquid if there are no buyers around and you have to sell; and you could be exposed to dramatic fall in values.

The upside, of course, is you get to keep all the gains, and if you buy before the end of the year and hold for seven years, you won’t have to pay capital gains tax on it.

Johnny Horgan, head of capital markets with CBRE, says there are signs of cash-rich individuals buying up properties themselves, pointing to the example of two Georgian buildings the agency recently put on the market. They attracted viewings from about 40 individual buyers, before being snapped up by one of them.

“With interest rates where they are, if you have cash it’s very attractive as an investment,” he says.

Another option is a syndicate, where investors pool their resources in a structured investment.

However, given many people’s bad experiences in highly leveraged deals – the glass bottle site in Ringsend to name possibly the most egregious example close to home – allied with the absence of debt financing, they’re not on the horizon just yet for most people.

“I don’t think there is much appetite yet for syndicates because they were a source of so much of the pain that people have gone through,” says Hassett.

Horgan agrees. “It will happen, but it’s not happening in a large way yet,” he says.