It’s Time For Another Look at Commercial Property

Tom Clinch
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The third quarter of 2024 looks like a watershed moment for the European commercial property market. For the first time in over two years, all the major institutional commercial property funds produced a positive return.

UK commercial property funds started falling in early 2022 and Irish and Eurozone funds followed in early 2023, as interest rates rose and post-Covid working-from-home trends began to affect retail and office property demand. The Dublin office market was also particularly hard hit by the retrenchment of big tech sector occupiers who had shown a seemingly insatiable appetite for new Grade A office space in the preceding years. Despite all these negative factors, and the doom-laden predictions of some commentators, the dip in the value of the institutional commercial property funds that we use for our clients at Clinch has been very shallow. For example, the Aviva Irish Commercial Property fund is down 1.6% since Jan 2023 and the Standard Life UK Property fund is down 3.8%.

Since 01 July 2024, the Aviva Irish Commercial Property fund is up 0.87%, the Standard Life UK Commercial Property fund is up 0.39% and the New Ireland Property fund managed by State Street, which is a mix of Irish, UK & Eurozone Property, is up 0.74%. The IPUT Irish Property fund also produced a shareholder return of 0.48% for Q3 2024.

So, what is causing this stabilisation and, why does our Investment Committee believe it is the start of a recovery if the broader economic trends continue?

  1. ECB and sterling interest rates are falling and that supports the market by making the property rental yields of c. 5% more attractive relative to cash and bonds, and by reducing the cost of debt for loan-backed investors.
  2. Retail customer footfall has found a new post-Covid equilibrium, with Grafton Street bustling and rents and values finding a floor, from which they can gradually grow along with consumer spending.
  3. The working-from-home trend has sparked a boom in online shopping, which has led to a huge increase in demand for out-of-town distribution space, and the property funds are increasing their allocation to this sector.
  4. The office sector is still adjusting to working-from-home trends and the need to improve its environmental sustainability. This is creating a two-tier market: one for top-spec Grade A property, and another for older office assets that are struggling with vacancy.  These older assets face an uncertain future that may require demolition and rebuilding as top-spec office, residential and retail property.
  5. Meanwhile, employers are upgrading their offices to attract workers back to their desk, and most employers are moving back towards 3-5 days in the office.
  6. Office vacancy is currently high in many Irish, UK and Eurozone markets, but the development cycle is slowing down just as demand appears to be improving. It seems likely, therefore, that vacancy will fall over the next 2-3 years putting upward pressure on rents, particularly for high-quality and well-located space.
  7. In all of this, it is important to remember that the property funds are not the same as the property market. Through careful property selection, prudent tenant choice and suitable renovations, they can outperform the wider market.

Over the medium term, commercial property tends to produce rental income of c. 5% per annum and capital growth of c. 2%. The asset class does require capital reinvestment and tends to be less liquid than equities, but it is also less volatile. So, it is a very useful diversifier and, if it can produce typical long-term net returns of 5% per annum over the next 3-5 years, then it is definitely worth consideration. Your portfolio manager will be happy to discuss all of the suitable options with you.

 

Tom Clinch
MD & Head of Investment Strategy

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