The above headline ran in the Atlantic magazine last week in the US.
Also, the Financial Times speaks of a “financial storm” bearing down on the US commercial property market. Many analysts are talking of commercial property as the biggest systemic risk in the US today and being the next shoe to drop.
Is there a read across to the Irish Property market?
Firstly how dire is the situation in America? There are a lot of factors prompting the property panic. In New York and other “super-cities”, buildings are selling for less than the value of the land they sit on. Many valuations are less in absolute terms than they were 20 years ago. Office vacancy rate is over 20%. With a third of all office leases expiring by 2026, this vacancy rate could rise. The refinancing occurs at a time when costs of doing so are at a 20 year high.
So, it’s definitely challenging.
And the issue about property in the US is how critical it is to many other sectors. Property in the US is highly inter-linked in the system and seems to be Hydra-like in its impacts elsewhere in the economy.
Property taxes underpin municipal city budgets. In New York, commercial real estate provides 16% of city’s total tax revenue. Many pension funds, public and private have been adding to commercial real estate. Some funds now have over 15% exposure. And as we know from the recent crisis, many regional banks have lending exposure to property. About 70% of all commercial property bank loans are with regional banks.
How should investors in Irish commercial property respond?
The sector has already been under pressure here, and in many of our European neighbours. A typical fund of listed European real estate is off about 18% in the past 12 months. As with the US, we all face many of the well-rehearsed challenges – struggles through Covid, disruption with hybrid work practices and rising interest rates.
It is worthwhile to take pulse of Irish commercial property.
A typical institutional property portfolio will consist of, in ascending importance, logistics, retail and office.
Logistics typically means warehouses and transport hubs. Today this sector is characterised by solid demand, long term leases, low vacancy rates and good visibility. We have seen rents move up as retail, aided somewhat by the pandemic, has seen the trends to on-line continue.
Retail itself, has seen the highest share of investor activity so far this year. Volumes and footfall are up and we are beyond pre-pandemic levels. Those parts of the retail market that need that “face to face” option are doing well. Vacancy rates are still high at around 13% for Dublin city centre. Some locations on Henry Street have seen a 14% increase in rent! But a lot of café-type retail, dependent on office occupancy, is challenged.
The bulk of commercial property investment is in offices. Today this is the sector of maximum change, maximum risk and maybe maximum opportunity. The office sector is intensely impacted by one of the major consequences of the pandemic – WFH (working from home).
While rising interest rates or economic growth are typical issues to consider in analysing property trends, WFH is new, unique and revolutionary.
And we don’t know how it ends.
For some it’s a matter of time, and like the Nike “swoosh”, after the sharp fall, over time we see a pick up in office attendees. Many companies are now looking to limit WFH absences or issue return to work mandates.
Others, such as the consultants McKinsey, say hybrid working is here to stay and that office attendances are stabilising at 30% below pre-pandemic norms. It is hard to see the genie going fully back into the bottle.
But it’s clear Office Property has not caught up with this change in behaviour.
New York city has lost 5% of its urban core residents in the past two years. Footfall in many CBDs in US and Europe is down 20%. McKinsey estimate on modest assumptions that demand for office space in 2030 will be 13% lower than today.
Already Dublin is seeing changes. There are examples of massive remodelling within existing structures, changing how space is used. We have also seem companies simply relocate to smaller spaces. Buildings may need to be aligned more specifically with the culture of the occupier company, and indeed with the local community. The good news on this front is that we clearly have the skills as evidenced by IPUT’s award winning Tropical Fruit Warehouse project where art, culture, and sustainability all shine through an office space.
It’s hard to see a clear picture as activity has been subdued so far. Vacancy rates across all offices is about 14%.
Is it a US level risk? We are probably less exposed to knock on effects such as bank exposure, tax dependence and pension fund allocation. A consensus pension fund here has under 4% exposure to property compared to that 15% exposure in the US.
But of the sectors within a property portfolio, Office looks the most uncertain – and probably with the greatest distance to travel.
Tradewinds 