Property Outlook
A Different Kind of Divergence
Real estate has had a challenging few years but seems poised to deliver healthy returns in the coming years. With interest rates falling and real estate having experienced significant negative valuation adjustments, we believe there are opportunities ahead. The asset class should also be a valuable source of diversification within a multi-asset portfolio given its differentiated characteristics compared to equities and bonds too.
Within the asset class, we expect a somewhat bifurcated market, with subsectors exhibiting a green premium and limited supply serving to boost values for such properties, whereas properties lacking such characteristics are set to trade at an increasing discount.
Property, like other asset classes, won’t be immune to the impact of policy divergence. Taking a closer look, divergence is likely to be a theme within different sectors. We expect stronger performance from well-specified, well-located assets. The green premium combined with the brown discount is set to magnify divergences, while limited supply is likely to remain a feature in a number of subsectors. On a broader level, sustainability in the property sector is something we remain focused on and committed to at ILIM, as shown by our 2024 GRESB 5 star ratings.
Office: The Largest Sector with the Largest Change
Since the onset of the Covid-19 pandemic, the Dublin office market vacancy rate has been increasing (17% in Q3 2024) as employers remain unsure of their future need for space amid evolving work patterns. Demand is increasing, however, with take up in line with the 10-year average as occupiers realise that they still need office space but may need to occupy the space in a different way amid hybrid working. As a result, we are starting to see increasing signs of investor activity picking up. Office investment activity is on track to be up by over 150% in the second half of 2024 compared to the first half.
Supply has also been suppressed in recent years, supporting prices. Availability in the prime end of the most desirable Dublin city centre market is now only 3.5%, supporting a positive outlook for true grade A space. Very limited Grade A /Grade A+ space is due for completion after 2026. This significant undersupply, coupled with rising demand, will drive prime rental growth, with 80% of occupiers targeting Grade A offices. These conditions have led to the widest gap between prime and secondary offices in working memory, creating opportunities.
We continue to see a trend of increasing ESG requirements from tenants and investors, as shown by offices with dark green credentials commanding a premium. We expect the value of brown properties relative to green ones (the ‘brown discount’) could widen further given the significant amount of capital expenditure required to bring properties up to a dark green standard. That is, the green premium could rise due to rising demand and reduced supply while the brown discount could increase as demand falls and supply remains on the market due to high upgrade costs. We expect far stronger performance from well-specified, well-located assets.
On the macro front, major central banks have started rate cutting cycles and this should be supportive. If a slower pace of cuts is realised, however, it poses risks to those in the office sector with higher leverage or closer refinancing windows.
Retail: Return of the High Street?
Retail has long been a poster child for the "death of the high street" amidst the onslaught of online shopping over the last decade or so, which was only exacerbated by the Covid-19 pandemic. Post-pandemic, the sector has found a more solid footing, with vacancy rates now at levels lower than seen in recent years.
Shoppers increasingly value the "experience" element absent from online shopping. This has been evident on a macro level with the services sector being a key growth driver across many economies post pandemic. The retail sector also has strong income returns, which is attracting investors. With both tenants and investors showing increased confidence, this has seen values stabilise and even increasing in certain pockets. Retail yields have the scope to fall and drive capital value growth as confidence in the sector grows.
However, rising costs and inflation continue to pose a tail risk to the sector, particularly the food and beverage portion of the market. This sector is facing increased operating costs and diminishing latitude to continue passing these costs on to the end consumer that is being stretched by the cost-of-living crisis.
Residential and Industrial: Parallels Amid Difference
Industrial is the traditionally poor relation of the larger, more glamorous retail and office sectors whilst residential is the new kid on the block, in an Irish market context. As the chart below shows, residential is the most keenly priced sector. The reasons for this are complex but centre around supply constraints and low vacancy.
Whilst the physical buildings could not be more different, the parallels driving investor interest are clear. Both sectors are seeing demand outstripping supply which is driving rental growth. This is the case not just in Ireland, but also in continental Europe too, where we are seeing attractive opportunities that we wrote about earlier this year.
Where they diverge, is the level of market interventions in the residential market. Ongoing application of the rental caps together with state entities investing directly in the residential market to provide a mix of social and affordable housing delivery have stalled new private investment into the sector. A new government may well look to make the rental controls currently in place more appropriate for the long term, which provides potential upside in this sector.
Investment Outlook 2025 - Property
