Business Irish

Saturday 21 October 2017

Real estate is becoming better defensive investment than state bonds or equities

Sean O'Brien

THE case for investing in commercial real estate is now being further augmented by its risk/reward profile, diversification benefits and pricing.

At a time of great economic uncertainty, commercial real estate offers defensive characteristics not available from equities and bonds.

As a physical asset that also earns income, even in the most extreme cases, an investor in real estate would not experience a total loss.

The experience of the Lehman collapse provides a clear example of this. In contrast, it is unlikely that bondholders or shareholders will get a substantial return from the winding up process.

Even senior bondholders are expected to see a return of less than 25c on the dollar.

Contrast this with the position of the former owners of Lehman's UK headquarters. The administrator continued to pay most of the rent while the European operations were being transferred to Nomura, with Lehman's sub-tenants in the building providing additional security of income.

Subsequently, the building itself was sold to JP Morgan for £495 million.

In terms of the Irish market over the last five years, investors would have been better off owning the buildings occupied by the banks rather than shares in the banks themselves.

At times of high uncertainty and volatility in the capital markets generally, this is a valuable quality.

This is evident from the chart above left showing the relative performance of commercial property versus Irish financial shares.

Real estate displays the main features of both bonds and equities. Like bonds it offers a relatively predictable income stream, while at the same time offering the potential for capital growth (and the opposite!) akin to equities.

However, it is the rental income that is the main driver of real estate performance and also underpins its defensive capacity.

This can clearly be seen from the long term IPD figures of rental income and capital growth and loss.

Over the long run, the income return from Irish commercial real estate has been 6.7pc a year, while capital growth has returned just 2.2pc per annum.

Furthermore, the volatility of the income return is extremely low compared to the wide fluctuations in capital value.

Therefore, real estate should be looked upon as a primarily income-producing asset with the potential for modest capital growth over the long term.

Additionally, the yield on Irish commercial real estate is at a historic high and is also significantly higher than those achievable in virtually every other international market.

Based on IPD's institutional Irish property portfolio, the IPD Index shows Q1 equivalent yields at 9pc for Irish offices, which are an all time high and 8.9pc for all property, which is also at a high.

CBRE's own records indicate that Irish yields have strengthened in recent weeks and yields for prime Dublin central business district offices have tightened to 7pc from 7.25pc earlier this year and from their high last year of 7.5pc.

This analysis indicates a strong case for investment in Irish commercial real estate on both defensive and pricing grounds.

Of course, real estate is very asset-specific, and the features of individual properties can enhance or erode its fundamental attraction.

Sean O'Brien is head of capital markets in CBRE Dublin.

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