Surprise over foreign interest in industrials

Nigel Healy

February 15 2012 04:45 AM

Some property professionals seem surprised that foreign-based property funds could be interested in acquiring Irish industrial property in the current market.

In fact, this interest in industrials is not confined to overseas funds, but is also attracting domestic investment.

Clearly the levels of return, coupled with the potential for real rental growth, are factors.

"Rental growth!" I can hear the naysayers shout from the rooftops that rents are still falling.

Undoubtedly they have fallen and indeed very substantially -- to less than half the market peak for modern quality stock.

However, older buildings are now back to the rental values of the late 1970s to early 1980s.

But let our focus be on more modern facilities and if you accept that the rents for modern distribution facilities are at -- or close to -- the bottom of the cycle, as I do, clearly there has to be the prospect of some uplift.

Surprisingly, the take-up in industrials is higher than last year which in turn was an improvement on the year before.

Therefore given that a significant portion of the market is affected by obsolescence and take-up is increasing, albeit very modestly, it follows that supply will constrict and values will be underpinned.

On the demand side, there has been an increasing number of potential occupiers looking for larger distribution facilities in the 100,000 sq ft plus category.

There are only very few realistic options available and if they were to be absorbed, we would have a situation where existing rents cannot justify the economics of development.

I am reminded in this context of an observation made to me by a UK-based agent who was charged by his client with the task of acquiring a substantial warehouse facility. He commented that his single biggest issue was to be able to convince his client that there was simply not a vast choice available of suitable product.

So if we have established that rents are relatively low, the supply line has potential issues, within defined locations and size categories, and there is emerging demand, it is no wonder that investors, both domestic and otherwise, are beginning to consider that the environment is now right. More particularly, the current returns are competitive against other markets, attracting overseas investors to Ireland in general.

But what other attributes will the building need? Aside from modern functionality, it seems clear that funding will only be available where a long-term stable lease and covenant are on offer. This has to be the fundamental issue and if these hurdles are crossed, why would any investor have an issue?

Let us look briefly at the figures. Assuming a rent of €5.50 per sq ft and a yield of 9pc, this equates to a price of less than €59 per sq ft. Benchmark this against figures of around €200 per sq ft achieved at market peak, and it is not surprising that there is renewed interest.

If the rents were to move to, say, €6.50 per sq ft and the yield to 8pc, the capital values adjust to a little under €80 per sq ft.

And while we may not get back to the levels of 2006 for a very considerable period, if ever, the realisation that the capital values above are substantially below replacement cost must give further comfort to the investor that the long-term value of the asset is underpinned.

Overall, and reflecting on my comments above in a balanced way, I am of the view that there will be an increased level of transactions in the industrial sector and the re-establishment of it as an alternative to what was the traditionally favoured office and retail sectors.

Nigel Healy is European director, Jones Lang LaSalle