Commercial property markets are heavily cyclical, which is usually the case when there is a long lag on the supply side- rising rents and prices prompt new construction but by the time this hits the market demand may have cooled. Ireland provides a good recent example of what that means for the sector; commercial property generated a 75% investment return in the three years to end-2007, according to the MSCI index, but returns then fell by 34% in 2008 alone and by over 60% in the four years to end-2011.
The global financial crisis and plunge in Irish economic activity precipitated a collapse in property demand, with the result that the vacancy rate soared- by 2010 it had reached 24% in the Dublin office market. Bank lending , the main source of commercial property funding at the time, also collapsed, contributing to the effective absence of any commercial construction activity for four years, with 2014 seeing the first tentative signs of a pick up in supply.
By that time demand has recovered, particularly for Office space, and investors, largely foreign and non-bank, had been buying property, seeing it as cheap following a peak to trough fall in capital value of 68%. Investment returns on Irish commercial property turned positive again in 2013 (12.7%) followed by some spectacular gains in the next two years (40% and 25%). Commercial rents also started to pick up appreciably from 2013, according to the Lisney index, led by the Dublin Office market, which saw rents almost double in the three years to end-2015.
The Dublin Office market also provides a clear picture of the impact of stronger demand and little or no supply, with the level of vacant office space falling from around 9 million sq.ft in 2010 to around 3.2 million at present, according to JLL, with the vacancy rate falling below 10% for the first time in 2015.
Yet there are signs that the boom is over, at least in investment terms. 2016 returns eased to just over 12% and the Lisney index shows a sharp slowdown in Office rents in the second half of 2016, albeit less so in terms of retail , with the annual rise in the former slowing to 6% in the final quarter, from 28% in 2015. The take-up of Office space in the capital was strong, at an estimated 2.7 million sq.ft in 2016, but supply is once again responding to the price signals. Estimates vary , but it is clear that there is now a very substantial increase in construction activity in the Office sector in and around the capital. Savills, for example, put the amount of potential supply at some 10 million sq.ft. over the next three years. Some of that is pre-let, of course, and not all that is planned sees the light of day, but with a longer term average demand of less than 2 million sq.ft the potential for a supply overhang is certainly there. Demand could well be stronger, of course, and indeed may well be if Brexit results in an appreciable increase in demand for Office space in the capital. In that sense it may well be that the Irish commercial propety market now requires that boost to maintain strong returns.